If you are a growing company, there are many reasons why a opting for a small business loan could prove a savvy decision; offering you a cash injection when you really need one. But without the necessary knowledge, comparing small business loans and the range of business finance related products available on the market can be a minefield for small business owners, with varying costs, terms and uses for each product. So in this article we run you through 12 types of small business loans, helping you to settle on the right package for your business.
- Comparing small business loans
- Short term business loans
- Long term business loans
- Secured business loans
- Unsecured business loans
- Merchant cash advances or business cash advances
- Bad credit business loans
- Debt consolidation business loans
- Start up business loans
- Business lines of credit
- Equipment financing
- Working capital loans
- Peer to peer loans for business
- What's right for you?
Comparing small business loans
A small business loan refers to a financial product in which a lender provides a loan to a small business. Depending on the type, small business loans can obligate the borrower to meet a range of requirements and can be taken out for various purposes.
Here we look at the 12 main small business loan types including short term loans, long term loans, secured business loans, unsecured business loans, merchant cash advances, bad credit business loans, debt consolidation business loans, start up business loans, business lines of credit, equipment financing, working capital loans, and peer to peer loans. We confirm the definition of each loan, before covering their advantages, disadvantages, and which businesses they might be most suitable for.
Short term business loans
A short term loan provides small businesses with quick working capital, in the form of a cash lump sum upfront. The borrower then repays the lender over an agreed period of time. This repayment period can last for anything from one month up to four years.
Short term loans offer growing businesses the advantage of a cash injection when it is needed, making up for a lack of funding, or easing the strain on a company’s cash flow. Companies can also benefit from the ability to plan ahead, knowing how much their repayment instalments will be each month. In some cases, a company can opt for a repayment plan which is revenue based and linked to their turnover. The main disadvantage of short term business loans are the relatively high interest rates – from four per cent up to 99 per cent for some online loan packages.
Long term business loans
Long term business loans offer SMEs the option of repaying the lump sum which they borrow over several years. Because immediate large repayments are not a concern, long term loans offer the business owner the chance to take care of any larger expenses which might need addressing. These expenses could be a significant investment, an internal expansion, a new product or a marketing campaign. While they offer lower repayments than short term loans, long term loans are typically harder to qualify for, requiring strong business credentials. This can make the application for a long term business loan more lengthy than for short term options. In general, lenders can expect borrowers to have been in business for three years or more and already be generating a sizable annual revenue. For established businesses focused on maintaining growth over the long term, long term loans can be a good fit. Interest rates are typically lower in comparison to short term business loans.
Secured business loans
Secured business loans are a financial product which allows the borrower to obtain a higher value cash lump sum by offering an asset as security against the loan. This is typically a business asset such as land or property. The loan can be secured against one or several of the assets. In the scenario that the borrower ceases to make repayments during the repayment period, the lender may have the right to claim the assets which have been used to secure the loan. Businesses with the right credentials can benefit from the longer repayment periods and higher cash sums which this financial product can provide.
Small businesses which don’t have a large inventory or collection of assets can have trouble accessing secured business loans. The forfeiting of assets due to inability to repay can be critical for a growing firm. Established businesses looking for lower interest rates can be suited to long term business loans, which can offer reduced rates due to the additional collateral of the secured assets.
Unsecured business loans
Unsecured business loans are financial products which do not require any business assets to be used as collateral – i.e. the securing of the loan. This arrangement attaches a higher element of risk for the lender, and is recognised as the reason why interest rates are typically higher. By opting for an unsecured loan, SMEs can take peace of mind that their assets are not risked, and that the value of the loan is not linked to the value of an asset or collection of assets. There is also typically a faster application process than for secured loans, and the advantage of being able to build up a positive credit history, improving a business owners chances of obtaining other loans in the future. On the other hand, you can expect a tighter repayment schedule than with secured loans, as well as smaller loan values and higher interest rates.
Merchant cash advances or business cash advances
One of the most innovative and effective financial products to come on the market in recent times are merchant cash advances. A merchant cash advance uses a card terminal as an asset to secure lending, taking repayments as a proportion of revenue through transactions. Because of the nature of the arrangement, merchant cash advances are especially suitable for businesses in the leisure sector and those in the retail industry. For SMEs operating in the relevant business spaces, a merchant cash advance can offer many advantages when compared to other types of small business loans. They provide quick access to a cash boost, and no fixed monthly instalments to worry about. There is also the possibility of taking out a merchant cash advance even if you have a poor credit history. A merchant cash advance can free you up to use other finance methods. So if you have already taken out a secured business loan, you could use a merchant cash advance for a more consistent cash flow.
Bad credit business loans
As the name suggests, bad credit business loans are financial products which are specifically designed for small businesses that have a poor credit rating. They are offered by alternative lenders who can offer funding solutions for those with bad credit ratings, subject to them having the right criteria in relation to their revenue, business strength and potential. Bad credit business loans can offer smaller companies fast access to cash, a range of options for securing the loan, and the opportunity to repair a poor credit rating. However, it should be noted that borrowers could be subject to automatic withdrawals, multiple fees and higher interest rates when compared to other types of small business loans detailed in this article.
Debt consolidation business loans
The best debt consolidation business loans provide a way for small businesses to manage their debt in a more organised manner, helping them to progress as an organisation.
They are able to consolidate existing debts into one single loan by refinancing them, while also lowering the size of repayments which must be made. This can all go towards repairing a poor credit rating in the long term, once you get back on track with your repayments. It works by the debt consolidation business loan provider negotiating with your creditors to secure a lower interest rate.
This reduced interest rate is seen as perhaps the biggest advantage for businesses looking to manage several debts. Among the disadvantages of debt consolidation business loans is that there can be severe consequences should you miss one of your repayments, including the possibility of significantly increased interest rates.
Start up business loans
Even if you have no business history to speak of, SMEs are still able to raise finance through a small business loan. Start up business loans are a financial product which is designed specifically for firms in the embryonic stages of their development. Among the type of small business loans which fall under this category are SBA microloans and business grants.
These loans offers start ups accessibility to funding which can be crucial in the early stages, as well as the convenience which comes with a loan from a bank, rather than from an outside investor. With start up business loans, owners of start ups also have the advantage of keeping full ownership of their firm. This is opposed to deals which are struck with venture capital and angel investors, who can take a share of an SMEs ownership in exchange for the financing which they provide. Potential disadvantages include a long application process and difficulty gaining approval. Interest rates for start up business loans are considered low compared to those from private equity lenders.
Business lines of credit
A business line of credit differs from the typical structure of a small business loan. That’s because they offer the borrower the option of credit up to a certain limit – let’s say £50,000. Under that arrangement, the company will pay interest only on what it borrows, rather than the full value of the credit limit which has been agreed. In this respect, a business line of credit is similar to a credit card. Business lines of credit are valued by SMEs for their flexibility. They typically do not need to provide a reason for applying – unlike common small business loans – and don’t have to be used at all. This means an SME owner could keep the funds available for emergencies or to cover unforeseen outgoings. There is also the potential of an improved credit rating for small businesses who use their lines of credit carefully and responsibly.
Among the potential disadvantages of business lines of credit are high fees for maintenance and withdrawals, as well as the possibility that a business could spend all the available funds and be saddled with a debt which they cannot repay due to challenging circumstances.
For SMEs who want to purchase physical assets for their company – from company cars to new IT equipment – equipment financing can be a savvy solution. Under this financial arrangement, a loan is used for the specific purchase of physical assets for the business. Benefits include a cash injection which can allow vital equipment to be bought, that would not have been afforded otherwise. That means broken equipment can be replaced, and that there is no waiting involved – equipment can be bought immediately. For companies whose equipment is vital to their day to day running, being able to access new equipment can be critical to the bottom line. With equipment financing, the cost of the purchase can be spread over the repayment schedule, and no additional collateral, such as business assets, are typically needed for securing against the financing deal. SMEs should note the disadvantages of equipment financing arrangements is that they are restricted purely to equipment, and can offer higher interest rates than more traditional small business loans.
Working capital loans
When a business requires cash to cover their operational costs in the short term, a working capital loan can prove the best option. They are taken out specifically for the purpose of financing the everyday operations of a company, and are not for the use of investments or long term assets. The primary advantage of working capital loans is that you can rectify cash flow problems quickly and minimise disruption to business operations. You won’t need to worry about giving up a share of your business to the lender, and you won’t necessarily have to secure the loan using your business assets. There is the option of paying back a working capital loan quickly, negating the need to budget for a repayment schedule over the long term. There are also typically few restrictions on what the money can be spent on. Potential downsides include the possibility that the loan must be secured against collateral, that the loan might have a negative impact on your credit rating in the short term, and the possible tight time frame for repayment. If you take out an unsecured loan, this could pose the issue of higher interest rates compared to a secured option.
Peer to peer loans for business
A peer to peer loan involves borrowing from other individuals, rather than a financial institution as such. This offers the ability to cut out the middle man; and can provide small businesses with the advantage of better deals than they might expect from traditional lenders. There are plenty of incentives for peer to peer lenders, such as tax-free interests in the UK. Peer to peer loans are commonly arranged online, and have increased in popularity during the digital era. Among the other benefits is the easier approval which business owners can enjoy for peer to peer loans, as well as the advantage of a quicker application process which can be as short as a day. Disadvantages include potentially high interest rates for SME owners with a bad credit rating, and complications if repayments are missed. Taking out P2P loans for the purposes of consolidating debts can backfire if outgoings are out of control.
What's right for you?
Ultimately, the loan which you choose will be dictated by the short, and long term objectives of your business. Each loan has its advantages, but there is no doubt that we have seen a new wave of innovative loan type arrangements which can be game changers for small businesses. These can include the merchant cash advance, which takes the stress out of loans for retailers and leisure outlets in so many ways. Gone are the fixed monthly payments, which business owners can be saddled with no matter how their business performs any given month, and in is a new flexible payment plan that means businesses only pay a fixed percentage of their card sales. Meaning repayments are directly linked to the performance of the business.
Could we witness an increase in these more flexible types of small business loan arrangements?
Perhaps, but for now, the importance of more traditional short and medium term business loans for small businesses should not be dismissed. From working capital loans which can get firms out of a hole quickly, to secured loans and debt consolidation loans which put companies back on the road to financial independence – they all have their value, and their uses. As always, it can be vital to create realistic financial plans and stick to them. And if you are still not sure which is the best small business loan for you, don’t be afraid to call on the help of a professional financial advisor.
Capify is a leading provider of merchant cash advances. Even if you have a poor credit rating, we are dedicated to finding workable solutions for our customers.
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