Small Business Loans

Small business loans are used for business expenses. While some loans are for general business funding, other small business loans are for specific uses, such as working capital, commercial mortgage, or the purchase of new equipment or furniture.

Types of Small Business Loans

Term loans. A business term loan offers a lump sum with a fixed term and repayment amount. With each payment, you’ll pay the principal and interest.

Business lines of credit. Business lines of credit are very similar to credit cards and offer a lot of flexibility. With a business line of credit, a lender approves you for a revolving line of credit with a maximum limit you can borrow. Similar to credit cards, you’ll be charged interest for the amount of money you draw, not on the maximum limit.

You can access your line of credit for any of your business needs, whether it’s to purchase inventory or equipment, invest in marketing or manage fluctuations from seasonal sales. As long as you make the minimum payments and don’t go over your limit, you can use your line of credit and repay what you borrowed for as long as you like.

Equipment loans. Equipment loans can be used to purchase and spread out the cost of a large piece of machinery or equipment for your business. The down payment can be up to 20%, but some loans may be available with no down payment. Usually, the equipment serves as collateral for the loan. Instead of taking out a loan, you may also have the option to lease equipment.

Invoice financing. If your small business struggles with cash flow issues because you’re waiting on invoices to be paid, you can use invoice financing, also known as factoring. With invoice factoring, you sell your unpaid invoices to a lender at a discount. The lender will provide you with the majority of the amount owed on the invoice upfront and hold a portion of the outstanding amount (usually 20%) until the invoice is paid.

You should carefully weigh the costs when considering invoice financing. There is a fee that is based on a percentage of the invoice, plus interest charged on the cash advance.

Merchant cash advances. If you need cash immediately, a merchant cash advance can provide access to capital. With a merchant cash advance, the lender provides you with a lump sum of cash in exchange for a portion of your future sales.You’re responsible for paying the amount of the loan plus fees.

You repay the advance with either a portion of your future credit and debit card sales, or with fixed daily or weekly transfers from your bank account. Your fee is determined by a risk assessment, with lower fees for lower-risk borrowers. Because of the high interest rates which can be in the triple digits, merchant cash advances are not recommended.

Commercial mortgage loans. The money borrowed from a commercial mortgage loan is used to buy, develop or refinance commercial property such as a warehouse, mixed-use building or retail center.

Franchise loans. If you want to purchase or expand a franchise, a franchise loan can help you pay for it. Franchise loans can be used for standard business opening expenses and franchise-specific expenses such as marketing fees or the franchise fee, which is paid upfront to open a franchise. While you can finance a franchise with a traditional term loan, some lenders that offer loans specifically for franchises. Some franchisors may offer funding to help you establish your franchise.

SBA Loan Guarantees

The Small Business Administration, a government agency that offers support and resources to small businesses, offers guarantees for loans. These SBA-backed loans were created by the SBA to help small businesses and startups, and are executed by commercial lenders who are approved by the SBA. With 7(a) loans, the SBA’s primary lending program, the SBA guarantees up to 85% of loans up to $150,000 and up to 75% of loans over that amount, so there is reduced risk to the lender. The SBA doesn’t directly offer the loan, only the guarantee. There are four types of SBA-backed loans:

7(a) loan program. The SBA’s primary lending program, 7(a) loans are the most common, flexible and simple type of SBA loan.

Loans under the7(a) program can be used for many different purposes, including toward working capital, construction of new buildings, renovations, establishing new businesses, the expansion of existing businesses and debt refinancing. There are restrictions, such as not using the money to pay back an owner for money they’ve already put into their business.

There are also special types of 7(a) loans to provide financial assistance for businesses with short-term capital needs, for businesses affected by NAFTA and to help with employee stock ownership plans.

There is an Express Loan Program where you will receive a response within 36 hours of submitting an application. The maximum loan amount is $350,000 and the SBA provides a 50% guarantee for loans granted through this program.

Loans of up to $5 million are available and are typically repaid in monthly installments. You can apply through a participating lender. The loan maturity depends on how the money is used but typically ranges from five to 25 years.

Microloan program. New or expanding small businesses are eligible to receive loans up to $50,000. These loans can be used for working capital or purchasing inventory, equipment, furniture, supplies or machinery. Microloans can’t be used to pay existing debts or purchase real estate.

The SBA makes funds available to designated intermediary lenders, which are nonprofits with demonstrated experience in lending and assisting others in business management. The maximum repayment term is six years, and the loan repayment terms vary according to several factors, including the loan amount, planned use of funds, the intermediary lender’s requirements and the small business borrower’s needs.

Real estate and equipment loans. The CDC/504 loan program provides businesses with long-term, fixed-rate financing for major assets such as real estate and equipment. These loans are provided by a Certified Development Company, which is a nonprofit corporation that helps with the economic development of its community.

Funds from a 504 loan can be used to purchase existing buildings, land or long-term machinery, to construct or renovate facilities, or to refinance debt in connection with an expansion of the business. These loans cannot be used for working capital or inventory. The typical 504 loan includes a 50% non guaranteed loan secured from a private-sector lender; a 40% loan secured by the CDC, which is 100% backed by the SBA; and a 10% equity contribution from the borrower. The maximum amount of a 504 loan is $5.5 million, and these loans are available with 10- or 20-year maturity terms.

Disaster loans. These low-interest loans can be used to repair or replace real estate, machinery and equipment, and inventory and business assets that were damaged or destroyed in a declared disaster. The SBA offers disaster loans of up to $2 million to qualified businesses and includes assistance in both economic injury and physical damage.

Types of Small Business Lenders

Banks and credit unions. Banks and credit unions typically serve larger, more well-established businesses, including those that are categorized as small businesses. The APRs, terms and length of loans offered by banks and credit unions may vary, but rates on commercial and industrial bank loans have remained below 5% since 2009, according to the U.S. Small Business Administration.

If you’re having trouble getting approved for a small business loan through a big bank, you’re in good company. According to the NSBA report, only 15% of small businesses received a loan through a large bank.

You’ll have a better chance of getting a loan from a traditional bank with an SBA-backed loan. While SBA loans have more requirements for approval, they reduce the risk for the lender and can make it easier to get approved for a small business loan.

Alternative lenders. “Small businesses should be aware there are multiple channels available for borrowing needed funds,” says S. Michael Sury, lecturer of finance at the University of Texas at Austin. “There is a cottage industry full of private investors, hedge funds and private equity firms that have entered the direct lending business.”

Alternative lenders can be more flexible than commercial banks, as they have less regulation on the types of loans they can make.

There are two categories of alternative lenders:

Direct lenders. Direct lenders are finance companies that fund your loan with capital other than a bank and without a middleman such as a broker, investment bank or private equity firm. Some direct lenders offer SBA loans. Typically, small to midsize businesses borrow from direct lenders.

Peer-to-peer lenders. Online peer-to-peer lending directly connects you with investors who usually have a diversified loan portfolio made up of small portions of loans. A loan is often divided among several investors.

Borrowing criteria is usually less stringent than at traditional brick-and-mortar banks. Alternative lenders provide loans to borrowers who otherwise may not have access to financing, such as startups or businesses with a shaky financial history.

Because financing through a P2P marketplace poses a larger risk to lenders, the interest rates are often higher. Interest rates vary, but alternative loan products can have annual rates from 15% for a 36-month P2P loan and up to 45% for a four-month institutionally backed loan, according to the U.S. SBA. This is compared with an interest rate of less than 5% for industrial and commercial bank loans.