Most entrepreneurs will need a cash injection at some point. Money is available, but the many different loan programs fund specific functions. Until you understand your needs and what type of business loan you qualify for, you might make costly errors or just give up in frustration.
The first step is understanding the types of financing for business. Here is a brief introduction to the common types of business loans:
Business Loan Starting Point
Determining the term and collateral requirements is your business loan starting point. The time it takes for funding will vary depending on the program. So will the term, interest rate and whether the you must secure the type of business loan you want. Lenders will almost always require collateral when inventory or capital assets are involved.
Security (Collateral) for Loan
- Secured – Using company or personal assets as collateral.
- Unsecured – Loan based only on creditworthiness of borrower. (Obviously harder to obtain an unsecured loan.)
Term of Business Loan
- Short Term – Generally one year or less, for amounts less than $100,000. Often repaid in a lump sum at the end of the term, instead of monthly.
- Long Term – Generally one to seven years. The most common general purpose loan. Long term loans are almost always secured with collateral of whatever is purchased. They are usually repaid monthly over a term based on the lifespan of the assets.
Types of Business Loans
The types of businesses and their needs vary widely. Loans are tailored specifically. You may seek financing from private sources, or commercial lenders.
Peer to Peer Loans – Borrower receives a business loan from an individual rather than a lending institution. This might be family, friend, “angel investor”, business associate, etc.
Startup Loans – Loans to small businesses from private sector lenders.
Business Acquisitions – Loans to acquire an existing business.
Microloans – Certain non-profit organizations offer loans up to $35,000.00 in specific counties. They help certain types of entrepreneurs, such as women or minorities, who have credit challenges. Microlenders provide training and technical assistance to the business owners.
Revolving Lines of Credit – A designated amount of credit (usually based upon existing inventory or accounts receivable). The line “revolves,” allowing the amount to be borrowed again upon repayment. Occasionally unsecured, based upon business credit worthiness.
Equipment Financing – Business Loan to purchase equipment. The equipment is used as collateral.
Construction Financing – Loans for commercial construction.
Equipment Cashout Refinance – A loan to get cash for existing equipment, which is then leased back from the lender. Value for the lease is approximately 50 – 75% of vendor’s valuation.
Working Capital Loan – A loan to finance everyday operations of a business.
Professional Loans – Tailored for accountants, doctors, dentists, and lawyers.
Franchise Startup Loans – Specialized financing for investing in established, nationally known franchises. Borrowers are required to invest 10 – 30% of the capital needed to open the franchise outlet.
Accounts Receivable Factoring – Generally used for short term working capital loans. Invoices are sold to a third party for a small fee (3% to 5% of the receivables). Typically, the factoring company will provide 80% of the invoice value upfront, and the balance after the customers pay.
Credit Card Advance, also called Merchant Cash Advance – If you’ve been in business for three or more years, credit card sales are a good estimation of future earnings. You may be able to take a Merchant Cash Advance business loan based on anticipated credit card sales.
Hard Money Equity Loan – Hard money lenders may provide funds to those who have trouble qualifying for a business loan from a local bank. Secured hard money equity loans usually have much higher interest rates and shorter terms.
To make the process more confusing, there is no universal application form. Every business loan application you submit will be listed on your credit record. If one application is declined, the next lender will see it. So you want to get it right the first time.
Take a few basic steps before starting the complex business loan application process. Prepare early by getting your business plan and financial information organized to bolster your chance of approval.