As a small business owner, you know that having access to affordable financing is generally crucial for the success and growth of your company. However, with so many different types of small business loans available, it may be challenging to determine which one is the best fit. Here are some tips to help you choose the right type of small business loan for your unique business.
Why business loans are important
From working capital to debt refinance, funds from the right business loan can keep your business humming along. It may sound counter intuitive to take on debt. However, the right funding may strengthen business operations and help you reach your goals. If you use low cost funding to refinance expensive debt, you may even save money and protect your cash flow. Reasons to go the funding route include:
- You're in control
If you have investors who provide capital, they typically want a say in how the business is operated. When you take out a loan from a bank or alternative lender, you generally maintain control over operations and profits.
- Fast funding
Going the investor route may take lots of time. With online lending platforms, receiving money from a bank or online lender is much faster.
- Lower interest rates
The interest rates for loans are generally lower than for credit cards or other financing. Your credit score is key to low rates and long terms so it is typically a good idea to strive to keep your scores high.
Identify your needs
The first step in choosing a small business loan is to understand what your business needs the financing for. Do you need the money to invest in growth, manage cash flow, or take advantage of a new opportunity? Debt refinance is generally another smart way to use a business loan, helping to free up cash flow so you can fund more pressing business matters. Knowing what you need the loan for will typically help you narrow down your options and find the right loan type.
Review your credit score
Your credit score is a key factor in determining the terms and rates of any loan you take out. Before applying for a small business loan, review your credit score and take steps to improve it if necessary. A higher credit score will make it easier to secure a loan with better terms and rates. For example, to qualify for an SBA loan from a bank in the SmartBiz® network, the business owner's personal credit score must be above 650.
The SmartBiz blog has lots of resources to help you improve your credit scores. Start with this article to learn more: 7 Essential Habits to Achieve a Great Credit Score.
Consider the loan amount
Consider the amount of money you need to help you determine the type of loan that is most appropriate for your business. If you need a small amount of money to cover short-term expenses or to purchase equipment, a short-term loan or line of credit may be the best option. On the other hand, if you need a large amount of money to expand your business or make a major purchase, a long-term loan may be more appropriate. For example, the popular SBA 7(a) loans have amounts up to $350,000 available for qualified businesses.
Take time to look at your business plan and current financial situation before you settle on a loan amount. Not being clear on how much your business needs may stop the loan process in its tracks. Ideally, work with your accountant or another financial professional to help crunch the numbers.
Review the repayment terms
Finally, consider the repayment terms of the loan. This includes the interest rate, repayment schedule, and any fees or charges associated with the loan. It’s important to choose a loan that is manageable for your business, so be sure to carefully review all the terms and conditions before signing on the dotted line. You should be comfortable that you can make all payments on time for the life of the loan.
Once you’ve addressed the questions and considerations above, it’s time to choose the loan that’s right for you. Below are three common types of funding available for small businesses.
- Small Business Administration (SBA) loans
The SBA is a federal agency that provides financial assistance to small businesses through a network of approved lenders. SBA loans are typically easier to qualify for than traditional bank loans, and they often come with longer repayment terms and lower interest rates. However, the application process may be lengthy and SBA loans are generally only available to businesses that meet certain criteria and are in good financial shape. Learn more about this popular funding option on the SmartBiz website.
- Bank term loans
Bank term loans are offered by banks and credit unions, and typically require collateral, such as real estate or equipment, as well as a strong credit score. You may need to produce a well-defined business plan. Bank term loans are often the best option for small businesses that have been in operation for at least a few years and have a strong track record of profitability. Learn more about bank term loans available from banks in the SmartBiz network here.
- Business line of credit
A business line of credit is a revolving line you can draw against as you need it, meaning that you only pay for the money that you use. Lines of credit may be extended by a large traditional bank, a small local bank, or an alternative online lender. The use of funds is flexible, there are no set monthly payments, and no interest is charged on the unused money in the account. When you repay a borrowed amount, those funds are typically immediately available again.
Although taking on a loan might sound intimidating, getting the right loan at the right time may help your business flourish. Check out our blog post on how a small business loan can help spark growth: The Benefits of Long-Term Debt for Your Small Business.