Many types of loans are available for borrowers seeking financial assistance for working capital, real estate purchases, and other significant expenditures. However, not every type of small business loan offers the level of support your business might need to thrive. The below guide to several common financing options can help you determine which loan is the best fit for your small business ventures.
Which Loan Is Best for a Small Business? 8 Kinds of Loans
It can feel overwhelming to learn all the ins and outs of the various loan types available to your business. That’s even truer when you factor in the additional requirements that each small business lender might impose. The list below highlights the differences between each loan package, and you can use what you learn to help you determine which loan best suits your business.
1. Business Line of Credit
Business lines of credit are financing options that allow you to borrow up to a maximum amount set during the application process. You can draw as much or as little as you need from this revolving credit line – you’ll only pay fees on the money you use. That said, a line of credit typically won’t provide enough funding for significant expenses, though it can help cover payroll and small emergency purchases.
- Loan amount: $1,000 to $250,000
- Loan term: Generally, a short-term line of credit has repayment terms of a year or less. A long-term credit has repayment terms of longer than a year.
- Acceptable loan uses: Managing cash flow issues and covering payroll and unexpected business-related expenses.
- Qualification criteria: A minimum credit score of 500 and minimum business experience of six months.
- Extra funding is available whenever you need it.
- You’ll only have to pay off the funds you use.
- You can more easily keep cash flowing during periods of higher expenses or lower income.
- Properly paying off your credit line can help you build your business credit in the long run.
- You’ll often pay interest rates higher than with other small business loans.
- You might need a larger loan amount for certain growth initiatives.
- Depending on the lender, you may incur additional fees.
2. SBA Loans
The U.S. Small Business Administration (SBA) partners with lenders to back loans designed to fund small businesses. While the agency doesn’t provide funding itself, its backing can minimize risk for banks that might not otherwise offer small business funding. The result of this arrangement is SBA loans, which include highly sought-after SBA 7(a) loans. These loans are often cited as the best financing option for any small business that qualifies. Key facts and figures about them are below.
- Loan amount: $30,000 to $5,000,000
- Interest rate: 6.25% - 8.50% for debt consolidation or working capital loans
- Loan term: 10 to 25 years
- Acceptable loan uses: You can use an SBA 7(a) loan for debt consolidation, working capital, or commercial real estate purchases. Other SBA loans may have different acceptable loan uses.
- Qualification criteria
- A minimum personal credit score of around 650 (or 675 for commercial real estate loans)
- Minimum two years of business experience
- No delinquencies or defaults on government loans
- No outstanding tax liens
- No bankruptcies or foreclosures within past three years
- U.S. citizenship or permanent resident status
- Interests rates are typically low
- Long repayment terms put minimal financial strain on your business
- Various use cases
- Borrowers are carefully vetted, so the application process can be lengthy
- Stringent prerequisites for eligibility
- Can require collateral that introduces risk
*Interest rates are reflective of the prime rate of 6.25% - 8.50% – subject to change based on Fed.
Microloans are a type of small business loan designed to help startups or similarly sized companies. These companies may not need as much money to support everyday operations. That’s why microloan amounts don’t generally exceed $50,000.
- Loan amount: Up to $50,000, with an average of around $14,000 approved in 2017
- Interest rate: 8% to 13%
- Loan term: At most six years.
- Acceptable loan uses: You can use a microloan for most business expenses, including equipment, fixtures, and working capital. You can’t use a microloan to refinance existing debt or buy commercial real estate.
- Qualification criteria
- A minimum credit score of 575
- Prior financial history that demonstrates the ability to repay loans going forward
- Collateral or a personal guarantee
- Microloan funds can be distributed in approximately one month.
- Microloans are accessible to various business owners.
- Microloans have lower interest rates than many other financing options.
- Although microloan funds are disbursed quickly, the approval process can still be lengthy.
- Microloans restrict your spending to expenses – debt refinancing and commercial real estate purchases are not allowed.
- Eligibility requirements may vary among lenders.
4. Same-Day Funding
Your business may find itself in a situation where it needs an immediate influx of capital. Same-day funding loan plans offer this relief with terms that provide business owners money soon after they qualify. There are several types of same-day funding loans, and each can help keep a business afloat in dire financial situations.
- Loan amount: Depends on the lender. Typical loan amounts range from $1,000 to $50,000.
- Loan term: 12 to 60 months
- Acceptable loan uses: Depending on the lender, make sure you’re able to use the funds to meet your business goals.
- Qualification criteria: Vary by lender, but typically modest
- Same-day loans are made to accommodate borrowers with bad credit, so you can easily qualify for them.
- Funds are wired directly into your checking account shortly after qualifying for a loan, making same-day funding perfect for emergencies.
- Fast application process.
- High interest rates and short repayment terms can make it challenging to pay off a same-day loan.
- Same-day loans are generally geared toward personal rather than business use.
5. Term Loans
Term loans are traditional financing options that you’ll typically access through a bank. These loans require regular repayments at a fixed interest rate to pay off a one-time lump sum of added capital. They’re often the next-best option if you aren’t eligible for an SBA 7(a) loan.
- Loan amount: $25,000 to $500,000
- Loan term: Two to five years for a short-term loan or 10 years for a long-term loan
- Acceptable loan uses: You can use term loans for most business expenditures, including marketing, inventory, equipment, and payroll. Debt refinancing and business acquisitions are also allowed.
- Qualification criteria:
- A high credit score (the exact number may vary by lender)
- Minimum business experience of two years
- Collateral, in most cases
- The predictable payment schedule and fixed interest rate mean no guesswork on when payment is due and in what amount.
- Long-term loans typically have lower interest rates than most other financing options.
- Short-term loans may be easier to qualify for than SBA 7(a) loans.
- Term loan payment schedules are inflexible. Borrowers are expected to make payments on or before the due date regardless of whether or not they have the money.
- Qualifying for a term loan can be tough.
- Strict borrower criteria can cause lengthy processing times for applications, particularly for long-term loans.
6. Equipment financing
Equipment financing is a lump-sum loan you can use to buy business machinery. The equipment you buy acts as collateral for the loan and can be seized if you default. This type of financing is best for borrowers who need new equipment but don’t want to use their own assets as collateral.
- Loan amount: $10,000 to $500,000
- Interest rate: Fixed interest rate of 7.99% to 24.99%
- Loan term: Two to five years
- Acceptable loan uses: Equipment purchases only
- Qualification criteria: A minimum credit score of 550, plus other criteria that may vary by lender
- Equipment loans are often quicker to process than traditional loan plans.
- It’s typically easier to qualify for an equipment loan since the purchased equipment is the collateral.
- Equipment loans can help spread the cost of large equipment purchases over a long period.
- Your monthly payments could exceed the revenue your new equipment brings in.
- Your funds can only be used for equipment purchases.
7. Merchant cash advances
A merchant cash advance is a lump-sum payment you receive from a credit card processor. Afterward, the processor automatically deducts a portion of your loan from your daily credit and debit card income until your debt is repaid. A merchant cash advance loan is suitable for borrowers in search of hands-off repayment, but it comes with tremendous downsides.
- Loan amount: $5,000 to $500,000
- APR: 40% to 350%
- Loan term: Four to 18 months
- Acceptable loan uses: Merchant cash advances lack use restrictions, but small business owners typically use them during periods of financial struggle.
- Qualification criteria:
- Enough credit card business volume to support automatic repayment
- Minimum revenue of amounts that vary by lender
- Minimum time in business that varies by lender
- Fast application process
- Low barrier to entry
- Takes only a few days for funds to reach your checking account
- While good for emergencies, merchant cash advances often come with sky-high interest rates, which can quickly prove too expensive.
- Your payments are often a daily portion of your credit and debit card sales, so you have little control over outgoing cash.
- Merchant cash advances may well be the most expensive financing option available.
8. Online alternative lenders
Alternative lenders are private companies that provide many of the same financing options as traditional institutions. However, online alternative lenders typically set more flexible qualification requirements. That said, their loans are typically more expensive as well.
- Loan amount: $5,000 to $10 million
- APR: Up to 63%
- Loan term: Varies depending on the type of loan you apply for
- Acceptable loan uses: Varies depending on the type of loan you apply for, but generally few restrictions
- Qualification criteria
- At least a year of business experience
- Minimum credit score of 600
- Minimum annual revenue of around $60,000
- Easy application process and rapid approval
- Flexible qualifying requirements make alternative lenders more accessible for smaller businesses.
- Funds arrive in your business checking account soon after qualifying.
- Online alternative lenders typically charge higher average interest rates and other additional costs as compared to traditional institutions.
- Loan amounts are usually lower than traditional lenders.
Other things to consider when choosing your small business loan
At this point, you understand the factors that lenders consider when deciding whether you’re eligible for a loan. However, it helps to understand why these traits are essential to most lenders. This bigger-picture view can help you see things from the lender’s point of view – and make your case while aligning with their perspective. Below are the reasons behind four key borrower criteria.
- How long you've been in business. When lenders know that you have business experience, they know you can make your business profitable. Knowing you have what it takes to succeed can help lenders feel confident you’ll be able to repay their investment.
- Your personal and business credit scores. Personal and professional credit scores measure how reliably a borrower pays off their debts. No wonder lenders prioritize them – they’re the single most obvious indication of whether you’ll repay what you owe. The higher your credit scores, the more likely you’ll qualify for a loan.
- How much money you need. Not every financing option will provide the same amount of money. This practice reflects the lender’s intent and risk. Namely, the loan amount matters to lenders because they take more risk with every additional dollar they lend. You should determine how much money you need for a certain initiative and then find lenders that check both boxes.
- Your timeline. You should determine how fast you need the funds and how quickly you can pay off the loan. This consideration is important to lenders, so it should be important to you. Certain lenders, such as SBA-backed banks, offer low interest rates and long terms since they prioritize a great borrower experience. Other lenders may be in it solely for profit and offer exorbitant fees with short repayment terms. Look for loans you can pay back on your timeline without excessive fees, and you’ll likely find one.
Find the best loan for your small business
Several small business loan types exist, and choosing the right one can be a complicated decision. The best one for your business might not be the best one for another business – but it will be in the list above.
In general, SBA loans and bank term loans are the best options for your small business if you qualify for them. And with SmartBiz®, you can find out whether you pre-qualify in just a few minutes. See if you pre-qualify* for low interest rates, long repayment periods, and a generally great borrowing experience.
*We conduct a soft credit pull that will not affect your credit score. However, in processing your loan application, the lenders with whom we work will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and happens after your application is in the funding process and matched with a lender who is likely to fund your loan.
WHAT YOU NEED TO KNOW: The SmartBiz® Small Business Blog and other related communications from SmartBiz Loans® are intended to provide general information on relevant topics for managing small businesses. Be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed. Please consult legal and financial processionals for further information.