The world of small business financing can be difficult to navigate. In recent years, traditional banks have grown reluctant to approve loans to entrepreneurs and even established small businesses looking to expand.
In response, alternative online lenders have emerged to fill this void. This new breed of lenders offers less stringent requirements and faster approval, which makes it a popular choice among potential borrowers.
But the choices that entrepreneurs have are much more varied than whether to approach a bank or online lender for small business funding. Both banks and online lenders offer a wide range of loans according to both type of loan and industry-specific loans.
The many changes in the world of small business financing have left small business owners and entrepreneurs alike wondering how are most small businesses funded and what the marketplace looks like today. In other words, what are the different types of business loans and lending today and where can I get funding for my small business?
Types of Business Loans
Some of the most popular types of small-business funding are:
- Small Business Term loans
- Business Lines of Credit
- SBA Loans
- Short-Term Online Loans
- Equipment Financing
- Invoice Financing
- Invoice Factoring
- Merchant Cash Advances
- Unsecured Business Loans
- Business Acquisition Loans
- Disaster Loans
A term loan is a traditional form of small-business lending, in which the loan is repaid over a set term with a fixed or variable interest rate. This structure is typical of most traditional business loans, which originated historically from a bank. Usually, a borrower would go into the bank, present their business plan, explain why they needed the funding and why their business was worth the risk, and hopefully leave with an offer. Over time, this traditional type of term loan has been one of the best financing options for a business.
But term loans are now also available online. Potential borrowers can apply for a term loan directly from an online lender’s website. The application process online can be easier and approval much quicker than term loans through a bank or credit union, even with bad credit. The terms and fee structure may be the same, but funds can be received and payments made electronically.
For those who qualify, SBA loans may be the best type of funding for a small business. These loans are available through both traditional banks, credit unions and online lenders. The SBA doesn’t actually issue the loans itself. Rather, it guarantees that at least a portion of the loan will be repaid in case of default. This guarantee results in borrowers paying lower interest rates than they would normally pay without backing from the SBA.
Of the several different loan programs offered by the SBA, the most popular is the 7(a) small business loan. Eligibility criteria is strict, and it may take up to several months to receive the loan funds after approval. But the technology of online lenders can simplify the process of applying for an SBA loan, which may lead to faster funding.
A business line of credit is one of the types of funding for small business that doesn’t require collateral. A business line of credit is available from either from a bank or an online lender. But, as is the case with term loans, business lines of credit are typically easier to get online than from a bank. A business line of credit provides a sum of money to draw from at any time. Interest is charged only on the amount borrowed.
An online business line of credit is a good fit for a business that doesn’t need to borrow a specific amount of money but wants access to extra funding to cover expenses during lean periods.
Short-Term Online Loans
Short-term online loans are one of the relatively new types of funding available to a small business. This loan type is designed to help small businesses meet needs when a large capital investment isn’t necessary, such as covering emergency repairs, hiring seasonal help, building inventory or helping with cash flow.
These loans offer less upfront money, with shorter repayment terms, higher interest rates and higher fees than bank loans. On the plus side, short-term online loans have an easier path to approval and quicker access to funds.
Equipment financing can be used for both loans and leases. Loans for equipment work best for companies that can afford a down payment on equipment that will be in use for a long period of time. For companies that use equipment that needs to be frequently replaced or upgraded, leases may be a better option.
When an equipment loan is used to purchase business-related equipment, borrowers agree to make periodic payments over a fixed term that include interest and principal. The equipment purchased is typically used as collateral.
Invoice Factoring is best suited for small businesses that have a steady flow of unpaid invoices and, as a result, suffer cash flow problems. In this arrangement, a small business can sell unpaid invoices to an invoice factoring company for typically 85 to 95 percent of the value of the invoice. The factoring company then collects the invoice and sends its balance to the business, but keeps a factoring fee of between one and five percent. The size of this fee is partially based on how long it takes the invoice to get paid.
Invoice financing is different from invoice factoring. With invoice financing, borrowers receive a line of credit from a financing company. The amount of the line of credit depends on the dollar amount of the borrowers’ unpaid invoices, which the company then uses as collateral.
The responsibility of collecting the unpaid invoices remains with the business owner. Invoice financing can be a good option for businesses that don’t have cash flow problems or don’t want to pay a third-party to reconcile their invoices.
Invoice Financing, Invoice Factoring, Business Lines of Credit and Term Loans are all examples of loans for working capital.
A business acquisition loan is a small business loan to use for financing the purchase of an existing business or franchise. Business owners can also use this type of loan to buy out their partners.
Borrowing amounts vary by lender, as do eligibility requirements. Business acquisition loans may have more demanding criteria for borrowers to meet for approval. There are four specific financing options to use to acquire a business: SBA loans, term loans, startup loans and a Rollover for Business Startups (ROBS).
Disaster loans for small businesses are typically provided the Small Business Administration (SBA). Economic Injury Disaster Loans (EIDL) are low-interest loans can be used to repair or replace property that’s damaged or destroyed in a declared disaster. Disaster loans cover expenses including personal property, machinery, equipment, inventory, and any other business assets.
In addition to physical damage, SBA disaster loans and CARES Act PPP Loans can also be used to help mitigate the economic damage that a disaster can cause.
These are commercial loans for businesses that don’t require any collateral. This makes them a potential option for startups and other businesses that have little that to offer as collateral. The downside is that, because of the lack of collateral, lenders charge higher interest rates for unsecured business loans to compensate for the increased risk. Payment terms can also be shorter and more inflexible for unsecured loans.
A merchant cash advance is not a loan. It’s an advance of the future earnings of a business. The borrower receives a lump sum of money. The lender then recoups the advance with their additional margin added, as a percentage of the daily sales of the borrower’s business. Merchant cash advances don’t have a set timeline to repay funds. The funder will simply keep taking the agreed-upon portion of the borrower’s sales until the balance is repaid.
Merchant cash advances can be more expensive than traditional loans. But they are one of the few funding vehicles available to start-up businesses, or businesses with bad credit.
Specialty Business Loans
As online lending has emerged and the credit market has changed in recent years, a variety of new loan types have emerged. Some of these are:
Microloans are typically given to startups or newer businesses that need working capital. They are for typically small amounts, normally from $5,000 to $10,000, and can range up to $35,000.
Given their size, and the fact that they are usually given to disadvantaged and under-represented groups that can include borrowers with bad credit, banks traditionally haven’t been interested in this market. That’s opened the door for alternative lenders, including both for-profit and not-for-profit lenders, to occupy this area.
The logic behind veteran business loan assistance programs is sound. After all, veterans own approximately 7.5 percent of the nation’s 5.4 million businesses, according to the U.S. Census Bureau. Their time spent in the armed forces can create financial hardship and a spotty financial history, which is an impediment to getting a traditional loan.
Veteran business loans can provide the funding veterans or their spouses need to grow or start a business. These loans can be used to start or expand a business, hire new employees, purchase equipment or provide working capital.
Any veteran, active-duty military personnel or service-disabled service veteran is eligible for a business loan for veterans. Spouses and widowed spouses of veterans or active-duty personnel are also eligible for these programs. But veterans who were dishonorably discharged cannot qualify for the program.
Financing a franchise of an existing corporation can be more complex than financing other types of small business. Franchises also need funds for to pay franchise fees, royalty costs and advertising. There are a number of options to acquire franchise financing, including going through the prospective franchisor itself.
Commercial banks, SBA loans and alternative lenders are also viable options to finance a franchise.
Interest-only business loans are loans in which the borrower pays only the interest five to seven years of the loan. At the end of this interest-only period, the borrower begins to pay off the principal in addition to the interest. This type of loan can be a good fit for business owners who expect their revenue to increase significantly over a few years.
Since an interest-only business loan doesn’t include payment of principal for several years, the monthly payments required are lower than a traditional loan. As a result, this allows more revenue to be re-invested in the business to improve cash flow. Interest-only business loans can thus benefit business owners whose revenue fluctuates.
Getting a business loan with reasonable terms and fees can be difficult for small business owners with poor credit. But the good news is that, thanks to the online loan marketplace, getting a bad credit business loan is not as challenging as it used to be.
There are a variety of online lenders who are willing to work with potential borrowers who have bad credit. Interest rates will be higher – but not unreasonable — and the terms of their loans are more stringent, but these lenders are willing to provide funding when needed without damaging the financial health of a small business.
Related: How to Improve Your Credit Score
As is the case with residential properties, traditional banks and other independent lenders are actively involved in making loans on commercial real estate. Unlike residential mortgages, which are typically made to individuals, commercial real estate loans are often made to businesses that have been created to own commercial real estate. Examples of these businesses entities are corporations, limited partnerships and trusts.
Unlike residential mortgages, commercial real estate loans usually have terms that range from five years or less to 20 years. In addition, the amortization period – or payment schedule – on commercial real estate financing is often longer than the term of the loan.
The number of women-owned business is now at a record high 12.3 million companies in the U.S., and the figure continues to grow, according to a report by American Express and SCORE.
According to the Kauffman Indicators of Entrepreneurship Research, 40 percent of new entrepreneurs in the U.S. are now women, so making financing more accessible to this expanding market seems natural.
But research has shown that roughly 25 percent of women entrepreneurs apply for business loans. Those who do apply tend to ask for significantly less than male applicants. This occurs even though SBA loans and alternative lenders have made it easier for women business owners to get the financing they need.
Each year, Biz2Credit does an online study of women and small business lending that is reported annually by CNBC. The 2020 analysis found that the average annual revenues of women-owned business rose 68% in 2019, to $384,359 from $228,578 in 2018, according to the annual study of 30,000 women-owned companies by Biz2Credit. However, male-owned businesses generated a much higher average annual revenue, of $752,154 in 2019, up from $473,157 in 2018.
According to the U.S. Census Bureau, Hispanics are now the most rapidly growing segment of the U.S. economy. The U.S. Hispanic Chamber of Commerce says that Latino-owned businesses have grown more than 31 percent since 2012. That’s more than double the growth of all American businesses. Small business loans and have played an important role in this growth. The SBA and other organizations, such as Accion and Opportunity Fund, can help facilitate funding for Hispanic-owned small businesses.
Latinos are driving small-business growth and contributing $700 billion to the US economy every year. According to Biz2Credit’s annual study, the average revenue of Latino-owned businesses improved 46.5% in 2019, increasing to $479,413 from $327,189 in 2018, according to Biz2Credit’s annual study. Meanwhile, the number of credit applications from Latino-owned businesses increased by 23% over the past 12 months.
In addition to types of loans, there are a variety of industry and occupation-specific small business loans available.
Similar to any other small business, a lack of working capital may restrict a medical practice from expansion. Medical practice loans can help alleviate this problem. These loans are available to both general practitioners and specialists. While established physicians receive then majority of these loans, some lenders will make medical practice loans to medical professionals who are preparing to open their first practice.
With revenue that’s prone to fluctuation, a lack of working capital is a prime reason that many restaurants fail. The failure rate of restaurants can also make it difficult for new restaurant owners to secure startup funding. That’s why restaurant loans are so vital to the industry.
But with new and different ways to access restaurant loans, and with more alternative lenders entering the marketplace, restauranteurs now have more funding options than has historically been the case.
It’s not unusual for gas stations to need financing help for their daily operations. As with many other small businesses, working capital, real estate, equipment purchases, payroll and expansion are all reasons why gas stations may need financing.
As alternative fuels continue to emerge, many gas stations may need funding to keep pace. In addition, gas stations are increasingly connected with convenience stores. Creating these stores also requires financing. In these cases, Convenience Store Loans are also available. Convenience Store loans are also available to the owners of convenience stores that aren’t connected to a gas station.
There are a variety of gas station loan options available, including alternative funding options as mid-prime gas station loans. Traditional banks and the SBA are also involved in gas station-specific financing. It’s important to note that being approved for a gas station loan can be more difficult than other businesses given the ecological hazards in the industry.
A hotel or motel loan is a type of commercial mortgage for a specific class of hospitality property. Hotel or motel loans are usually the result of borrowers looking to buy a hotel or to refinance a hotel mortgage they already have. This type of loan can also be used to build the capital reserve of the business, fund large expansion or renovation projects or strengthen a property financially.
A variety of financing options are available for liquor store owners. In fact, there are liquor store-specific versions of several types of paths to funding. As with virtually all small businesses, the best available loan is an SBA loan. Beyond that, liquor store inventory financing allows store owners to get cash for the products they sell by using the products themselves as collateral.
Liquor store equipment loans are also a viable financing option, and allow borrowers to use the equipment being purchased as collateral. Business lines of credit can be a good fit for store owners who could use a little extra cash on hand, but not enough to warrant taking out a conventional loan.
Dentists can graduate from dental school with roughly $300,000 in student-loan debt, so they may be understandably wary of taking on more debt to start a practice. They may also have doubts about whether they could even qualify for a loan. But lenders are sensitive to this plight. Some traditional banks have loan specialists dedicated to dentists and other health-care providers.
Loans for dentists can have graduated payment structures with up 100 percent financing available on startup loans, or they can be interest-only. Banks may also have partnerships with industry groups such as the American Dental Association that offer membership benefits such as reduced fees.
Short and medium-term loans from online lenders, business lines of credit and equipment loans are also available from online lenders to help established practices with more immediate funding needs.
Opening and operating a hair and nail salon can take a lot of money – both up front with construction and equipment and over time with supplies, product and payroll. All of this overhead can require access to extra capital, especially since the salon business lends itself to peak seasons and slower periods. Both traditional banks and online lenders can help with startup costs, marketing, capital reserves and cash flow.
Some lenders may consider insurance agencies high risk for conventional financing like term loans and lines of credit. But there is financing that’s designed specifically for insurance agencies. Insurance agency loans customize underwriting to the uniqueness of the industry. Insurance book of business financing is an example of this type of financing. It operates similar to a term loan, using the agency’s insurance book of business as collateral. This structure can help the agency qualify for larger loan amounts and lower rates.
As anyone who’s ever had to file a tax return knows, few businesses are more seasonal than accounting firms. Business lines of credit can be a great help in dealing with the lull that follows this peak season. For more long-term needs, a term loan can be a good fit for accounting firms.
Contingency-fee attorneys can get tied up in lengthy cases, running up expenses in those cases and losing opportunities to build their business until those cases are settled. Since they have to turn away new cases, this costs these attorneys potential capital, which is needed to manage and expand their practices.
In addition, most of the funds invested in cases expenses is not tax deductible as a business expenses, which can further squeeze an attorney’s cash flow. To remedy this, there are lenders who tailor loans for attorneys to the nature of the business of attorneys and law firms. In some cases, these lenders don’t expect principle payments until at least one contingency case is settled.
In the eyes of lenders, veterinarians are especially creditworthy as the demand for their services continues to grow. As such, some lenders today try to appeal to veterinarians through special financing options, such as 100 percent financing and graduated payment plans. This can be good news for veterinarians who want to start, expand, renovate or relocate a practice, or replace or upgrade equipment.
Over the past two decades, the default rate for pharmacy business loans has been extremely low. As a result, most lenders consider pharmacies to be low-risk investments. The flow of new opportunities from the healthcare industry have expanded patient-care roles in both chain drug stores and community pharmacies. A pharmacy loan can provide the additional capital needed to take advantage of this increasing demand, no matter whether pharmacy owners or potential owners want to expand, acquire or start a new business.
Whether a car dealer has been in business for a while or just starting, there are a variety of car dealership financing options available. The same applies to auto repair shops. Lenders are sensitive to the fact that opening an auto dealership is cash-intensive, and that new dealerships take a while to establish a foothold in the marketplace. But they also realize that car dealerships and repair shops offer products and services that are in high demand, which makes them more likely to produce consistent revenue.