May 6, 2022 | Last Updated on: August 16, 2023
So many business financing options! How are small business owners to choose? What’s right for a new business may not be appropriate for a more established one.
Don’t worry. This article will explain all the different loan possibilities — and other types of financing available — along with the pros and cons of each to help you find the ideal financing for your business needs.
When you think of getting financing for your small business, traditional bank loans from traditional lenders may not be one of the first funding options that come to mind. Banks seem built for big companies, not small startups.
The truth: Traditional bank loans often come with the lowest rates and most favorable loan terms. Established small businesses with good credit ratings usually qualify for them. Check with your bank to see what it offers. Also, look into local banks because it’s often a part of their mission to support businesses in their local areas. Check out online banks, as well, because they tend to be small business-friendly.
Most banks offer a full range of small business loan products. Term loans are the most popular. There are short-term loans and extended medium- and long-term ones that can be used for different reasons. Term loans provide cash in a lump sum. Depending on how much you need to borrow and what you can afford to pay back each month, a banker should be able to help you find the right term loan for you.
Pro: Flexible loan options at reasonable interest rates.
Con: Must have a solid credit rating to qualify.
The U.S. Small Business Administration (SBA) has been committed to helping small business borrowers get financing for many years. Except for disaster loans, such as Economic Injury Disaster Loans (EIDLs), the SBA doesn’t make loans directly. Instead, it guarantees loans made by lenders affiliated with it. Some of the most common SBA financing options include:
These are the top SBA loan option. They provide U.S.-based small businesses with low interest financing. The maximum loan amount is $5 million. They may be used for a range of things, including working capital, real estate, and refinancing debt. SBA 7(a) loans are designed to help small businesses that haven’t been able to get financing a way to secure loans at competitive rates and with reasonable terms. You need good credit to qualify for SBA 7(a) loans.
These are a fast version of the SBA 7(a) loan. Instead of waiting weeks or months to find out if you’re approved for a loan, the SBA Express Loan program can provide you with an answer in a few days. It may take a day to two longer to get funded. You will likely pay slightly higher interest rates for a loan.
If you need to finance real estate or significant equipment for your business, the 504 loan program could be right for you. The loans can be used to purchase fixed assets, such as machinery and business property. Low-interest rates and reasonable repayment terms are two reasons small business owners turn to the SBA 504 loan program.
Another type of SBA-backed financing is the SBA Microloan program. The amounts for these types of loans are relatively small, capping out at $50,000. Instead of regular loan providers, these loans are usually made through nonprofit community development financial institutions. Microloans are often granted to startups or business owners who have overcome bad credit. SBA microloans come with fair interest rates. Expert advice is available through the program to help small business owners participating in it to succeed.
This financing option is available for you to use when you need it, and you only have to pay it back when you use the money. It’s similar to a credit card in that you are granted a limit you can borrow against, then pay it back and borrow again. Interest rates vary from five to 35 percent. The better your personal credit score or business credit score, the more favorable the rate you’ll get.
Term loans supplied through the SBA are similar to ones provided by other lenders. However, they’re backed by the SBA and, because of it, typically come with more favorable interest rates and terms.
Pro: Small business owners who can’t get loans elsewhere often are able to through the SBA.
Con: The SBA loan process can be slow, and you may not get your cash on time.
All small business owners should consider getting a business credit card. In addition to allowing you to borrow cash in an emergency, they also provide a great way to track business expenses and keep them separate from personal ones.
Make sure you make your monthly credit card payments in full and on time, so you don’t get into high-interest debt. (Many business cards come with high annual percentage rates.) Also, get a card that offers cash back and other perks.
Pro: Credit cards can provide ready cash when you need it. And the rewards and perks can be awesome.
Con: Interest rates and payment terms on business credit cards could be enough to put you out of business.
Equipment financing is a type of financing that essentially lets you rent equipment until you purchase or return it in the future. You borrow money from a lender to buy equipment. The equipment becomes the collateral required to secure the loan. You continue to make payments until the financing is repaid. Once that happens, you own the equipment outright. Interest rates range from eight to 30 plus percent.
Pro: Great option for companies that need new equipment.
Con: Can’t get cash for anything but equipment.
Your outstanding invoices can be turned into cash by a lender. Invoice financing, also referred to as invoice factoring, is a loan secured by your accounts receivables. A lender advances money from invoices due and is allowed to collect on the overdue invoices. This type of loan is one of the most expensive types of small business financing, and the collection activity through a third party could harm your relationship with clients and customers.
Pro: No business credit check is required.
Con: Invoice financing is costly and collection activity can turn customers off.
Commercial real estate loans can provide financing for the price of a commercial building or property itself, along with closing costs, fees, surveys, inspections, taxes, and title insurance. Commercial real estate loans can be large, depending on the financed property. The biggest are known as jumbo loans. Because the business property backs the loans, interest rates are relatively low.
Pro: The best financing option for small businesses purchasing property.
Con: Financing is not available for anything but business buildings and related real estate expenses.
When it comes time to purchase any business vehicle — from a car to a van to a truck —you may need commercial auto loans. Rather than a traditional bank, you may want to get a loan through a lender specializing in business financing. Banks or credit unions may be one option, but many manufacturers or dealers offer commercial auto loans, as well. You owe it to yourself to check out your options to find the best commercial auto loan provider for you.
Pro: The best option for financing business autos, vans, trucks, and other vehicles.
Con: It can be challenging to find the most attractive commercial auto loan offer.
Vendor credit can be an excellent way to improve cash flow. With vendor credit, also referred to as a supplier credit arrangement, you get goods from vendors and suppliers without putting up cash for them upfront. You get a set time frame to pay for them, typically 30 days. In many cases, vendors don’t check credit, so you usually don’t need good credit scores to qualify for vendor credit. Many vendors report payments to credit agencies, which can help you build business credit.
Pro: Great for affordable short-term financing.
Con: Only provides financing for goods you sell, not other things.
How are online loans different from traditional ones? They are essentially the same, except that most of the loan application process is online, including uploading bank statements, tax returns, your business plan, and other information required to determine creditworthiness. Online loans can be used for virtually any purpose and are usually faster to get than traditional ones.
Online systems generally provide tools to determine if you have a reasonable chance of qualifying for a loan, your best funding options, how much you are eligible for, and the costs before you even apply. Online loans may be more expensive than traditional ones because of their flexibility. Still, they can also come with lower interest rates and fees because the firms are often powered by tech companies that run efficiently.
Pro: Ideal option for fast and flexible funding.
Con: You must do your due diligence to ensure you’re entrusting your business to a top-tier online loan provider.
The Small Business Administration isn’t the only option for getting microloans. Some online lenders and nonprofit community development financial institutions offer them, as well. They may be available to startups or entrepreneurs with mediocre credit. To find a microloan, connect with your local SBA resource partners, such as your small business development center or SCORE or your local small business chamber of commerce.
Pro: Microloans may be the only financing option for startups, minority businesses, or niche companies.
Con: The loans are, by their nature, small and may not be enough for the needs of every small business.
A merchant cash advance makes it possible for your business to get an advance against expected future sales. The application process is much easier than for just about any other type of funding. The lender will base how much cash you get based on your average credit and debit card sales. You’ll receive funds quickly, typically in a day or two.
Sound too good to be true? It may be. Factor rates determine the cost of financing rather than interest rates. That can make understanding the cost of financing confusing. Expect to pay 30 to 80 percent or more. At those rates, it can be hard to earn a profit with a merchant cash advance.
Pro: Able to get fast cash with no credit check.
Con: Merchant cash advance rates are often usury level and could put a small business at risk.
Cash flow loans use the projected amount of cash you’re expecting to receive in sales or liquidated assets to establish risk. The lender will determine that you’re suitable for a certain level based on cash flow alone. Interest rates and fees vary for cash flow loans. They are typically only approved for companies earning annual revenues in the millions of dollars.
Pro: Possible option for relatively large small businesses with mediocre credit histories.
Con: A financing possibility for only the biggest of small businesses.
If you have a close network of friends and family or customers who are committed to your business, crowdfunding (sometimes referred to as kickstarter funding) may be a possibility for you. You raise funds from people who want to back your small business. They’re rewarded by becoming a lender or investor in your company and earning interest or a return. While crowdfunding can be successful for some small operations and startups, it can be hard to break through. You need a committed investor base or a great marketing campaign to get crowdfunding.
Pro: If you have fans or a stand-out small business, crowdfunding could get you the cash you need.
Con: If your business is solid but not standout, you may be another one left out in the crowd.
Small business grants are the most sought-after forms of small business funding — and also the most elusive. Grants are considered free money because they never have to be paid back. Competition for most grant programs is fierce.
Governments, private companies, community organizations, and nonprofit foundations offer grants that range from a few hundred to tens of thousands of dollars. The requirements vary by organization, so do research to see if you qualify. You can learn about grant opportunities through community groups and your local small business chamber of commerce.
Pro: There are no negatives if you can get a grant for your small business.
Con: It can be very challenging to find — much less earn — a grant.
Of course, you can always borrow money from family and friends, but mixing personal relationships with business is rarely a good idea. If your family and friends believe in your small business, it’s alright to ask them to invest or provide loan money. Make sure you do so with some guidelines in place. Either should come with a contract that clearly explains the repayment terms or percent of ownership and return expectations.
Pro: Your family and friends love you and want to support your vision. They’re likely open to offering you business funding.
Con: Getting cash from family and friends could negatively impact your relationships.
Startups often turn to angel investors for funding. They’re people who put cash into a business opportunity that interests them. Angel investors are generally wealthy and will research opportunities in depth before jumping in. They often join a business because they see its potential before it ever gets off the ground.
What’s in it for them? Equity. They will own a piece of your business and expect a cut of profits. If you ever get involved with an angel investor, make sure you work with a lawyer, so your interests are protected.
Pro: Angel investors are often the ultimate answer for many small business owners.
Con: How often do angels come along? When they do, you have to ask yourself if it’s worth parting with a portion of your business to get financing.
Venture capital is similar to accepting funds from an angel investor. It’s a form of equity financing where you sell a portion of your company, as opposed to debt financing, which you have to pay back, but you still own your complete business. Venture capitalists will own a share of your business in exchange for cash. The difference is that they’re experienced in advising startups and making them successful. Venture capital could be a good option if you envision your business growing from a small one to a large one.
Pro: Great funding source if you want to scale your operation.
Con: You’re selling a part of what you built to get funded.
Every small business financing option, except for, perhaps, grants, comes with some trade-offs, whether interest, fees, or percent ownership. You owe it to yourself and the future of your operation to select the one that’s right for you.
