What is a Business Loan?
A business loan is a way for merchants to secure funds without giving up equity or control of their company. Business loans are a type of debt financing, meaning the merchant takes on debt they must repay in exchange for access to immediate funds.
There are many types of business loans available, from traditional installment loans to invoice financing and business lines of credit. Some types work better than others depending upon the business’s history, financial situation, and assets.
Types of Small Business Loans
Below are descriptions of the most common business loan terms and types you may find during your search for a loan. Which is best for your business?
Banks loans are, simply, business loans originated by a bank. Banks may offer many types of business financing, including installment loans, lines of credit, and equipment loans. These institutions can normally offer the best rates and fees, but also have a reputation for low acceptance rates and very long application processes.
Bank loans are alternately referred to as traditional financing or traditional business loans.
Business Expansion Loans
These are loans used to purchase and open additional business locations. Most business expansion loans are installment loans, but some businesses may use lines of credit if they do not know exactly how much the project will cost.
These are loans used to purchase equipment. Normally, the lender will loan about 80% of the cost of the equipment, and the merchant is responsible for paying the remaining 20%. Equipment loans are an alternative to leasing or purchasing equipment outright.
Also commonly called term loans, installment loans are loans repaid in fixed, regular installments over a set period of time. The repayment period for business installment loans is normally between one and 10 years, though some lenders will allow for shorter or longer terms.
Installment loans may also be called short-term loans (loans with repayment terms under two years), medium-term loans (repayment terms between two and five years), or long-term loans (repayment terms of six years or more).
A catch-all term that includes (among other non-loan financing products) loans that are backed by unpaid invoices. If you have cash flow problems caused by unpaid invoices, invoice financing may be for you.
Lines of Credit
Loans that grant you a credit facility from which you can draw any time without the need for application. These loans are convenient for businesses that have occasional cash flow problems, those that often have to deal with unexpected expenses, or any other businesses that need financing but don’t want to go through an application process each time. For our full list of line of credit reviews, head over here.
Also called marketplace loans or alternative loans, online loans are originated by a variety of non-bank lenders that utilize technology to make fast and easy lending decisions. Individual online lenders may offer products including installment loans, lines of credit, short-term loans, or other loan types, but are similar in that most can offer funding within two weeks or less.
SBA (Small Business Association) Loans
While SBA loans are usually originated by banks, the application process is handled by the Small Business Association itself. The SBA also guarantees a portion of the amount borrowed, which means these loans are often easier to get and require less collateral than standard bank loans.
Unlike most loans, in which the fee is calculated by an interest rate, short-term loans carry a fee that is calculated once based on the original borrowing amount. As you would expect, short-term loans carry short term lengths; normally they are intended to be repaid in under two years, but some lenders allow term lengths up to three.
Head over here for a list of all our reviews of short-term loans (and their non-loan counterpart, merchant cash advances).
Quite simply, these are loans used to finance startups. As startups are very risky, there are very few lenders that will finance this type of business. However, entrepreneurs may be able to get a loan through certain nonprofits or by utilizing their personal creditworthiness to get a personal loan for business.
Working Capital Loans
These loans are used to cover business operating costs while business funds are tied up elsewhere.
Are You Eligible For a Loan?
Eligibility for a loan is contingent upon a number of different factors; lenders cannot make the final decision about whether or not you’re eligible, and what rates they can give you, until they have performed the full underwriting and verification process. However, lenders can look at a few business factors to determine whether you have a good chance of getting a loan from their company.
Here are four big factors lenders will look for when deciding if your business is eligible for a loan:
- Time in business: Lenders want to be able to see that your business has successfully been operating for some time.
- Personal credit score: You must have a track record of making payments in a timely manner.
- Business revenue: Your business has to be making enough money to meet the incremental payments. Many lenders will not let you borrow more than 15% – 18% of your total business revenue.
- Collateral: In the event that you can no longer pay, some lenders want collateral so they will be able to recoup the lost money. While plenty of lenders do not require collateral (or don’t require specific collateral) businesses that can put up collateral will find the search for a business loan much easier.
Each lender has different requirements regarding each of these categories; the stronger your case, the more lenders you will have access to. However, most businesses will have access to some form of business loan.
Each of our reviews list the borrower qualifications for individual lenders, so don’t spend your time considering lenders you aren’t yet qualified for!
For more information on the business loan process, take a look at our Small Business Loans 101 series: