Types of Small Business Loans: 12 Types You Should Know

There comes a time when every small business needs extra capital in addition to incoming cash flows. Perhaps an unexpected emergency popped up or the business needs new equipment to replace outdated or broken machinery. Maybe the business hasn’t even started yet, and an entrepreneur is ready to launch but the money’s just not there. In these situations, many small business owners make the decision to take out a small business loan.

However, just as every business is unique, so are the needs for capital. Whether you’re brand new to the industry, your personal or business credit scores are low, or you’re aiming for specific rates and terms, there are different loan products available. As a business owner, you should only take out a loan for purposes that are going to improve your business and its cash flow, not lead to a cycle of burdensome debt. This is why it’s important to carefully research all your options for business loans, starting now.

Types Of Business Loans At A Glance

Installment Loans

Best for…

Most small businesses.

An installment loan is one of the most common types of loans and one that most business owners are already familiar with in some capacity. Mortgages and vehicle loans are just two examples of installment loans.

An installment loan involves a specific amount of money that is paid back through a set schedule of payments. Typically, these payments are made each month, but the pay schedule varies based on the policies of the lender. Each payment will be applied toward the principal, or the balance of the loan, as well as to interest charged by the lender.

The interest rate of a business installment loan is determined by a variety of factors, including but not limited to business and personal credit history and scores, as well as the time in business. Startup businesses, for instance, are seen as riskier borrowers by lenders and may receive a loan with a higher interest rate.

Terms vary and may be determined by the amount borrowed as well as the lender’s policies. Some term loans may last for just a few months, while others may be stretched over several years.

Because installment loans are available in different amounts with a wide variety of rates and terms, it’s important for a business to understand the cost of the loan (use our nifty installment loan calculator for help). A low-interest, long-term loan could be a great business decision, while a high-interest, short-term installment loan could be a burden.

Installment loans can be used for just about anything. However, the smartest and most affordable ways to use these loans is by obtaining a low-interest loan for a larger purchase, such as buying expensive long-term equipment or a commercial vehicle. This allows the business to obtain the funding they need for a large purchase without having to pay the full cost up front. To receive the most favorable rates and terms, a business should be established (in operation for more than 2 years), have proof of positive cash flow, and have a strong credit score.

Installment loans are available through banks, credit unions, and online lenders.

SBA Loans

Best for…

Small businesses with strong credit histories looking for competitive, non-traditional loan options.

The Small Business Administration is a federal organization that serves as a resource for small business owners. One of the biggest benefits offered by the SBA is its low-cost, government-backed loan program.

Business owners do not go directly to the SBA for loans. Instead, SBA-approved lenders known as intermediaries provide funding to small businesses. Since the SBA guarantees large percentages of each loan, lenders are more apt to provide funding to small business owners when traditional options aren’t in the cards.

There are several types of loan programs available through the SBA. This includes the 7(a) standard program, which provides up to $5 million for almost any business purpose. Microloans up to $50,000 are available for smaller financing needs. The SBA also offers the 504 program for the purchase of real estate, the Community Advantage program for businesses in underserved communities, and the Veterans Advantage program for military veterans and service members.

These loans are typically reserved for business owners with strong credit scores (at least in the high-600s). The process to receive an SBA loan is notoriously long, potentially taking months from application to funding. However, because the SBA has set interest rates and terms, these are also some of the most affordable loans on the market. Find out more about qualifying for SBA loans.

SBA loans serve many different purposes. They are ideal for large purchases, including equipment, commercial real estate, or even acquiring a business. They can also be used for working capital or to refinance existing debt. These loans are extremely flexible and with so many programs, it’s easy to find one that works for any business that meets the SBA’s requirements.

SBA loans can be obtained through intermediary lenders, including banks, credit unions, non-profit organizations, and Commercial Development Companies.

Business Lines of Credit

Best for…

Businesses that want a flexible credit option and on-demand access to funds.

A business line of credit is very similar to a credit card. A business is given a maximum credit limit. The business can spend up to that limit, making multiple draws if needed. Interest will be applied to the borrowed funds and will be paid back with the principal through scheduled payments.

Unsecured and secured credit lines are available. Unsecured lines do not require any collateral and are available to borrowers with positive credit histories. Secured lines are often given to startups and applicants with lower credit scores. Secured lines of credit are backed by assets or property to be used as collateral. If a borrower defaults, the lender can use the collateral to pay off the debt.

Lines of credit are best used for unexpected expenses or to resolve cash-flow shortages. They can also be used to purchase supplies or inventory for seasonal increases. Like a credit card, it is important to use a business line of credit only when needed and to pay borrowed funds back as soon as possible to avoid paying hundreds or even thousands of dollars in interest.

Business lines of credits are available through banks and credit unions. Some alternative online lenders also provide lines of credit. For example, SBA has lines of credit can be issued via SBA-approved intermediary lenders. Learn more about how to obtain business lines of credit.

Short-Term Loans

Best for…

Emergency financial needs or businesses with low credit scores.

A short-term loan must be repaid over a short period of time, usually within one year. The repayment period varies according to lender, but it could be months or even a few weeks. Short-term loans offer a quick way to get much-needed cash and are best for unexpected emergencies.

Short-term loans may also be an option for businesses with bad credit. Low business or personal credit scores may disqualify business owners from long-term loans with better terms and rates. A short-term loan could be a good way for borrowers with a poor credit history to get the money they need quickly while also boosting their credit after paying off the loan.

However, it is very important to remember that these loans often come with very high interest rates. Because short-term loans can be very expensive, it’s important to use them only when emergencies arise that cannot be resolved through other means. Find out everything you need to know about short-term loans before applying.

Short-term loans can be obtained through alternative online lenders. These loans are typically easy to receive and do not require an extensive application process like other types of loans.

Equipment Loans

Best for…

Companies that want to purchase equipment with low monthly payments.

Sometimes, entrepreneurs need to purchase equipment to get their businesses off the ground. Other times, more equipment is needed when production increases or new equipment is needed to replace old or outdated machinery. When this occurs, it can be difficult for a small business to come up with the funds to pay out-of-pocket. Instead, businesses turn to equipment loans to make these large purchases more affordable.

An equipment loan is used to purchase equipment. The business will immediately get to use the equipment but won’t have to pay the full cost up front. Instead, it will be able to pay smaller payments on a monthly basis (or other repayment schedule). The lender charges interest for loaning the funds to the borrower.

Equipment financing is a good choice for anyone who wants a more affordable option for purchasing expensive equipment. Equipment financing is also an option for startups or business owners with lower credit scores, and it’s easier to obtain than other loans like SBA loans or installment loans. No collateral is typically required for this type of financing, as the equipment itself serves as the collateral and can be repossessed if the owner defaults.

Some banks and credit unions offer equipment financing. Online lenders also have options. Equipment manufacturers may also have their own credit program available for qualified borrowers.

Invoice Financing

Best for…

Businesses that have cash flow shortages due to unpaid invoices.

There comes a time for many small businesses when there’s a cash flow shortage due to slow-paying accounts receivables. To resolve these cash flow issues, invoice financing can help.

There are two main options for invoice financing. The first is known as invoice factoring. With invoice factoring, a lender pays the small business a percentage of its outstanding invoices. The lender then collects payments from the invoiced customers. Once payment has been collected, the lender pays the business the remaining outstanding balance, less any interest and fees for providing the service.

Invoice discounting is another type of invoice financing. With invoice discounting, a percentage of the unpaid invoice is paid to the small business. Once the business collects payment from its customers, the loan is repaid along with interest and fees.

Invoice factoring is best used for resolving cash flow issues that stem from unpaid invoices. These loans are usually quite easy to receive, and unlike other types of loans, your credit score isn’t the most important factor. The invoices serve as the collateral for these loans, so no additional collateral is needed. Invoice financing is available through banks and alternative lenders.

Merchant Cash Advances

Best for…

Small businesses with lower credit scores that need cash quickly.

Small businesses that need money quickly for an emergency situation or to purchase supplies or inventory may consider a merchant cash advance. With a merchant cash advance, a lender advances a company money in return for a percentage of future credit card sales.

After receiving a merchant cash advance, daily payments are withdrawn by the lender from the business’ bank account. When sales are lower, the payment is also lower because the payment is based on a percentage of sales. Merchant cash advances may be a consideration for businesses with lower credit scores, as the lender is more concerned with the amount of credit card sales. This type of financing is usually provided very quickly – in some cases, within 24 hours.

The major drawback of merchant cash advances is that interest rates can be much higher than with other lending options, making this a very expensive form of credit. As with other types of loans, a small business should consider the total cost of the merchant cash advance and shop around for the best rates. Merchant cash advances are available through alternative lenders. Learn more about applying for a merchant cash advance.

Personal Loans For Business

Best for…

Startup businesses that have not established a positive business credit history.

A personal loan for business is an option for businesses that do not have the credit score or business documentation required to qualify for a business loan. With a personal loan, the small business owner uses his or her own credit score and income documentation to qualify. The business owner will be held personally liable for the debt.

This is often a lending choice for startup businesses. If the business is new, it isn’t able to prove its success through past income tax returns, profit and loss statements, and other documentation. The business also likely hasn’t built up a solid credit history. All of this together throws up a red flag for lenders, who see the startup as being a bigger risk.

While there are loans available specifically for startups, sometimes interest rates can be high. If a startup owner has good personal credit and documentation to prove that the loan payments can be made each month, a personal loan may be a more affordable form of financing.

Personal loans are flexible and offer many different rates and terms. A long-term loan with a great interest rate could be an affordable form of financing for large business purchases. A personal loan can even be used to acquire or start a new business.

Personal loans are available through banks, credit unions, and alternative lenders. Private lenders, including family and friends, may also be an option.

Microloans

Best for…

Smaller businesses, sole proprietors, and startups with low capital requirements.

Small businesses that don’t require a lot of capital may want to consider applying for a microloan. A microloan is defined as a smaller loan of typically $50,000 or less. These funds can be used for many business expenses, including but not limited to expansion and startup costs.

Because these are smaller loans, they are best for smaller businesses, sole proprietors, and startups that have lower capital requirements than other businesses. Small businesses that don’t have any luck working with traditional financial institutions turn to microlenders.

Microloans can be obtained through non-profit organizations. The potential drawback is that these organizations often receive government grants, limiting the amount that they can lend out, as well as the number of businesses they can help. However, one big advantage is that in addition to providing needed funds to small business owners, many nonprofit organizations offer additional benefits such as training and education to help a small business or startup succeed.

Crowdfunding & Peer-to-Peer (P2P) Loans

Best for…

Businesses that are looking for an alternative to bank loans.

Receiving a loan from a bank or other financial institution usually means low interest rates and competitive terms. However, any business owner that has ever received a loan from a bank knows that the process can be quite lengthy – taking as long as several months from start to finish.

Maybe the timeline isn’t a problem, but instead, the business is a startup and hasn’t yet built a reputation to even qualify for a traditional loan.

Startups and businesses that want to avoid the hassle of working with a bank have two alternatives: crowdfunding and peer-to-peer loans.

With crowdfunding, a small business or startup uses an online platform to raise money from a group of investors. The small business pitches its idea to investors, and investors donate money if the idea appeals to them. It’s important for the business seeking financing to map out a strategy to entice investors. The borrower will need to promote their campaign, encourage others to share, and offer rewards to investors – think equity in the business or free products. There are hundreds of crowdfunding sites available online.

Peer-to-peer, or P2P, is a type of lending that also involves private investors. However, it differs significantly from crowdfunding. Small businesses are connected with lenders through a P2P network. After filling out information, such as the amount of money needed and how it will be used, the borrower is matched with a lender. Rates and terms are agreed upon, and the paperwork can be completed and signed online.

This form of financing is much quicker than getting a loan from a bank or other traditional source. Borrowers will pay monthly payments over a set period of time, which could be as short as a few months or as long as several years. Business owners with high credit scores can receive very competitive interest rates, making this an affordable form of financing. Small businesses can apply for P2P loans online through lending networks.

Commercial Real Estate Loans

Best for…

Businesses that need funds to purchase real estate.

Commercial real estate loans can help you purchase or upgrade commercial real estate. These funds can be used to purchase an existing building or land, upgrade or add-on to an existing property, or construct a new building.
Commercial real estate loans are long-term loans that are paid off over a longer period of time, such as 20 or 30 years. This allows a business to expand their operations through affordable monthly payments.

These loans can only be used toward the purchase, development, or construction of commercial real estate. In some cases, the funds may be used to purchase long-term fixed assets (such as with the SBA 504 loan).

Commercial mortgages are available through banks and credit unions. SBA 504 loans can also be used to purchase commercial real estate. The SBA 7(a) program is also another great option that provides up to $5 million for the purchase of real estate or any other business expense.

Business Credit Cards

Best for…

Businesses that need on-demand financing for emergencies and business expenses and want to boost their credit scores.

A business credit card is a card that is used for business purposes. The lender provides the borrower with a set credit limit. The borrower can use the card to make multiple charges up to the amount of the credit limit. Interest is charged only on the funds that are used. The borrower then makes monthly payments to pay down the balance. As long as the card hasn’t been used up to its credit limit, it can be used over and over again.

A business credit card is a good financing option for emergency expenses or cash flow shortages. It can also be used to purchase supplies or inventory or to pay for other expenses. However, it’s important to note that the balance should be paid off or reduced as soon as possible to prevent paying interest month after month.

When used responsibly, credit cards can also be used to boost a business’ credit history. This could lead to higher credit lines in the future, as well as opening up other opportunities for funding (including long-term loans). However, carrying a high balance can lead to a high level of credit utilization, which can negatively impact a credit score. Late payments and missed payments can also hurt a credit score, which is why it’s so important to never miss a payment, just like any other financing option.

Business credit cards are available through many banks and credit unions. Retailers that provide supplies and other items needed by a small business often have their own business credit cards available.

Final Thoughts

Running a small business can be expensive, and seasonal increases, unforeseen emergencies, unpaid invoices, or the need for expansion can all lead a business owner to pursue financing options. While there are many affordable loans available, it’s important to fully evaluate all lending options, the total cost of the loan, and the return on investment from taking the loan. A smart business owner will take the time to weigh out the pros and cons before signing the paperwork to ensure that the loan will help the business prosper.