What Kinds of Loans Do Small Businesses Look For?
Small business loan
Financial institutions can also call these term loans or business venture loans. These loans are often larger than line of credit borrowings, and require at least as much documentation. Unlike corporate credit cards and lines of credit, borrowers usually draw down the entire amount of small business loans for a major purchase. The loans usually have a much longer repayment term than a line of credit. A Small Business Administration-backed loan is different from a general business loan. If you default, the SBA will cover part of the loss to the bank from an SBA-backed loan. But the application process is substantially more involved – so much so that many banks will not offer SBA-backed loans. Depending on the size of your business, a typical non-SBA-backed small business loan will require the “personal guarantee” of the owner of the company. This means that if a company defaults on the loan, a lender will be able to approach the owner for the money – it makes the owner personally liable for the loan performance.
Line of credit
This type of loan is designed to finance short-term working capital needs – inventory purchases or operating expenses. You wouldn’t use this kind of loan for big purchases. But businesses with choppy sales patterns – big gains during the holidays and weak sales in the summer, for example – tend to want lines of credit to smooth out their operating finances. You generally need to be a profitable business that can demonstrate positive cash flow to receive a line of credit loan. Lines of credit come in two varieties: secured and unsecured. A secured line of credit uses your inventory or other property as collateral. An unsecured line of credit does not.
The application process takes longer and requires more documentation than that for a corporate credit card, but the interest rate is lower and the amount available to borrow is usually much higher. Lines of credit can generally be renewed annually. The interest rate is fixed, unlike a credit card.
Corporate credit cards
A business credit card works more or less like a personal credit card. It’s a revolving loan with a set limit. It’s usually easier to qualify for a business credit card than a business loan, assuming your company’s credit is pretty good. Unlike business lines of credit, you usually don’t have to reapply for a credit card every year. Credit cards make it easy to keep your business expenses separate from your personal expenses, if you’re disciplined about using your business card only for business spending. The incentives offered by credit card companies – free flights, cash-back discounts – can be useful for small businesses. And a credit card, used wisely, can help manage cash flow. However, the interest rate on a credit card is usually higher than available rates for lines of credit or small business loans. The loan limit is lower. Business credit cards can be lost or abused by unscrupulous employees. And, most of the time, your bank will require a personal guarantee to put you on the hook for repayment if your company can’t pay the bill – there’s no limited liability for a corporate credit card.
Commercial Real Estate Loans
This is a mortgage, more or less just like your home mortgage, with three major differences. First, commercial real estate loan are generally considered more risky than home loans … even these days. Thus, lenders will tend to require a larger down payment. Also, lenders evaluate commercial real estate as much by the expected future cash flow from the property as by its relative value and likelihood of appreciation. Finally, commercial property loans tend to be shorter term than home mortgages. Each of these factors will influence a lenders’ decision to finance property.
Hard Money Loans
These are loans made against the equity in a business, either its real estate or other assets. It’s a cornerstone in the asset-based financing industry, along with merchant cash advances and factoring (two forms of finance that are not lending, strictly speaking, but have similarities to lending.) Hard money loans are almost always made by nonbank lenders, and generally carry interest rates several points higher than standard bank loans. Borrowers who can’t obtain bank financing are candidates for these loans.
Businesses seek bridge loans to sustain short term financing in between major financings. The loan is a “bridge” between one state of stable financing and another, when, for example, a firm is reaching the maturity date for a bank loan, but hasn’t yet secured funding for a refinance of the debt, sold assets to cover the loan or placed a bond. Bridge loans are more expensive than most traditional financing, but are meant to be a short-term stopgap.
This is a loan for building a new facility, office space or other commercial property. It differs from a commercial real estate loan because of the increased risk. Often, lenders disburse this kind of loan in stages of construction, with each phase of completion prompting a new disbursement.
Angel and Venture Capital Loans
Most of the time, angel investors and venture capitalists trade cash for equity, not debt. But a surprising number of these investments are loans. According to research in the Entrepreneurship in the United States Assessment, a survey of investor behavior, debt accounts for about 40 percent of the money invested by angels to startups. About 14 percent of angel investments are pure debt. Convertible bonds that allow a lender to take equity in the company later have fallen out of favor among some professional angel investors, but are still relatively common.
These are loans to purchase equipment. These loans tend to be easier to make for lenders, because the equipment can be valued with relative accuracy and serves as collateral on the loan.