Business lending is a complex topic, but the key to success is mastering the basics.
This is true for veteran small business owners and those just starting out. The reason is simple: there are more options than ever before. By fully understanding the ABC’s of business loans, you can make the decision that works best for you.
What is a Small Business Loan?
A small business loan is a loan that can be used for a multitude of purposes — start-up costs, equipment purchases, inventory purchases or other reasons related to expansion. The borrower repays the lender the amount and added interest established under the terms and conditions. There are two types of interest rate structures: fixed rates, which do not change throughout the life of the loan, and variable rates, which change based on certain specified conditions.
Generally, repayment time for a long-term loan is more than a year while short-term loans must be paid back in less than a year. Mostly, short-term loans will have lower rates and often do not require collateral while long-term loans frequently are higher interest rates and require collateral.
The following are description of some of the different types of loans.
- Traditional bank loans are when a bank is the lender. These loans can be either short or long term. Collateral requirement is based on the specifics of the loan. These loans are generally lower-interest than many other types of business loans. It can be an attractive option but the requirements are often difficult to meet and the rejection rate in recent years has been around 80%. Traditional banks often prefer higher loan amounts and longer terms than other loan providers.
- The Small Business Administration (SBA) provides a government-backed guarantee on part of the loan. SBA loans are made through banks, credit unions, and other lenders who partner with the agency. The requirements are more flexible than traditional bank loans and these loans can range from microloans to more substantial amounts.
- Alternative lender loans from alternative finance companies, such as BFS Capital are more flexible in requirements compared with traditional banks, but the interest rates are typically higher. The acceptance rate is generally higher as the borrower as credit isn’t weighed as heavily as cash flow and the sustainability of the business. There is more flexibility on the loan and repayment options and funding can occur in days rather than months.
- A business line of credit provides small businesses access to funds, similar to a credit card. This option has compounded interest and often high fees so it’s best for short-term lending needs.
- Other non-bank lending options include:
- Working capital loans which are short-term loans for day-to-day financing needs, with fluctuating interest rates, dependent on length of loan and the risks involved in the business.
- Peer-to-peer lending which generally involve internet marketplaces, where individuals or companies invest in small businesses.
- Crowdfunding is where a business can raise cash contributions from a large number of people.
A Few Other Things to Note
Most lenders will make loan recipients sign a promissory note, which is a legal agreement in which the borrower promises to pay a determinate sum of money to the lender, within the time agreed or in certain cases on demand of the lender, under specific terms
Lenders often require that another person co-sign or guarantee a loan. If you are going to ask someone to co-sign or guarantee a promissory note, you need to be sure they understand that their personal assets could be at risk if you default on the loan.
For married couples, a lender may insist that your spouse co-sign a promissory note. If this is the case, your jointly-owned property may be at risk for this debt, along with any assets that your spouse owns separately, including property and even potential job earnings.