Having access to working capital when your business needs it is vital; however, there are many different types of business loan programs. Knowing the pros and cons of each can give you the confidence to choose the program best-suited to the particular needs of your company.
The answers to these questions can help you choose the type of business loan that would be a good match for your organization as you evaluate the following list of pros and cons that differentiate various types of business financing:
- How much money do you need?
- How fast do you need it?
- How quickly do you want to repay the amount?
- Where will repayment proceeds come from?
- How will you prove credit worthiness to potential lenders? (e.g., credit score, time in business, sales history, projections, collateral, etc.)
Pros and Cons of 10 Loans Might Make One Ideal for Your Business
- SBA Loans
First, a disclaimer: SBA loans aren’t actually loans granted by the U.S. Small Business Association, they are guarantees the SBA makes to lenders who adhere to their small business loan guidelines. In effect, the SBA acts as a co-signer, enabling small businesses that might not otherwise qualify for bank financing to get access to capital at the low rate offered by big banks.
- Low interest rates
- Endorsement by the SBA improves chances of approval
- Stringent eligibility qualifications and oversight (use of funds)
- Lengthy approval process
- Low approval rates
- Bank Loans
Most banks have financing programs that are exclusive to business customers. They are especially attractive due to their low financing rates; however, the small business loan approval rate from big banks is very low (less than one in five are approved). Bank loans may be offered with fixed or adjustable rates, balloon payments and comparatively long repayment periods. Banks also prefer to finance larger loans, rather than smaller amounts that many businesses are looking to borrow.
- Low interest rate
- Large amounts of capital available to qualified applicants
- Low approval rates
- Lengthy application and underwriting process
- Limitations on what funds can be used for
- Small loan amounts are not usually considered
- Stringent qualifications (business loan may be denied due to short length of time in business, poor credit score or banking history, inability to prove projections, lack of collateral or other factors)
- Line of Credit
Line of credit financing may be granted by banks and platform lenders, but may also be available to your business from suppliers in the form of a supplier or vendor credit facility. Essentially, a line of credit allows your company to get access to working capital (or supplier products/services) up to a given amount. Repayment periods are usually short and the cost of financing is more expensive than bank loans.
- Depending on lender type, fast approval and underwriting process
- Control the amount of financing based on need instead of a lump sum
- Flexible – funds can usually be used at the business owner’s discretion
- Ability to draw on the line when needed
- Allows repeated access to capital as the line is paid down without re-applying
- Higher approval rates from non-bank lines of credit
- Faster repayment reduces financing fees
- Higher cost of financing vs. bank or SBA guaranteed loans
- Similarly stringent qualification requirements as bank or SBA guaranteed loans
- Business and Merchant Cash Advances
Cash advance financing programs give business owners access to working capital in a lump sum amount that is awarded based mainly on the organization’s sales history. Like a line of credit, as repayment is made the business owner often has the ability to draw out another lump sum without having to start the application process all over again.
- Short application process and fast (sometimes even instant) approvals
- Young businesses or those with low credit scores are not automatically disqualified
- Flexible use of funds and repayment options
- High approval rates
- No collateral at risk
- No UCC filing programs
- Automated repayment makes it easy to manage
- Higher cost of financing compared to bank loans
- Financing fee is fixed regardless of how quickly the amount is repaid
- Equipment Loans
Equipment loans (or equipment lease financing) usually refers to a financing tool whereby a lender extends working capital on your behalf, so that you can obtain equipment your business needs, and you repay the lender. Depending on which lender’s program you choose, financing rates, underwriting and approvals, qualifications and repayment options could vary widely. In addition, business cash advances, bank loans and business line of credit financing are all equivalent options for financing equipment purchases and leases, the only real differentiator being potential use of funds.
- Loans from Private Investors
You can negotiate private loans to fund your business as a startup or at any time during the life of your organization. The cost of financing could vary widely as could repayment terms. One factor to consider with this type of financing is whether investor loans can be called in at any time, which could put your business or some of its assets at risk.
- Payroll Loans
Like equipment loans, payroll loans are a financing tool that is used for a very specific purpose – ensuring that payroll can be met during a given payroll cycle. In the U.S., payroll loans are heavily regulated in part due to their high cost and strict repayment schedule.
- Short application and approval process
- Ability to cover payroll costs during a temporary cash flow lull
- Short repayment (usually by the date of the following payroll cycle)
- Comparatively high APR (annual percentage rate) from 15 to 30 percent
- Additional fees accrue if repayment schedule is not met
- Micro Loans
Micro loans help bridge the gap for businesses that can’t meet the strict qualifications that accompany most bank loan programs, enabling young or smaller businesses with limited collateral and capital resources to get access to working capital in smaller amounts.
- Fewer qualification requirements than bank loans
- Available in smaller amounts – as low as $500 to as much as $100,000
- Stringent oversight (depending on lender)
- Borrowers required to receive business training (SBA microloans)
- Peer-to-Peer Lending
Peer-to-peer lending models come in many different forms. Some allow individuals to select which businesses and projects they want to lend to, others are overseen by executives or boards that decide which projects receive funding. Financing rates, qualifications, limitations on use, repayment schedules, application and underwriting processes and other characteristics vary widely depending on the peer-to-peer lending program.
- Business Credit Cards
Business credit cards provide instant access to capital which can be advantageous for business owners, especially when opportunities or capital demands come without warning. However, their comparatively high interest rates make them a better choice only when repayment can be made in full before the next billing cycle.
- Relatively easy to qualify
- Instant buying power
- High interest fees if not paid in full each month
- Credit limit may be too low to accommodate significant working capital needs
The type of business loan you utilize to meet your company’s financial needs can have a big impact on your organization. It’s important to understand the differences that distinguish one from another so that you can choose the one most-aligned to the unique financial needs of your company.