There are times when your business needs a cash injection. You may require a major piece of equipment, say, or have to cover expenses as you increase your employee count. Whatever the reason, borrowing money is something that might be necessary from time to time.
But what exactly should you apply for? There’s not just one type of loan appropriate for all businesses or purposes. Here’s a quick guide to help demystify business loans and provide guidance on choosing the best one for your needs.
Different loan types and when to use them
There are numerous types of loans available, and there are instances when one variety is more appropriate than others. I won’t get into all of them, but here are some of the most common varieties to know about.
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Traditional business loans
First, there is the traditional business loan, also known as a term loan. With such loans, you contact a lender — either a bank or a private lender — and apply for a set amount of funds. These are then scheduled to be repaid over a certain time period. Getting a traditional business loan approved is by no means guaranteed. Banks will want to see a solid business plan or history in addition to a good credit rating.
Traditional loans are usually best when businesses need a predetermined amount of money for a specific purpose. That may include things such as a large equipment purchase or a set period of time you’ll have to cover payroll.
Term loans oftentimes require collateral of some sort before the funds are released. This can be business equipment, real estate, accounts receivable, inventory or securities.
There are instances where no collateral is required. Usually, these unsecured loans come with higher interest rates, carry extra fees or require a personal lien.
SBA loans
A Small Business Administration loan is similar to a standard business loan but has a couple of key differences. With an SBA loan, you still take out a loan through a banking institution. Unlike a standard loan, however, the government will back a portion of your loan. In addition, you will provide a personal guarantee against the loan. Because you and the government are relieving the majority of the risk, the bank is more likely to approve your loan and possibly offer lower interest rates.
Other benefits of SBA loans include longer repayment periods, higher loan amounts and low fees. All of that probably sounds pretty good, so why don’t all businesses take advantage of SBA loans? The answer is that they can be difficult to qualify for.
Not only is good credit required, but businesses typically need to have been established for at least two years. A great deal of documentation is necessary, as well. Then, if you’re successfully approved for a loan, it can take a while — sometimes months — to receive the funds. So if your cash requirements have a quickly approaching deadline, a traditional loan or line of credit might be a better option.
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Lines of credit
As I just mentioned, lines of credit can work well for quick cash needs. With a line of credit, companies have a set amount available that they can draw from. Some lines of credit are even directly linked to a business’ bank account as a kind of built-in overdraft protection.
Some businesses find lines of credit to be an efficient system, but they’re definitely for smaller, ongoing cash necessities. Lines of credit almost always have higher interest rates than standard business loans. So if you consistently max out your line of credit and never look at your monthly statements, you might be unaware of how much you are paying in interest.
Choose your banking institutions carefully
Whether it’s a small business loan, a line of credit or an SBA loan, you’ll likely be dealing with a bank. While banks must adhere to certain rules and regulations, not all of them are equal. Since your financial institution can have a major impact on your overall business wellness, choose carefully.
The first thing to avoid is being tricked into a tempting introductory offer. Maybe a bank is offering an ultra-low interest rate on new loans. Check to see how long this interest rate is good for. If the rate is subject to change after six months, it might not be such a good deal.
Something else to consider is the depth of the relationship you can develop with the people at your bank. With national banks, you might benefit from robust online banking capabilities and other perks but be a virtual stranger to their employees.
With local or regional banks and credit unions, there tends to be more potential for customization and negotiation. One of my peers was able to structure a line of credit at his local bank that automatically fed into multiple entities. The bank created this option at his request and did some custom coding to accomplish it. Without that close relationship, this arrangement would likely not have been available. So before choosing a bank, check around with your business peers to see which institutions have top-notch people who value customer service.
Do your research, get what you need
Given all the options that exist, business loans can seem complex. But just knowing the basic types and which ones might be available to you can be beneficial.
So before applying for a loan, figure out exactly what you need and why. If you don’t, your business could suffer devastating cash shortages during the crucial startup stages. In fact, according to CB Insights, 38% of startups fail because they ran out of money or failed to raise funding. To avoid failure, do your research and give yourself the best chance of getting the right loan for your purposes.
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The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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