Standard business loans can take on several different forms in specific situations:
Term loans are the most common general purpose loan. They’re used for working capital, expansion, refinancing, and acquisitions. You’ll repay them monthly over a term based on the expected lifespan of the assets you’re purchasing. This straightforward loan is most common for larger amounts.
Short term loans are almost always set up for terms of one year or less, and are repaid in a lump sum at the end of the term, instead of monthly. They’re usually for smaller amounts – less than $100,000 – and are best for seasonal inventory buildup or small investments with quick returns.
Equipment financing is generally easier to obtain then general lines of credit, simply because the equipment you buy serves as direct collateral for the loan. It’s also less risky, in that if you are unable to make your payments, you don’t have a lien against your entire business or your personal real estate: all you lose is the equipment you bought. Depending on the size of your business, equipment financing can cover huge expenses into the millions of dollars.
Lines of credit are more general business loans that are often set up to insure against cash flow problems. Instead of getting a check for the full amount of the loan, the financial institution will allow you to borrow up to a certain amount per year – you take out the money in increments as you need it. The flexibility comes at a cost, though: if you don’t repay the loan balances fairly quickly, they can quickly become more expensive than other types of loans. Avoid using a line of credit for significant business improvements: they’re designed for temporary cash shortfalls.
Credit card advances – in lending, this phrase does not mean taking out cash through your business credit card, although many businesses do that. Instead, it’s a loan based on your track record and your expected future business. It’s a good choice if your business has at least a three-year history of accepting credit cards. Because the credit card sales are such a good estimation of your future earnings, you’ll be able to get a fairly good rate on a loan against your expected income.
While there are stringent federal guidelines about how banks and other lenders conduct business, there are no definitive standards as to how the various types of business loans are structured: terms and conditions may vary from one lender to the next, and minimum and maximum amounts can differ. Be sure you know exactly what conditions apply to each loan you’re considering.
Another option for many small businesses is factoring, also known as receivables financing. Factoring is basically selling your invoices to a third party: instead of waiting for your customers to pay, you can get the funds immediately – minus a small fee (3% to 5%) due to the factoring company. Typically you’ll receive 80% of the invoice value upfront and the remaining value once the client pays.
Your business might be a good candidate for factoring if you have:
- Fewer than three years in business
- Good growth prospects but less than stellar cash flow
- Active accounts but slow paying customers