Deciding what type of funding is right for your small business can be difficult – there is no one-size-fits-all solution for financing. There are many options, each with its advantages and disadvantages, and every business owner has acutely unique needs.
In an effort to help you understand what sort of funding you can (and should) seek for your company, here are the pros, cons, and price for the top five small business loan products.
1. Commercial Bank Loan
A commercial loan is what most people think of when they think of business lending. They have a set repayment time, set number of payments, and can have fixed or variable interest rates.
- Pros: Commercial bank loans usually offer relatively low interest rates, making them the most affordable option for a small business loan.
- Cons: They can be difficult to secure compared to other loan products, both in time spent and in approval rates. To apply, your bank may require extensive documentation, including financial statements, business history, and many other documents before approving you for a small business loan – and in the end, big banks only approve approximately 20% of their applicants (down from 50% ten years ago).
- The Price: Receive large sums ($25,000 or more) to be paid back over the course of several years. Rates generally run around 6 - 8%. Intermediate-term loans usually run less than three years, and are generally repaid in monthly installments, while long-term loans can run for as long as 10 or 20 years and include additional requirements such as collateral and limits on the amount of additional financial commitments the business may take on.
2. Non-bank Term Loan
A non-bank term loan is similar to a commercial bank loan – only with faster access to capital for a wider variety of businesses. Offered by many of the new online lenders that sprung up to fill the void left by banks, it offers a promising middle ground between borrowing from a big bank and getting a merchant cash advance.
- Pros: While traditional banks may only work with established businesses that have excellent credit, alternative lenders are often open to working with a variety of small businesses. Rather than a 20% approval rate, data suggests that approval rates for alternative lenders are as high as 60%.
- Cons: Even though they are easier to secure, they do require some collateral, and just because you are approved, doesn’t mean you can expect red carpet treatment. A non-bank loan will cost you more money than a bank loan, as they have higher interest rates across the board.
- The Price: The amount you can borrow is based on business revenue. Amounts tend to range from $5,000 to over $1 million to be paid back with a 7 to 25% interest rate over the course of 6 months to 10 years. And you can potentially receive funding much faster than with a traditional bank loan. Six months? Try two days.
3. Line of Credit
A line of credit can be a flexible option for small businesses, as once you establish the line of credit, you only draw on it when you absolutely need it. Your line of credit can meet nearly any business need, including buying more inventory, working capital, handling seasonal cash flows, paying off other debts, and more.
- Pros: You only pay interest on the funds drawn, rather than the entire established line of credit, and the capital is available to you in the moments you need it most to use for virtually any business purpose.
- Cons: The maximum credited amount available, duration of the credit line, and the repayment terms depend on your business, revenues, credit rating, and many other factors. While many small businesses can and will qualify for a line of credit, newer and less-established businesses might find it isn’t a viable option.
- The Price: Depending on revenues, businesses may receive between $10,000 and $1 million (sometimes more) to be paid back anywhere between six months and five years, with about 7 to 25% interest rate. Lower credit scores can expect to see higher rates. Additionally, a line of credit could potentially tie up your credit, preventing you from applying for other loans.
4. Business Credit Card
Like with any other card, a business credit card provides you with easy access to a line of credit with a set limit, in order to increase your purchasing power. If the balance isn’t paid in full each month, you incur an interest charge. It’s very similar to a line of credit, save that the line is a fixed time period and a credit card provides you with revolving credit over time.
- Pros: Small business credit cards are easy to qualify for, as they don’t require any collateral to secure – instead, you sign a legally binding agreement to pay back the credit. In fact, just under 50% of small businesses receive the capital they need via credit card.
The revolving door means you only have to apply once – with loans or credit lines, if you need additional financing after the terms of the agreement are met, you’ll have to apply all over again.
Additionally, they can be good to have on hand for smaller, everyday purchases, giving you a cushion in times when your cash flow is low. And if you have poor credit, you can improve your standing over time with regular, above-minimum payments to the card.
- Cons: Despite the fact that the card represents your business, some providers require you to sign a personal guarantee – if you (or someone at your business) doesn’t manage the card properly, it could hurt your personal credit as well. As well, if you need hard cash, using your credit card to get it will make your interest rates soar. And don’t forget, like with any other credit card, you must be diligent about monitoring the card for fraud or security issues.
- The Price: Unlike with a loan or line of credit, your provider can alter or reset your interest rate and credit limit, depending on how you handle your account. Furthermore, providers usually charge a much higher interest rate (1-3% over prime) than a bank loan or fixed line of credit. However, by paying the credit in full each month – or as close to full as possible – this can still be a cost effective option for small business owners.
5. Merchant Cash Advance
A merchant cash advance is a way to receive business cash without having to exchange collateral or prove your credit standing. Once you have the money, you pay back the sum, plus a fee, by authorizing the MCA provider to take a fixed percentage of your daily credit card receipts until the advance and the fee have been repaid.
If you receive a large portion of your revenues through credit card payments, you can use a merchant cash advance as a short-term financing tool to help with cash flow, purchase inventory, pay other debts, meet unexpected expenses, and more.
- Pros: If you have poor credit, a MCA is still a way to receive funding – and fast (it’s possible to receive funding in just a day or two). And because you repay the advance as a fixed percentage, there are no minimum payments. You pay larger amounts when your business is bustling, and smaller ones when you find yourself in a bit of a dry spell.
- Cons: Because payment is automatically deducted from your account based on credit card receipts, a cash advance can hinder cash flow. Additionally, some providers charge a prepayment penalty fee, meaning you could be fined if you pay off your debt before its maturity date. And because the fees are much higher than with traditional loans, merchant cash advances can be very expensive.
- The Price: Fees tend to range from 15% to 80% APR of the amount financed, but providers measure their fees as a factor rate, which can range from 1.14 to 1.48. The advance amount you receive is multiplied by that factor rate to determine the total amount you’ll pay back. For example, looking at a $50,000 loan:
$50,000 advanced cash x 1.48 factor rate = $74,000 owed to the provider
Because payments are collected from your receipts (in increments sometimes as little as 8% of your daily intake), the amount it takes to repay a cash advance can vary; average repayment times are usually between 8 and 9 months.