Access to financing is essential for many small business owners, whether you’re starting a new venture or looking to expand an established one. However, it’s not always easy to secure the capital you need. According to the latest Small Business Credit Survey by Fed Small Business Administration, 59% of employer firms sought financing in the 12 months leading up to the survey, but only 41% received the amount they requested. The remaining 36% received less capital than they sought, while 24% couldn’t access any.
However, the good news is—you have more financing options today than ever before. Capital is no longer solely available from traditional banks with strict requirements and tedious application processes. In recent years, a wide range of non-bank, digital business lenders have cropped up with more versatile financing options, convenient online applications, and flexible eligibility requirements. If you’re looking for a loan or for your small business, read on for a guide to six popular types of financing and tips on how to find the right lender for your situation.
Quick list:
- Business term loans
- Business lines of credit
- Business credit cards
- SBA loans
- Accounts receivable financing
- Revenue-based financing
1. Business term loans
A business term loan provides a lump sum amount upfront, which you repay (plus interest and fees) over a set term through fixed payments. For example, you might take out a loan for $10,000 and repay it over five years through 60 monthly payments of $212. The amount of interest you pay will depend on the interest rate the lender assigns you and the length of your loan term. The lower the rate and the shorter the term, the lower your interest costs will be. Additionally, lenders may charge fees, such as an origination fee to cover underwriting and processing. It’s also important to note that these loans can come in many forms, including secured and unsecured versions. They may be positioned as loans for certain assets or industries, such as agriculture loans, equipment loans, or commercial real estate loans, but share the same underlying term loan structure.
A term loan can be advantageous because it provides you with a lump sum upfront that you can use to fund business expenses. It also typically provides a predictable monthly payment amount, a fixed overall cost, and a defined payoff date. Further, if you pay off a term loan early, you may be able to save on the interest costs—although some come with prepayment penalties. On the downside, term loans are less flexible than some other types of financing. You can’t borrow more or less as you go, the loan amount is fixed from the start, and you have to pay interest on the full amount from day one. They’re often best when you know how much you need to borrow and are going to spend it all upfront—or if you simply prefer predictability over flexibility.
2. Business line of credit
A business line of credit provides you with a set amount of credit that you can use, repay, and use again. Unlike a term loan, where you pay interest on the full amount from the start, you only pay interest on the money you actually withdraw from a line of credit. The rest just sits there available. As for the repayments, once you use a credit line and have an outstanding balance, the financing company requires you to make a minimum payment toward the balance each month. If lenders have a set draw period, you’ll only be able to use the credit line for a certain amount of time (often one to five years). After the draw period ends, common options include a balloon payment, a renewal, or a conversion of the balance into a term loan with fixed repayments.
A line of credit can be a good financing solution when you’d like general access to capital on an ongoing basis. More specifically, it can be beneficial when you’re not sure how much you need to borrow, you need to borrow money in phases, or you want to keep your initial repayments as low as possible. On the downside, lines of credit often come with variable rates, which can increase the cost of borrowing over time. The easy access to funds and revolving structure can also lead to overspending. Further, the terms aren’t always clearly communicated. To prevent surprises, be sure you understand all the details, including the fees, interest rate type, draw period, demand clauses, and repayment requirements.
3. Business credit cards
Next up are business credit cards, which also involve a revolving credit line that you can use, pay off, and use again. Credit card providers assess your finances and credit history to determine the maximum credit limit and interest rate you qualify for. If you get approved and accept the terms, you can use the card to make purchases up to your credit limit. Generally, you won’t be charged interest if you pay off purchases between the date your billing cycle closes and your payment due date. However, if you decide to carry a balance beyond that, interest charges will typically accrue according to the rate listed in your credit card agreement. Further, credit cards often come with various fees that can increase your costs, such as annual membership and foreign transaction fees.
Business credit cards can be beneficial because they provide you with an easy way to finance purchases on an as-needed basis. If you pay off your balance each month, they offer an interest-free, short-term financing solution that may come with rewards and member benefits. If you choose to carry balances, you can do so as long as the card is open and will only be required to make a relatively small minimum monthly payment. However, carrying balances long term can get expensive. If you only make the minimum payment, you can end up in a never ending cycle of paying the provider interest. Other drawbacks include that credit cards tend to have higher interest rates than other types of financing and often don’t offer as much capital.
4. SBA loans
The U.S. Small Business Administration (SBA) has multiple loan programs in place designed to make funding accessible and affordable for small business owners. However, the federal agency doesn’t provide the financing directly. Instead, it sets out loan guidelines and guarantees loans provided by SBA-approved third parties. The main SBA loan programs include:
- SBA 7(a) loans (primary program): Guarantees loans up to $5 million provided by intermediary lenders, which can be used for a wide range of business purposes, such as purchasing or updating fixed assets, working capital, refinancing business debt, and more.
- SBA Microloans: Guarantees loans of up to $50,000 provided by intermediary lenders, which can be used to start or expand a small business. These loans can’t be used to pay existing debts or buy real estate.
- SBA 504 loans: Guarantees loans of up to $5 million provided by Certified Development Companies (CDCs), which can be used to finance major fixed assets that promote job creation and business growth (e.g., buildings, land, new facilities, machinery, equipment, etc.). These can’t be used for working capital, inventory, refinancing non-qualified debt, or investment in rental real estate, and more.
Thanks to the guarantees, SBA loans typically have lower interest rates and longer terms than traditional, unsecured small business loans. However, you will have to meet the eligibility requirements of both the SBA and the intermediary lender. Additionally, the origination process can take longer and be more involved than applying for a loan that doesn’t involve the SBA.
5. Accounts receivable financing
Accounts receivable (AR) financing involves selling your outstanding invoices or receivables to a finance company. In return, you get an immediate cash advance, often equal to around 80% to 90% of the invoice value. Once your client pays you, you repay the AR financing company for the advance, plus any fees or interest due. Fees are often structured as a flat percentage of the advance amount and are charged based on how long it takes you to repay the loan (e.g., 3% per week).
AR financing can be beneficial if net payment terms are causing you to experience cash flow shortages. The advances allow you to get paid right away, which can help to keep your business operations running smoothly. On the downside, you typically can’t advance the full amount of an invoice. Further, taking an advance comes with a cost, which becomes increasingly expensive the longer it takes your client to pay you. Additionally, if your client doesn’t end up paying you, you’re still on the hook for the balance and fees with the financing company.
6. Revenue-based financing
Revenue-based financing provides small business owners with a lump sum upfront, similar to a term loan. However, instead of making fixed repayments over a set term, you allow the financing company to take a percentage of your ongoing revenue until the advance is paid in full. That percentage may be taken from each payment you receive or at regular intervals, such as once per day or week. Along with repaying the original loan amount, you typically have to repay a fee known as the factor rate, which is added to your loan balance at origination.
Revenue-based financing can be an enticing option for those with fair-to-poor credit or little time in business, because eligibility typically relies solely on your revenue trends. The funding times also tend to be very fast, making this helpful when you need financing quickly. However, the costs can be high, and there is often no benefit to paying off the loan early because the factor fee gets baked into your loan balance.
Explore business financing options with Lili
These are six of the most common business financing options on the market. When deciding which one is right for your needs, look for a loan type that best suits your business’s current risk profile, adequately covers the cost(s) you’re trying to finance, has a repayment structure that works with your budget, and keeps your borrowing costs as low as possible. While every loan type has pros and cons, the key is finding the one that offers the most advantages and fewest drawbacks for your situation. Once you decide on a loan type, be sure to shop around and compare the offerings of at least three lenders so you get a competitive deal.
Not sure where to start? Stay tuned for some exciting news about how Lili can now help you find great-fit financing options for your small business.
