Business Loans 101

A Guide to Borrowing for Your Small Business

Business Loans 101
December 20, 2013

If you own a small business or intend to buy or start one, you will probably be borrowing money at some point — and possibly more than once. You may need money for startup costs, expansion, cash-flow management, disaster recovery, or any number of uses requiring operating funds and/or capital investment. Unless you have a money tree, trust fund or fairy Godmother, you may need a business loan to tide you over when cash is tight.

Typical types of small business loans include:

  • Standard Term Loans - A standard loan used for working capital. They may be secured (using company assets as collateral) or unsecured (based only on the credit rating of the business). Personal assets can be used as collateral for secured loans, but with obvious risk.

  • Startup/Acquisition Loans - Funds used to start up a business or acquire a business/franchise. To convince a lender, startup loans will often require a sound business plan and the use of personal assets as collateral to persuade the lender.

  • Lines of Credit - These are short-term loans to smooth out cash-poor periods. They may be secured against business inventory, or unsecured if you have sufficiently good business credit. These types of loans are generally high interest and must be managed carefully and paid promptly.

  • Factoring - Effectively selling your accounts receivable for short-term cash flow (typically 1 month or less).

  • Revenue-based Funding - A loan where the lender is paid back in a percentage of the company's revenue until the loan is fully paid off.

Not every businessperson can borrow from family or friends, and it is often not a wise idea. Some people can relinquish equity to angel investors and venture capitalists. Your typical source for loans will be standard financial institutions such as banks and credit unions.

Local banks are the place to start; they are often more likely than larger, more bureaucratic institutions to provide loans to small businesses. They're also generally more flexible and willing to work with you. It's usually best to keep your lines of credit local if rates are favorable.

A relatively new source of lending is peer-to-peer services (from online lenders like Prosper or Lending Club). Being peer-to-peer, these lenders do not have the overhead of banks and are usually less expensive — but they are lending directly to you instead of to your business. If you have a hard time convincing a bank of your creditworthiness, you may not fare much better here.

Small Business Administration (SBA) loans are a bit of a last resort. They require you to exhaust all financial resources first, including personal assets — but if you are in this position, it is worth checking to see if you qualify. The definition of "small business" varies by industry, but it's generally less than 500 employees for manufacturing, and less than $7 million in net worth for other industries.

The SBA does not lend directly to businesses. They partially back the loans, reducing the risk to the lender and making it easier for them to provide small business loans. The SBA offers three primary types of loans:

  • General Small Business Loans - Known as 7(a) loans, they can provide up to $1 million to be used for most business needs (except for financing existing debt).

  • Microloans - Up to $50,000 is available per loan (typical loan is $13,000). There are often training requirements included.

  • CDC/504 Loans - These are for large expansion items such as capital equipment and real estate.

The SBA also offers disaster loans for those in areas that have been officially declared disaster areas.

Don't forget to check for alternate government assistance. State and local economic development programs are worth reviewing; they may be able to help you secure loans or acquire grants. Programs are also available to help veteran and minority-owned businesses. Even if you do not qualify for an SBA loan, local offices can offer training, mentor programs and other helpful resources to entrepreneurs.

If you are interested in a personal loan, visit our curated list of top lenders.

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