Business Loans and Other Funding Options
You’ve realized that your business needs more capital to sustain operations and fuel future growth. Where do you start? If the bank turns you down, what are your options?
This summary is a guide to the different types of loans and funding programs available to businesses. You should research those that seem like they might apply to your business, paying attention to costs, term, the impact to your credit rating, and the application process.
Traditional Small Business Loans
Traditional small business loans are offered by bank and non-bank lenders alike. Borrowers usually receive the entire amount of the loan upon the closing of the loan. The term and interest rate are influenced by numerous factors, including the amount borrowed, the purpose, and the credit standing of the borrower. In some cases, the lender may ask the borrower to personally guarantee the payback of the loan.
Small Business Administration (SBA) Loan
A Small Business Administration or SBA-backed loan is different from a traditional business loan. If you default, the SBA will cover part of the loss to the lender. However, this makes the application process substantially more involved. There will be more restrictions than with a traditional bank business loan. As a result of all these restrictions, not every bank will offer SBA-backed loans. For more information and details about SBA loans, visit www.sba.gov.
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Bank Lines of Credit
Bank lines of credit are designed to finance short-term working capital needs, such as inventory purchases or operating expenses. Businesses with fluctuating sales, such as seasonal businesses, tend to use lines of credit to smooth out and supplement their operating cash. To receive a line of credit, a business will generally need to be profitable and able to demonstrate positive cash flow. The interest rates are usually better than credit card rates.
Businesses seek bridge loans to sustain short-term financing in between major financings. The loan serves as a “bridge” between one state of stable financing and another. For example, if a firm is reaching the maturity date for a bank loan, but hasn’t yet completed the process for additional funding, they may use a bridge loan to maintain operating cash. Bridge loans are more expensive than most traditional financing, and are only meant to be a short-term stopgap solution.
Corporate Credit Cards
A business credit card is similar to a personal credit card. It’s a revolving line of credit with a set dollar limit. It’s usually easier to qualify for a business credit card than a bank business loan. The incentives offered by credit card companies, such as free flights and cash-back discounts, can be useful for small businesses. The interest rate on a credit card, however, is usually higher than rates for bank lines of credit or small business loans. The loan limit is usually lower, as well. The issuing bank may require a personal guarantee from the owner for repayment if your company can’t pay the bill.
Commercial Real Estate Loans
Commercial real estate loans are mortgages, similar to the one you may have on your home. However, there are three major differences. First, lenders generally consider commercial mortgages to be more risky than home loans; thus, they tend to require a larger down payment and more documentation. Also, lenders evaluate commercial real estate as much by the expected future cash flow from the property as by its relative value and the likelihood of appreciation. Finally, commercial mortgages tend to be shorter term than consumer home mortgages.
Hard Money Loans
Hard money loans are loans made against the equity in a business, either its real estate or in other assets. It’s a cornerstone in the asset-based financing industry, along with merchant cash advances and receivables factoring (two forms of finance that are not lending, strictly speaking, but have similarities to lending). Hard money loans are usually made by nonbank lenders, and they carry interest rates several points higher than standard bank loans. Borrowers who can’t obtain bank financing are candidates for these loans.
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Angel and Venture Capital Loans
Angel investors and venture capitalists are known for trading cash for equity. But a surprising number of these investments are loans. According to data from the Entrepreneurship in the United States Assessment, debt accounts for about 40 percent of the money angels invest in startups. Convertible bonds that allow a lender to convert the value of the debt to equity at a pre-determined date are relatively common.
Accounts Receivable Factoring
AR factoring, or invoice factoring, is the sale of your accounts receivable, at a discount from face value, to a financier. This type of financing is common in industries whose sales have payment terms. For example, you’ve sold a crate of goods to a client on credit with net 30 terms, but you need to pay your suppliers within the next 10 days. AR factoring allows you to sell your receivable to a financier in exchange for immediate cash. The amount of the discount and overall cost varies widely across industries and is dependent on the credit quality of both you and your client.
Merchant Access to Capital
A merchant access to capital program involves the sale of future card-based sales to a financier. Essentially, the financier offers money up front, making this transaction an “advance,” not a loan, for the right to collect a portion of a company’s future sales. Often, this kind of financing is offered in conjunction with credit card processing services, with the financier generally replacing the merchant’s credit card terminal with one that can direct a percentage of card sales to the financier’s accounts. Rates tend to be higher than for traditional financial sources, but the service is usually available to any merchant processing at least $2-3,000 in credit card transactions each month.