Access to financing can help a small business purchase equipment, manage cash flow, expand operations, acquire inventory, or invest in growth. However, borrowing money also creates a repayment obligation, so business owners should understand the costs and requirements before applying.
There are several types of small business financing, and the appropriate option depends on the company’s needs, financial history, cash flow, and ability to repay the debt.
Common Types of Small Business Financing
Business owners may encounter several financing options.
These include:
- Business term loans
- Business lines of credit
- SBA-backed loans
- Equipment financing
- Commercial real estate loans
- Business credit cards
- Invoice financing
Each product works differently.
A term loan may provide a lump sum that is repaid over a defined period. A line of credit may provide access to funds as needed, subject to the lender’s terms.
Consider an SBA-Backed Loan
The U.S. Small Business Administration’s 7(a) program is its primary business loan program.
The SBA does not generally lend directly to borrowers under the standard 7(a) program. Instead, it provides a guarantee to participating lenders, subject to program requirements.
According to the SBA, 7(a) loans can be used for purposes including working capital, equipment, real estate, refinancing eligible business debt, supplies, and changes of ownership. The maximum 7(a) loan amount is $5 million.
Know How Much You Need
Before applying, calculate how much financing the business actually requires.
Borrowing too little may leave the project underfunded. Borrowing substantially more than necessary can create additional interest expense and repayment obligations.
Create a detailed budget showing exactly how the funds will be used.
Review the Interest Rate
Interest is one of the most important costs of borrowing.
A loan with a lower interest rate may have different fees or requirements than another financing option.
Do not compare loans using the interest rate alone. Review origination fees, closing costs, collateral requirements, prepayment terms, and other charges.
Examine the Repayment Period
The repayment term affects both monthly payments and total borrowing costs.
A longer term can reduce the required monthly payment but may increase the amount of interest paid over time.
A shorter term may result in larger monthly payments but potentially reduce total interest expense.
Choose a repayment structure that fits the company’s expected cash flow.
Prepare Your Business Documents
Lenders may request business and personal financial information.
Depending on the lender and loan type, documentation may include:
- Business tax returns
- Personal tax returns
- Bank statements
- Profit-and-loss statements
- Balance sheets
- Business licenses
- Ownership information
- Debt information
- Business plans
Preparing these documents before applying can make the process more efficient.
Consider Collateral and Personal Guarantees
Some business loans require collateral, while others may require a personal guarantee.
A personal guarantee can make the business owner personally responsible for repayment under specified circumstances.
Read the loan documents carefully before agreeing to these obligations.
Compare Lenders
Do not assume that the first lender you contact offers the best terms for your situation.
Compare banks, credit unions, SBA-participating lenders, online lenders, and other legitimate financing providers.
Look at rates, fees, repayment terms, eligibility requirements, funding speed, and customer service.
Watch for Predatory Financing
Business owners should be cautious of lenders promising guaranteed approval, extremely fast funding without proper underwriting, or unusually attractive terms without clearly explaining costs.
Read the agreement before signing and verify the lender’s legitimacy.
Final Thoughts
The best small business loan depends on the company’s specific financing needs and financial position.
Start by determining how much you need, why you need it, and how the business will repay it. Then compare loan types, rates, fees, repayment terms, collateral requirements, and lender reputation.
For businesses that qualify, SBA-backed financing can be one option worth researching. The SBA provides official information about 7(a) loans and participating lenders.