Starting a business requires a lot of capital. Entrepreneurs are usually faced with the challenge of finding and sourcing funds that they can use to get their projects off the ground. There are different ways of obtaining funds, and one of them is borrowing.
Borrowing can be a good strategy to access capital when starting a business, expanding your business, or recovering from a dip. However, finding the right type of loan can be a daunting task. In this blog post, we discuss five types of business borrowing options that entrepreneurs should consider.
Traditional Bank Loan
These loans are the most common type of business loans. They are granted by traditional banks and require collateral, good business credit, and a solid business plan. The interest rates are relatively low (usually between 4-10%), and the repayment periods range from one to seven years. The downside is that they may require a long application process, and approval rates can be challenging.
Small Business Administration (SBA) Loans
SBA loans are backed by the Small Business Administration. They are designed to help small business owners secure funding more easily. The loans can be used for business expansion, inventory, equipment purchases, and working capital. SBA loans require a good credit score and a sound business plan. The interest rates are lower than traditional bank loans, and the repayment periods can be up to 25 years.
In order to get an SBA-backed loan, you’ll visit the SBA’s loans page to find a loan type, find a lender in your area, and then apply for a loan through your local lender.
Business Line of Credit
A business line of credit is a type of loan that allows entrepreneurs to access funds as needed. They are similar to credit cards where businesses use them when necessary and only pay interest on the amounts used. Entrepreneurs can use the loan for small purchases or to cover gaps in working capital. The interest rates are usually higher, but the flexibility is worth it.
Remember that the best time to obtain a business line of credit is when you don’t need it. So, apply for a line of credit when you’re flush with cash, and then it will be there when you have temporary, short-term cash crunches.
► PRO TIP: With a line of credit you should only be “in the line” 90-120 days per year, meaning the rest of the year pay down the line and carry a zero balance.
Invoice Factoring
Invoice financing allows entrepreneurs to get funds based on their outstanding invoices. It’s an option for businesses with high cash flow requirements, such as fast-growing businesses. The financing company takes over the outstanding invoices and receives payment from customers, while the entrepreneur receives the funds upfront minus the financing fee.
Personal Loans
Personal loans are an option for entrepreneurs who do not have a good business credit score or are still working on building their business credit. They’re granted based on personal creditworthiness and can be used for personal or business purchases. However, personal loans can be expensive, as they usually have high-interest rates and short repayment periods.
Also, make sure that if you personally borrow money for business purposes, that you also lend the money to the business. You’ll need a formal loan agreement between you and the business, stated repayment terms and a stated interest rate to avoid it being deemed as a capital contribution. And remember, personal loans to finance your business are different than personal guarantees on business borrowing.
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The Takeaway
It’s essential to understand the different types of business borrowing options and their pros and cons. Each option comes with different terms, interest rates, and requirements that can support or hurt your business. Assess you business needs, risks, and goals before deciding which borrowing method to use. When choosing business borrowing options, carefully review and compare the terms and conditions of each loan to find one appropriate for your business.
Make sure that you can afford the repayments, and don’t forget to include the loan payments in your business budget.
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