Starting or growing a business often requires financial support, and for many business owners, business loans are an essential resource. Banks offer a variety of loan options to meet different needs, each with their unique benefits and drawbacks. Let’s explore the most common bank loans for small businesses.
1. Term Loans
A term loan is the most straightforward type of loan offered by banks. Businesses receive a lump sum amount upfront and agree to repay it, with interest, over a fixed period—often 5 to 10 years. Term loans are the hardest to get and fall under the old adage that bankers only want to lend you money when you don’t need it.
Advantages include predictable payments as you will know exactly how much you need to pay each month. This helps with budgeting and planning although it is also possible to get a variable rate loan where the payments would change, usually quarterly, based on interest rate fluctuations. Another advantage is they are flexible. The funds can be used for a wide range of purposes, including equipment purchases, expansion, or working capital.
Disadvantages include the need for collateral. Most term loans require collateral, such as business assets and / or personal guarantees, putting your business and personal assets at risk. They also involve a rigorous qualification process. Banks typically require a solid credit history, strong financials, and usually a business track record to qualify for a term loan.
Tip: If you qualify for a term loan, go with a longer-term loan and make extra payments as long as you are not penalized for doing so. This gives you more flexibility with your cash. This goes for SBA loans as well.
2. SBA Loans (Small Business Administration Loans)
SBA loans are backed by the U.S. Small Business Administration, making them less risky for lenders and generally more accessible for small businesses. They are offered by the same banks that offer term loans and are easier to get than term loans. They have the same advantages and disadvantages as term loans in addition to the following:
Advantages include lower interest rates. Because SBA loans are government-backed, they usually come with lower interest rates compared to other loans. Another advantage is easier qualification. The SBA guarantees part of the loan, which reduces the lender’s risk and increases the chances of approval for businesses that may not have perfect credit.
A disadvantage is a potentially long application process. The SBA loan process can be slow, sometimes taking weeks or even months for approval.
3. Business Lines of Credit
A business line of credit is similar to a credit card in that it provides businesses with access to a set amount of funds. You can withdraw funds as needed and only pay interest on the amount you use. Lines of credit are often obtained at the same time as a Term Loan or SBA Loan is written but often need to be renewed annually. A common calculation for the amount the bank will let you borrow is 80% of your Accounts Receivable and 50% of your Inventory. Your Accounts Receivable and Inventory are the collateral for the loan in this case.
Advantages include flexible borrowing. You only borrow what you need when you need it. This flexibility can help with managing cash flow fluctuations. Another is it acts as a revolving credit. As you repay the balance, the credit becomes available again, allowing you to borrow more without reapplying. Having quick access to funds is another advantage. Once approved, you can access funds quickly, often through checks, online, or a linked business credit card.
Some disadvantages include higher interest rates. Business lines of credit often have higher interest rates than term or SBA backed loans, which can increase costs if you carry a balance. They also can have shorter repayment periods where the bank does not want to see a balance carried into a second year without being paid down to zero first. This can put pressure on your cash flow if you have a large balance.
4. Equipment Financing
Equipment financing is a loan specifically designed for businesses that need to purchase new equipment, machinery, or vehicles. The equipment itself serves as collateral for the loan.
Advantages include access to necessary equipment. This loan type makes it easier to acquire essential equipment without upfront capital. Also, many banks offer flexible repayment terms based on the cost of the equipment and your business’s cash flow. Equipment financing allows you to spread out the cost of expensive equipment over time, preserving cash for other needs.
Disadvantages include interest and fees. The loan typically comes with interest and fees that can make the overall cost higher than paying upfront for equipment. Also, this type of loan is restricted to purchasing equipment and cannot be used for other business needs, limiting its versatility. Finally, the value of the equipment will depreciate over time, potentially leaving you owing more than the equipment is worth if the loan is not paid off in time.
5. Commercial Real Estate
Commercial Real Estate loans are available from banks for the purchase of property. The property itself serves as collateral for the loan. Many businesses end up owning the property they occupy. They usually set up an LLC for the property and pay rent to it.
Advantages include the opportunity to make a property investment. The business owner uses the loan as leverage to buy a property that is paid off by a reliable tenant – their business. Another is longer terms. Real Estate loans have longer terms than other business loans. The longer term reduces the monthly cash outlay needed to cover the payment.
A disadvantage is default risk. If your business has trouble making rent payments to your property LLC, the loan could go into default.
In Summary:
These are the most common types of bank loans for small businesses. When considering a loan, it is crucial to assess your company’s financial situation, your ability to repay, and how the loan can help you achieve your business goals. Whether you are buying a business, need a lump sum for expansion, access to quick cash for inventory, or financing for new equipment, understanding the advantages and disadvantages of each option will help you choose the best path for your business’s future.
Final tip: Develop a relationship with your banker early and don’t be afraid to apply for a loan even if you don’t think you will get it. If your loan is not approved, they will tell you why and you will have good feedback on what needs to improve for them to consider your loan.
P.S. tap the photo below
Comentarios