Types of Business Loans: A Comparison of Different Business Loan Types
Types of Business Loans: A Comparison of Different Business Loan Types
It can be confusing trying to figure out which loan is the right one for your business. There is a myriad of financial options available for small businesses in the 21st century, each with specific advantages and disadvantages and various success rates. However, finance is always necessary, and it is the perfect time to apply for a loan.
SBA loans are the most well-known loan type in the USA. The SBA (7)(a) is a loan guaranteed up to 85% by the SBA, so banks are more willing to take on loans from small business enterprises. The rates for these kinds of loans are very competitive, which is one of the main reasons they are such a popular choice. On the other hand, this loan requires a staggering amount of documentation. A full list of the required documentation can be found here. The entire process can be laborious and time-consuming.
In order to qualify for an SBA (7)(a), you will need to have a credit score of 680 or above, be in business for more than 2 years, be seeking more than $30,000, have more than $100,000 in revenue over the past year. The company also has to be in profit. There are exceptions, but these are the general criteria for loan success. It is more common to satisfy these criteria and fail than to fail these criteria and succeed with the application.
A property loan is a loan used to buy property (generally land or house). It is not to be confused with the loan against property (LAP) which enables borrowers to put up their property in return for a loan. While land can be thought of as a safe investment, lenders often see loans to buy land as riskier and thus the application process tends to be more dogmatic and time-consuming.
A property loan to buy commercial real estate (CRE) will have different terms and conditions than a property loan to buy a residential home. Residential property loans are operated by banks in the form of mortgages. CRE loans attract large business enterprises and have a wide range of terms and conditions. Given the size of property loans, the length can be 5-20 years for CRE loans and 20-40 years for residential loans.
Term loans are loans for a fixed cash amount with a specific (fixed or floating) rate and a term period of expiration. It may or may not require collateral. A term loan is a basic loan that refers to the duration of the loan itself. It can be short (less than a year) medium (1-5 years) or long (5 years plus). Different lenders will attach different labels defining what constitutes “long” or “short”. It can also vary by industry. As a rule of thumb, anything less than 1 year is short and anything longer than 10 years is long.
Business term loans are offered by many online providers such as Kabbage, Ondeck, and Fundbox. Fundbox is one of the easiest providers, requiring only $50,000 in annual revenue and 3 months of transactions in a business checking account. They offer business lines of credit and invoice factoring, as well as small business loans for minorities. Fundbox also allows early payment so fees can be waived.
Kabbage offers business lines of credit and term loans up to $250,000. Potential applicants will need to be in business for over a year with a $50,000 minimum annual revenue. A business line of credit is a kind of unsecured business loan where the company can withdraw funds as needed and pay interest payments only on what is withdrawn. With Ondeck, the requirements are a little stricter, with a $100,000 minimum revenue and a 500 personal credit score for term loans.
A secured business loan is simply a loan that is backed by collateral. The rates on secured business loans are a little cheaper, as even if the business goes bankrupt the lending institution will still have a claim on the collateral. In the context of small business loans, collateral can include personal residential property and not just business assets. This can provide significant stress on business owners. Typically, the assets of the company will be enough, though the addition of personal property can lead to a better repayment rate.
An unsecured business loan, in contrast to a secured business loan, is one that is not backed by collateral. This means that the lending institution will offer far higher repayment rates in order to offset the potential risk. Unsecured business loans are frequently offered by alternative lending institutions with steep rates. However, in many instances, they can suit a company perfectly and are the ideal business loans for bad credit.
Consider, for example, a business enterprise with a high turnover that rents an office and only hires remote independent contractors. Unsecured loans are also suitable for those who are not willing to risk their business or residential assets or those who do not have any significant assets to speak of.
An asset finance loan is where the assets on a company’s balance sheet are used as a security to borrow money. This kind of funding is often used by businesses to cover short term costs such as bills or wages. It is an easy way to generate working capital and is a flexible way of borrowing compared to bank loans, which take too long to process with much documentation. But in general, it is not as effective as long-term loans, there is a risk of losing assets, and the valuations can sometimes be below the real price.
Trade finance loans are commonly used by wholesalers and manufacturers. They are short term loans linked to a specific import or export activity. Trade loans can help to improve cash flow during a firm’s trading cycle, operating as revolving credit facilities. This can also help to pay suppliers on time and to pay import collections. Another advantage is that it is typically offered in multiple currencies. Due to the short term, the interest is typically higher than standard business term loans.
Invoicing financing can be divided into two parts – invoice discounting and invoice factoring. Invoice discounting is where a company uses their invoice as a form of proof to obtain a loan of up to 90% of the total value of the invoices. This is not the same as invoice factoring, where the invoices themselves are sold to a third party who collects the funds on behalf of the company. Invoice financing is great for companies who need cash immediately and cannot wait 30-90 days for invoices to come in.
Equity crowdfunding has really exploded in the past decade. Investors fund a business enterprise in return for equity. Typically, groups of people will band together to invest. It is sometimes known as crowd investing or crowdfunding and is perfect for startups who need quick financial access for immediate growth and expansion.
Established businesses will have less of a need for equity crowdfunding, generally speaking. Alternative loans are available and such companies may not wish to give away equity that is expected to grow in value. Crowdfunding can also be debt based or follow a hybrid model between debt and equity.
Lease financing is where machinery, premises, or equipment is leased out to a “lessee” in return for finance. A down payment is not required with a lease agreement. When the lease has expired, the business gets its property back. The obvious advantage is that the business can get paid for equipment which is not in use, instead of paying interest rates on term loans. The process is also easier than applying for a business term loan.
Peer to peer (P2P) loans are where two entities agree to a loan contract, typically via a connecting platform. The rates and terms/conditions of these kinds of loans vary greatly depending on the individual circumstances of the borrower and seller. The interest rate is established by lenders who compete for the borrower in a reverse auction process.
A fee will also be taken by the P2P lending platform that facilitates the loan, for providing the infrastructure and performing a credit check on the applicant. Many P2P business loans are unsecured, though this is not always the case. P2P loans have experienced a huge increase in popularity in recent years given how stressful banks loans can be, along with the possibility of failure.
There are many P2P loan platforms available to connect buyers and sellers, and they make the application process run more smoothly compared with applying for a bank loan. One of the biggest and most popular platforms is Lending Club. It offers P2P business loans up to $300,000 with minimum requirements of a $50,000 annual turnover and 12 months in business. This was the first P2P platform to be publicly traded in the USA in December 2014.
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