“It takes money to make money."
It's an age-old expression that few business owners would deny.
When you're running your own business, achieving your goals and growing often depend on how much cash you have in the bank.
Sometimes you can build your business based on a disciplined use of cash flow. But for many, opportunities for growth often present themselves as an investment—an investment that your cash flow can't support.
So if you find yourself needing financing to invest in your business, the good news is that you've got options (and more options than ever).
The internet has done to business lending what it's done to so many other industries: expanded, diversified and democratized financing options for businesses.
If you're currently evaluating financing for your business, here are three types to consider.
1. Traditional Bank Financing
When your business needs funds, a bank is probably the first place you think of. Banks have traditionally been a major source of capital for businesses, and to date, they are still generally the most affordable source of capital.
It may not be as easy as it once was to get a bank loan or line of credit, but don't let that discourage you. Here's why:
- If you want to consider bank financing, here are a few things you should know going in: If you're going to get a bank loan, you must have decent financials. They'll want a strong personal and business credit, a profitable business with enough revenue to cover loan payments with no sweat, and they'll want your business to be somewhat established (2-plus years, if not more). If you're not sure you check all the boxes, don't let that deter you—but do set your expectations properly.
- It's important to set your expectations, as the bank-loan process can take quite some time. If you need fast cash, the bank is probably not your best option. If you need kind-of-quick cash, but aren't sure if the bank will fund you, be prepared that you might not hear back in a few weeks or months, and need to have a plan in place if the answer is no.
- Smaller banks can be more business-friendly than larger banks. If you want to increase your chances of getting approved, you may want to consider a community bank.
- Having a relationship with a bank is helpful. If they've seen you pay your credit card and mortgage, and you keep a healthy checking and savings account for years, that can only help you.
- Collateral is something a lot of business owners ask about related to bank loan. Every bank has different requirements, but be prepared that they may ask for collateral, and at the minimum, ask you to sign a personal guarantee.
Banks continue to be a good source of capital for businesses that have time to invest in an application and are already financially mature. If you don't have those two things, read on.
2. SBA Loans
SBA loans are often to referred to as bank loans, but they should be thought of differently, because they are, in fact, different.
While the majority of SBA loans are issued by banks, this financing type is worth noting for a few reasons:
- SBA loans are partially guaranteed by the government, which eliminates some risk for the financial institution making the loan.
- Therefore, SBA loans can be somewhat easier to qualify for than traditional bank loans.
- SBA loans are very affordable, often close to the cost of a bank loan.
- The SBA has a few different loan programs. The most common is the 7(a) loan program, which offers a traditional term loan product, but you should explore all of the agency's loan programs before applying.
SBA loans can be a great option for small-business owners. However, their applications can be just as extensive as bank applications. Be sure you know the application requirements and general eligibility minimums before taking the time to start the process.
SBA loans can sometimes be processed faster than a traditional bank loan, but may still take weeks, if not months, to process. If you need money quickly and want to consider an SBA loan, there are online options—for SBA loans specifically—that might move faster than going to your local bank.
3. Alternative Debt Financing
The world of small-business lending is much more complex than it once was. To the benefit of the business owner, it's no longer just banks lending money.
Alternative debt financing is an industry that has skyrocketed in the past decade. Post-recession, when bank lending to small businesses shrunk, alternative, “non-bank" lenders sprung up to fill the void. Now there are dozens of financing types for your business to consider.
There are finally options for younger or less-creditworthy businesses, but many of these loans are not like traditional bank loans.
If you aren't aware the loans that appear when you Google “small business loans" aren't all the same, you could end up getting a worse deal than you realize. Since these products are so different, it is important you know what they are and how to understand their pricing before getting one.
Here's what you need to know about the different products you'll find online:
Long-term loans from online lenders look very similar to your typical bank loan. They lend you a lump sum of money, which you pay back (with interest) monthly. These online term loans tend to only be 2 to 5 years in length, and their APRs can be more expensive than banks, sometimes in the double-digit range.
Pros: Generally easier to qualify for than bank or SBA loans and can offer a much faster process
Cons: Can be more expensive than a bank loan
Long-term loans are a good “in-between" for those that could potentially qualify for a bank loan but need capital more quickly.
Short-term loans are also a lump sum of money you pay back with interest, but stand out with their term length and repayment frequency. Short-term loans are paid back within 3 to 18 months and are often paid back with daily or weekly payments. Due to both of these things, even though the total cost of capital might be similar to long-term loans, their APRs can be high.
It's important to note that many short-term lenders may quote their pricing as a “factor rate." For example, they might say the cost of borrowing is a 1.15. You might assume that's a 15 percent interest rate, but on a short-term loan of, say, $40,000 (with no origination fee) that has to be paid back in 6 months, that's a 56.88 percent APR.
Be sure to calculate a factor rate to APR before taking on the loan.
Pros: Lower credit, revenue and time in business requirements than other products and can fund in days
Cons: High APRs
If you need fast cash and don't qualify for a long-term loan, short-term loans could be your next best option.
Lines of Credit
A line of credit is a product you're familiar with, but in online lending, the product might be a bit different (mainly, more expensive) than you'd expect. There aren't many lines of credit you can apply to through an online lender that are as affordable as, say, long-term loans you can apply to through an online lenders.
Most of the lines of credit offered through online lenders have high interest rates. You want to be careful to calculate the cost of any money you choose to pull on an online line of credit.
Pros: Easy to qualify for and you only pay interest on funds drawn
Cons: Often expensive
A line of credit is something all business owners should have access to. When running a business, emergencies can occur at anytime. Fast cash is expensive cash, and having a line of credit in place keeps you from frantically having to find funding. With online lines of credit, business owners who can't get a line of credit from their bank have another option.
Merchant Cash Advance
Merchant cash advances are a product where a financing company fronts you a set amount of cash that you pay back with a percentage of your daily credit-card sales.
These products are often how online lending is defined, but happen to be one of the more expensive products on the market.
While there are perks, such as “setting and forgetting" your payment, or paying more on days when sales are strong and less when they are weak, you should always consider your other options before taking on a merchant cash advance.
Pros: Easiest credit requirements
Cons: Very expensive and might require changing your merchant service provider
Merchant cash advances are typically best for businesses that qualify for no other products and firmly believe their cash flow can afford a daily payback.
Many alternative lenders are specialty lenders that look to use one of your business assets to collateralize a loan. The most popular asset-backed loans are invoice financing and equipment financing.
With invoice financing, lenders usually upfront you for a set percent of your outstanding invoices (say 85 percent). Once your invoice or invoices are paid, you get the remaining 15 percent back, minus any fees. They usually have a set fee for the transaction and then charge a fee per week outstanding.
With equipment financing, lenders will finance a piece of equipment you're buying. They can give you up to 100 percent of the equipment's value, with the equipment itself serving as collateral. You then pay back the loan as you would a normal term loan.
Pros: Collateral allows for easier eligibility requirements and lower costs
Cons: Can take more time to process application since lenders must audit assets
If you're looking for funding to purchase equipment, consider starting your search with equipment financing providers. If your cash flow is struggling due to late-paying customers, consider invoice financing to help even it out.
What These Options Mean for You
While the business-lending market is as expansive as ever and can feel overwhelming, just remember, it's a good thing. You may qualify for funding with a new lender that didn't exist 10 years ago, or you might finally be able to shop options, when you would have only had one in the past.
No matter what, remember to do just that—shop. With so many options, you want to make sure you're getting the best deal for your business, whether that means on price, ease or time to funding.