A Guide to Choosing the Right Small Business Loan

Examples

Date: 12.03.2018

If you are in need of a business loan in 2018, finding the right lender and type of loan can be a confusing process. To point you in the right direction, you first need to answer a few critical questions:

  • How much money do you need?
  • What do you need the money for?
  • How quickly do you need the money?
  • How long will it take you to pay it back?
  • How long have you been in business?
  • What is the current financial shape of your business?
  • How much collateral, if any, do you have to put up for the loan?

Answering these questions will help determine if you should pursue a government-backed loan, a loan or line of credit through a bank, or a cash advance, line of credit or loan from an alternative lender.

If, after answering these questions, you know which type of lender is best for you, you can check our recommendations for various types of loans on our best picks page. If you're not sure yet, keep reading. 

Here's a breakdown of what you need to know about each type of lender.

Small Business Administration Loans

  • The Small Business Administration offers several loan programs designed to meet the financing needs of a wide range of business types.
  • With these loans, the government isn't directly lending small businesses money. Instead, the SBA sets guidelines for loans made by its partners, which include banks, community development organizations and microlending institutions.
  • The SBA reduces the risk to lenders by guaranteeing that the loans will be repaid.
  • Businesses have a variety of SBA loan types to choose from, each of which comes with its own parameters and stipulations on how the money can be used and when it must be repaid.

Pros and cons: The government guarantee, which typically covers 75 to 90 percent of the loan, eliminates much of the risk for the lender. The terms of an SBA loan also tend be more favorable to borrowers. The downsides are that additional paperwork needs to be filed, extra fees need to be paid, and it takes longer to get an approval.

What the experts say: "The SBA provides a guarantee that enables the bank to extend credit it would have otherwise declined," Javier Marin, director of business development for the Central Florida Development Council and a former consultant with the Florida Small Business Development Center at the University of South Florida, told Business News Daily. "This is true for startups, companies with a tight cash-flow stream, and business owners with borderline, not bad, credit scores."

To learn more about specific SBA loans, review the SBA loans portion of the Types of Loans section below.

Conventional Bank Loans

  • While banks are often the sources of SBA loans, they also are lenders of conventional loans.
  • The biggest difference between SBA loans and non-SBA conventional loans is that the government isn't guaranteeing that the bank will get its money back. 
  • While a specific plan is still needed to get approval, bank loans don't come with such stringent use terms as SBA loans do.

Pros and cons: The biggest pluses of conventional bank loans are that they carry low interest rates and, because a federal agency is not involved, the approval process can be a little faster. However, these types of loans typically include shorter repayment times than SBA loans and often include balloon payments. Additionally, it's often difficult to get approved for a conventional bank loan.

What the experts say: "Even though approval rates have increased, big banks approve [only] slightly more than 20 percent of the loan requests they receive," said Rohit Arora, CEO and co-founder of Biz2Credit. "Smaller banks approve a little less than half of the loan applications they receive."

To learn more about specific conventional bank loans, review the conventional bank and alternative lender portion of the Types of Loans section below.

Alternative Lenders

  • Alternative lenders are particularly attractive to small businesses that don't have a stellar financial history, because approval requirements aren't as stringent.
  • Alternative lenders typically offer online applications, make approval decisions in a matter of hours and providing funding in less than five days.
  • There are direct alternative lenders, which lend money directly to small businesses, and lending marketplaces, which provide small businesses with multiple loan options from different direct lenders.
  • Examples of direct alternative lenders are Fundation, Kabbageand OnDeck Capital. Lending marketplaces include Bizfi and Biz2Credit.

Pros and cons: The positives of working with an alternative lender are that your business doesn't need to have a stellar financial history, there are few restrictions on what you can use the money for, and the loans can be approved almost instantly. The downside is that interest rates can be significantly higher than those charged by a bank.

What the experts say: "While a borrower is able to get money quickly, he or she pays a premium for that in the form of higher interest rates," Arora said. "Alternative lenders are more willing to provide money to companies that might not have great credit ratings. The increased risk the lenders take is reflected in the interest rate charged."

To learn more about alternative lender loans, see our Best Alternative Lenders for Small Business reviews.

Types of Loans

SBA Loans

Currently, the SBA offers four types of small business loans:

  • 7(a) Loan Program:7(a) loans, the SBA's primary lending program, are the most basic, common and flexible type of loan. They can be used for a variety of purposes, including working capital; the purchase of machinery, equipment, furniture and fixtures; the purchase of land and buildings; construction of new buildings; renovation of an existing building; the establishment of a new business or assistance in the acquisition, operation or expansion of an existing business; and debt refinancing. These loans have a maximum amount of $5 million, and borrowers can apply through a participating lender. Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets.
  • Microloan program:The SBA offers very small loans to new or growing small businesses. The loans can be used for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery or equipment, but they can't be used to pay existing debts or purchase real estate. The SBA makes funds available to specially designated intermediary lenders, which are nonprofit organizations with experience in lending and technical assistance. Those intermediaries then make loans up to $50,000, with the average loan being about $13,000. The loan repayment terms vary based on several factors, including the loan amount, planned use of funds, requirements determined by the intermediary lender and the needs of the small business borrower. The maximum repayment term allowed for an SBA microloan is six years.
  • Real estate and equipment loans:The CDC/504 Loan Program provides businesses with long-term fixed-rate financing for major assets, such as equipment and real estate. The loans are typically structured with the SBA providing 40 percent of the total project costs, a participating lender covering up to 50 percent and the borrower putting up the remaining 10 percent. Funds from a 504 loan can be used to purchase existing buildings, land or long-term machinery; to construct or renovate facilities; or to refinance debt in connection with an expansion of the business. These loans cannot be used for working capital or inventory. The maximum amount of a 504 loan is $5.5 million, and these loans are available with 10- or 20-year maturity terms. 
  • Disaster loans:The SBA provides low-interest disaster loans to businesses of all sizes. SBA disaster loans can be used to repair or replace real estate, machinery and equipment, as well as inventory and business assets that were damaged or destroyed in a declared disaster. The SBA makes disaster loans of up to $2 million to qualified businesses.

Loans From Conventional Banks and Alternative Lenders

Banks and alternative lenders offer some similar loans to those offered by the SBA, as well as funding options that the SBA doesn't offer, including the following:

  • Working capital loans:Working capital loans are designed as short-term solutions for businesses in need of money to help run their operations. Working capital loans are available from both banks and alternative lenders. The advantage of a working capital loan is that it gives small businesses the ability to keep their operations running while they search for other ways to increase revenue. Some downsides of working capital loans are that they often come with higher interest rates and have short repayment terms. 
  • Equipment loans:In addition to the SBA, both banks and alternative lenders offer their own types of equipment loans. Equipment loans and leases provide money to small businesses for office equipment, like copy machines and computers, or things such as machinery, tools and vehicles. Instead of paying for the large purchases all at once upfront, equipment loans allow business owners to make monthly payments on the items. One benefit of equipment loans is that they are often easier to obtain than some other types of loans, because the equipment being purchased or leased serves as collateral. Equipment loans preserve cash flow, since they don't require a large down payment and may offer some tax write-off benefits. 
  • Merchant cash advance:This type of loan is made to a business based on the volume of its monthly credit card transactions. Businesses can typically receive an advance of up to 125 percent of their monthly transaction volume. The terms for repaying a merchant cash advance vary by lender. Some take a fixed amount of money out of a business's merchant account every day, while others take a percentage of the daily credit card sales. The advantages of merchant cash advances are that they are relatively easy to obtain, funding can be received as quickly as in a few days, and the loan is paid back directly from credit card sales. The biggest downside is the expense: Interest on these loans can run as high as 30 percent a month, depending on the lender and amount borrowed. 
  • Lines of credit:Like working capital loans, lines of credit provide small businesses money for day-to-day cash-flow needs. They are not recommended for larger purchases, and are available for as short as 90 days to as long as several years. With a line of credit, you take only what you need and pay interest only on what you use, rather than the entire amount. These loans are usually unsecured and don't require any collateral. They also have longer repayment terms and give you the ability to build up your credit rating if you make the interest payments on time. The downsides are the additional fees and that they put small businesses in jeopardy of building up a large amount of debt. 
  • Professional practice loans:Professional practice loans are designed specifically for providers of professional services, such as businesses in the health care, accounting, legal, insurance, engineering, architecture and veterinary fields. These types of loans are typically used for purchasing a practice, real estate or new equipment; renovating office space; or refinancing debt.
  • Franchise startup loans:Franchise startup loans are designed for entrepreneurs who need financing to help open their own franchise business. These loans, offered by banks and alternative lenders, can be used for working capital or to pay franchise fees, buy equipment, and build stores or restaurants.

Now that you've got the basics, you might be ready to make some decisions on which type of loan and provider are right for you. If you're interested in an alternative loan, check out our best picks for alternative lenders.

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