There are many obstacles that entrepreneurs face when starting and growing a small business. The most critical issue, however, is having sufficient cash flow.
Balancing cash flow isn’t fun, but it’s important: According to a study by U.S. Bank, 82% of business failures are due to poor cash management. That’s why the best business owners always have an eye toward obtaining affordable forms of financing.
Business owners might need financing for a number of reasons. Maybe you want to expand to take advantage of increased demand, and need cash for a location renovation. Maybe your clients don’t pay their invoices on time and now you’re behind on your own payments. Or perhaps your business suffered through a natural disaster and you need to reopen right away — or risk closing for good.
And let’s face it: Most entrepreneurs aren’t going to luck into venture capital when starting up. They may not want to cede control of their business through equity financing, either.
This is where a good business loan product comes in handy. There are a number of loan options available to new and established business owners out there. Let’s review which ones might be the best fit for your venture.
Traditional term loans
When you think of a business loan, you’re probably thinking of a traditional term loan from a bank: You receive a lump sum of money, which you repay (plus interest) on a set schedule.
For decades, the primary source for business lending has been national and local banks — and while there are now more options than ever, thanks to the emergence of online lenders, the truth is that a bank term loan is almost always the most affordable option. Bank rates for loans are rarely above 6%, and some rates from large national banks go below 3%.
Generally speaking, however, banks are reluctant to extend loans to small businesses. To qualify for a bank loan, you need exceptional personal and business credit. You also need strong annual revenue and a well-established company with at least a few years under your belt.
It’s not fair to small business owners, or good for the economy, for small businesses not to receive any affordable financing from banks. (After all, 99.7% of all employer firms in the U.S. are small businesses.)
That’s why the Small Business Administration has a hugely popular loans program, where the agency guarantees the majority of a bank loan so the lender feels assured lending to a small business.
SBA loans also have low interest rates — they start at 7.75% and vary depending on the exact loan product — and are thus very competitive. You also need to meet strict requirements (good credit scores, strong revenue, etc.) and submit documents such as a business plan that explains how you will repay your loan when applying.
These are the three most popular SBA loan products:
- The 7(a) loan program: This general loan (good for expanding working capital, refinancing debt, renovations, and other needs) can be for as much as $5 million, repaid over a term up to 10 years.
- The CDC/504 loan program: This loan is specifically for purchasing large fixed assets, such as equipment and real estate. The loan amounts can crest $5 million and be repaid over 10–20 years.
- The Microloan program: New business owners looking for startup capital can receive up to $50,000 through the SBA’s Microloan program, repaid over six years.
Business lines of credit
Another helpful financial tool for entrepreneurs is a business line of credit (LOC). LOCs are similar to credit cards: They typically give the business owner access to a pool of money, which is replenished as the borrower repays the draw. Business owners can continue drawing on the line indefinitely as financial needs arise.
LOCs are prized for their flexibility. You can use your line to finance your business’s growth as you would with a term loan, or just keep one in your back pocket and use it in emergencies.
Interest rates for LOCs vary depending on the borrower, but they start as low as 7%, and you can sometimes be approved for one in as little as a single business day.
Sometimes the need for financing is very specific. B2B businesses often run into this issue: They’ve sent out invoices to clients and have been waiting for payment — and meanwhile, their own bills and required payments are piling up. If you can’t get your cash flow cycle to sync up efficiently, you might find yourself short on funds when payment is due.
Rather than taking out a loan to cover the gap, you might look into invoice financing. You essentially “sell” an invoice to a lender, who fronts you the majority of the invoice due amount. The remaining amount is held until the invoice is actually paid in full.
Although invoice financing typically has higher fees than traditional forms of financing (and the amount you pay in the end depends on how long your client takes to send their payment), there are some choice benefits.
For one, the invoice itself acts as collateral, which means you don’t have to put up anything to secure the loan. Second, you get your funds fast — as quickly as one day. And third, the requirements for qualifying aren’t quite as stringent as for traditional financing.
Another specific example of why you might need financing: You need to purchase an expensive piece of equipment. Maybe you have a restaurant and need to invest in a first-class fridge, or you own a moving service that needs a new van or truck.
The answer here might be equipment financing, where a lender extends you the funds needed to make your critical equipment purchase. Once again, this form of financing offers quick access to cash, a loan that is “self-secured” (if you default on the loan, the lender may seize your equipment to repay the debt), and limited paperwork and few requirements.
Interest rates are higher than for term loans, but they can be as low as 8% depending on the borrower’s situation.
If you’re an entrepreneur with a limited business history, you might find that the most affordable financing available to you is through a personal loan.
Business history is one of the most important factors that lenders weigh when considering a loan application. If you can demonstrate that your venture has survived a few years, you make a better case that you will continue to survive long enough to repay your loan.
If you haven’t been around very long, you may either be turned down by a lender, or given a loan option with a high interest rate and/or weekly repayment terms.
Instead of settling for a bad business loan, look for a personal loan, which has a much lower maximum loan amount (typically no more than $35,000) but also a lower interest rate. Then look for a business loan option after you’ve been around a few years.
Most people don’t think of credit cards as a form of financing, but in reality a credit card functions as a short-term loan.
For everyday needs, such as purchasing supplies, a credit card is an excellent choice. Using one (and making your payments on time each month) helps build your business credit score, rewards you with perks such as points and insurance policies, and can cover your costs without the need for a major loan.
If you already have a strong business credit history, you may qualify for a credit card with a 0% introductory APR. That means you essentially have a zero-interest loan for the life of your intro period — anywhere from 9 to 18 months. And no other business loan offer can touch that rate.
The term “affordable” loan means different things to different business owners. What seems like a decent rate for some may seem high to others — and not everyone qualifies for the same terms on the same products, even from the same lender.
The best way to guarantee the best possible loan is to work on your credit scores, extend your time in business, and build a strong venture that promises growth. Business loans are best used as springboards to greater success, rather than life preservers when the ship is going down.
Once you’ve put yourself in a strong position, look to one of the above loan options for your financing needs. You may find using debt financing to be worth the inherent risk, and the best option for your business in the long run.