Business loan types

Each loan type serves a different business need

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Selecting a loan for your small business may feel like a daunting task. There are a variety of loan types to choose from, such as term loans, lines of credit, SBA loans, equipment financing and invoice factoring. Then there are additional considerations like repayment terms, interest rates and the lender’s reputation.

Each type of loan suits a unique set of circumstances, and you may be pleasantly surprised to find financing that perfectly matches your business goals.


Key insights

  • Small business loans can be for very specific purposes, like financing equipment or purchasing commercial real estate.
  • The minimum qualifications vary for every type of business loan.
  • It’s important to do your homework so the loan option you choose works best for your business.

Term loans

A business term loan gives you a lump sum of money upfront, which you pay back over a fixed period of time with interest. This loan type is extremely flexible and can fund a variety of business expenses.

You may be a good candidate for a business term loan if you have clear loan objectives, a proven business track record, a strong credit history and solid financials.

Pros

  • Flexibility: You can use funds for almost anything, including refinancing existing debt.
  • Possible early loan repayment: In many cases, you can pay off your loan balance without penalty and reduce your interest expenses.
  • Predictable payment schedule: The fixed schedule allows you to effectively budget and manage cash flow.

Cons

  • Longer funding time: Funds may not be available as quickly as other types of financing because the application process is more involved.
  • Strict qualification criteria: You typically need a credit score of 600 or higher, at least two years in business and at least $8,000 in consistent monthly revenue.
  • Collateral requirements: If you’re applying for a secured business loan, you could lose assets if you default, or you could not qualify if you lack the assets needed for approval.

» MORE: What are common small business loan terms?

SBA loans

Small Business Administration (SBA) loans are loans guaranteed by the U.S. government and range in value from $500 to $5 million. As a result of the SBA guarantee, approved lenders offer loans at competitive interest rates and fees. SBA loans are well suited for startups and new businesses that are unable to qualify for traditional financing options.

There are a few different types of SBA loans available:

  • 7(a) loan: Used for a variety of purposes such as short- and long-term working capital, refinancing current business debt, purchasing equipment and more. The maximum loan amount is $5 million. 7(a) loans are extremely versatile and may suit borrowers across a variety of industries, provided you meet the eligibility criteria.
  • 504 loan: Designed to help businesses acquire or make improvements to fixed assets including buildings, land or equipment. The maximum loan amount for a 504 loan is $5.5 million. The borrower must contribute 10% of the project cost, while a third-party lender finances 50% and a Certified Development Company finances 40%.
  • Microloan: Loans up to $50,000 for working capital expenses such as inventory, equipment or supplies. Intermediary lenders approved by SBA provide financing. The flexible eligibility requirements make this financing option perfect for businesses that do not have an extensive credit history or traditional loan options. In 2023, nearly 50% of microloans went toward minority-owned businesses.

Pros

  • Startup-friendly: SBA loans may be more easily available to businesses that can’t qualify for traditional funding.
  • Lower interest rates: Lenders can offer lower interest rates because the SBA’s partial guarantee reduces their risk
  • Accessible for businesses with limited collateral: SBA loans offer flexible collateral requirements, with some requiring no collateral at all.

Cons

  • Lengthy approval process: The application process requires extensive documentation and may not be ideal for businesses that need immediate funding.
  • Specific eligibility criteria: For a 7(a) loan, you need at least $50,000 in annual revenue, at least two years in business and a minimum credit score of 620 to qualify
  • Personal liability: The SBA may pursue collection efforts against you, as the business owner, if the loan defaults.

Lines of credit

A line of credit is a flexible loan, similar to a credit card, which allows a borrower to withdraw funds as needed up to a certain credit limit. Many businesses will be eligible for a line of credit, but to receive a large amount, the business must have a strong credit history and stable revenues.

Uses may include covering cash flow or taking advantage of immediate purchasing opportunities. For this reason, businesses with liquidity issues or fluctuating revenue cycles benefit the most from a line of credit.

Pros

  • Looser eligibility standards: Criteria for qualification are not as stringent as other loan financing (but businesses with good credit typically qualify for higher limits and better terms).
  • Build your business credit: Managing a line of credit responsibly can boost a business's credit score and build its credit profile.
  • Financial cushion: A line of credit can serve as an emergency fund to ensure business continuity during downturns in revenue or cover unforeseen expenses.

Cons

  • Fees: Origination fees and draw fees are just some of the additional costs associated with a line of credit.
  • Cost: The interest rates are higher than traditional business loans, ranging from 8% to 60% APR.
  • Low limits: The credit limit a business qualifies for may be too low to be helpful.

Equipment financing

Equipment financing is a type of business loan designed to help businesses acquire machinery, equipment, vehicles or technology. The financed equipment serves as collateral, and the terms of the loan are structured around the life span of that equipment.

Businesses whose day-to-day operations rely on equipment — including medical practices, agricultural businesses and manufacturing organizations — are best served by equipment financing.

Pros

  • Equipment upgrades: Leveraging equipment financing allows businesses to update and replace their outdated equipment and stay competitive
  • Capital preservation: Businesses can retain capital and spread out the cost of new equipment over the life of the loan
  • No extra collateral required: The equipment purchased with the loan serves as collateral

Cons

  • Equipment depreciation: The equipment’s value may depreciate faster than the loan can be repaid.
  • Down payments are often required: Unlike with other types of business loans, expect to make a down payment for equipment financing.

» MORE: How to get a business loan

Invoice factoring or financing

Invoice factoring allows a business to sell its outstanding invoices for an immediate cash advance. A factoring company will purchase the unpaid invoices for 80% to 95% of their value (less a service fee) and pursue the invoice collection themselves.

Companies that face delayed client payments are the best candidates for this type of financing.

Pros

  • Credit score not as important: Because invoice factoring is based on sales, lenders may not have strict credit score requirements
  • Immediate cash flow: Ideal for businesses in need of cash for expansion, monthly expenses or payroll.
  • Outsource payment collection: The lender will collect the invoice amount from the client.

Cons

  • Cost: Factoring companies pay a percentage of the invoice and then charge service fees on the total invoice amount, so businesses with narrow margins may not benefit.
  • Customer nonpayment: In some cases the business may be required to pay the lender if a customer fails to pay their invoice.
  • Reputation: A company's reputation may suffer from invoice factoring because clients may perceive it as financially unstable.

Merchant cash advances

A merchant cash advance (MCA) provides you with a lump sum payment in exchange for future credit card sales. Your repayment amount is based on a fixed percentage of the revenue you earn.

“When times are difficult and revenue drops, the business is required to repay less, explained Ben Johnston, chief operating officer of Kapitus. “However, when times are good and revenue climbs, the customer is required to repay at a faster rate.”

According to Johnston, “MCAs are best for businesses with variable cash flows that may be unpredictable.” These products are “often underwritten to standards similar to those of nonbank small businesses lenders, in that applying requires fewer documents and a shorter time to decision than with most banks,” Johnston said.

Pros

  • Quick cash: The application process is faster than traditional loans, and funds are typically available within 48 to 72 hours.
  • Unique repayment structure: Payments fluctuate based on the business’s credit card volume. For instance, if sales volume is low on a given day, the repayment amount is adjusted accordingly.
  • Easier to obtain: MCAs generally have looser eligibility requirements than other types of business loans.

Cons

  • Higher cost than other financing options: MCAs often have higher fees, making them one of the more expensive loan options.
  • Terms and conditions can be unclear: MCA terms and fees are not always fully disclosed. Beware of predatory lenders and thoroughly review your financing agreement before signing.
  • Regulatory concerns: MCAs are not federally regulated, and borrowers are not afforded the same protections as other loan options.

Commercial real estate loans

A commercial real estate loan is used to buy, develop or construct income-producing properties such as shopping centers, office buildings or hotels. These loans appeal to companies that manage assets that generate revenue, such as real estate developers, corporations, limited partnerships and funds.

Pros

  • Lower interest rates: Commercial real estate loans often have the lowest interest rates of all loan options.
  • Cover startup cost: Because commercial real estate loans are for large amounts, a borrower can pay for a significant portion of their initial expenses.
  • Long-term financing: Repayment terms range from five to 20 years.

Cons

  • Complex approval process: Securing a commercial real estate loan involves complicated procedures, a lot of paperwork and strict qualifying standards that make them unattainable for most first-time business owners.
  • Vulnerable to market fluctuations: Property values can fluctuate due to economic conditions, which could affect the viability of the business and the ability to pay back the loan.
  • Limited flexibility: Because these loans are specifically focused on income-producing assets, they may not be the best choice for every small business.

Business credit cards

Business credit cards offer a revolving line of credit, allowing card holders to make purchases and manage ongoing costs as needed. Business cards can make sense for a variety of organizations but work especially well for companies with unpredictable expenses.

The amount of credit approved is dependent upon the business’s creditworthiness and estimated monthly expenditures.

Pros

  • Convenience: Easy access to funds.
  • Build business credit: Responsible use and management can build credit history.
  • No interest payments: As long as you pay your monthly balance in full, you will not be charged interest.

Cons

  • High interest rates: Especially if the monthly balance is not paid in full.
  • Risk of personal liability: Certain business credit cards may require a personal guarantee.
  • Overspending: Without sound financial management, there's a chance of going overboard and accruing high-interest debt, which might be harmful to the company.

Personal loan for business

A personal loan for business enables you to borrow money for your business based on your personal income and credit history instead of your business’s. The exact loan amount you get approved for will depend on, among other things, your financial circumstances and credit score.

“Entrepreneurs with early-stage companies often find that personal credit is the only credit available to fund their business,” said Johnston. You’ll have the best access to personal credit if you have low personal debt and a strong personal credit profile.

Pros

  • Flexible use of funds: A personal loan can be used for various business expenses, but also personal expenses for yourself.
  • Collateral criteria: Unsecured personal loans do not require collateral.
  • Quick cash: For individuals who qualify, personal loans offer a lump sum as soon as the same day.

Cons

  • Risk of personal liability: Borrowers have personal responsibility for repayment, possibly endangering their own credit should they default on the loan.
  • Lower loan amounts: Personal loans may not offer enough funding to get your business off the ground.
  • Doesn’t build business credit: When you use a personal loan for business use, you miss out on the opportunity to build your business credit score.
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FAQ

Which type of loan is best for a startup business?

“Entrepreneurs often finance their startups using personal loans that are acquired based on their personal assets and personal credit profiles,” said Johnston.

This is because most business loan eligibility is based on your business’s profitability and business profits, as well as the business owner’s assets. Since most early-stage companies do not have assets or strong earnings track records, they turn to personal loans for funding.

Which type of business loan is the easiest to get?

“Generally speaking, nonbank small business lenders typically require fewer documents and a significantly shorter time to make a decision than a bank does when making a small business loan,” said Johnston. “Nonbank lenders often lend for shorter terms at higher rates than a bank would, but their quick turnaround and simple application process make them preferable in some circumstances.”

Where can you get a business loan?

Business loans are available from a variety of lenders: traditional banks, online banks, credit unions and alternative lenders. Typically, traditional banks and credit unions will have stricter requirements than alternative lenders, but they may also have better rates and terms for those who qualify.

Bottom line

There are many different types of business loans. While some loans may be easier and quicker to get than others, they may charge higher fees. Examine the repayment schedule and any associated expenses to understand the full cost.

There are a myriad of ways to get financing for your small business; it all depends on your business needs. No matter which loan you choose, take a holistic view to ensure it aligns with your goals. Consider all the factors, like the loan’s terms, the lender's reputation and your total cost of borrowing.


Article sources
ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
  1. U.S. Small Business Administration, “Loans.” Accessed Dec. 11, 2023.
  2. U.S. Small Business Administration, “Types of 7(a) loans.” Accessed Dec. 11, 2023.
  3. U.S. Small Business Administration, “504 loans.” Accessed Dec. 11, 2023.
  4. U.S. Small Business Administration, “504 Loan Program.” Accessed Dec. 11, 2023.
  5. U.S. Small Business Administration, “Microloans.” Accessed Dec. 11, 2023.
  6. U.S. Small Business Administration, “List of microlenders.” Accessed Dec. 11, 2023.
  7. U.S. Small Business Administration, “7(a) loans.” Accessed Dec. 11, 2023.
  8. The White House, “FACT SHEET: Ahead of Small Business Saturday, Biden-⁠Harris Administration Announces Latest Steps to Support Small Businesses.” Accessed Dec. 11, 2023.
  9. U.S. Chamber of Commerce, “Is Business Equipment Financing Right for Your Business?” Accessed Dec. 11, 2023.
  10. U.S. Chamber of Commerce, “Small Business Funding: A Breakdown of Business Loan Types.” Accessed Dec. 11, 2023.
  11. Business Debt Law Group, “Does Merchant Cash Advance Regulation Exist?” Accessed Dec. 11, 2023.
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