If capital is the lifeblood of business, business loans are the most common medicine.
Many business owners enjoy the benefits of borrowing a set amount of money with a clear repayment plan. Loans are a familiar way to fund business growth.
- Business loans, credit cards, and lines of credit account for about three-fourths of financing for new firms, according to the Small Business Association (SBA).
- About one third of small businesses used a bank loan in the last 12 months, according to the National Small Business Association (NSBA).
- Banks are lending less to smaller firms. In 2016, 41% of small business owners complained that lack of capital is hindering their growth or expansion. Thirty-one percent said they couldn’t find the funding they needed (NSBA).
It’s clear that startups and mature small businesses rely heavily on business loans. But traditional bank loans are not the only option.
Let’s take a look at where business loans fit into the financing picture and how different types of loans compare.
A Quick Overview of Business Loan Basics
All business financing from outside the business falls into two categories: debt and equity. Debt financing involves borrowing a fixed sum from a lender.
Equity financing is essentially trading a certain amount of capital for a percentage of ownership. Lenders take less risk and make money through interest and fees. Investors take more risk and make money through returns on their investments.
When business owners think of debt financing, many only think of term loans. In fact, a term loan is only one of several debt financing options available to companies:
- Term loans
- Secured lines of credit
- Credit cards
- Invoice or receivables financing
- Merchant cash advances
If seeking equity, businesses can also choose among investor types, listed here in order of increasing ownership percentage:
- Friends and family
- Angel investors
- Venture capital firms
Types of Loans
Let’s look at the business loans that each type of lender offers.
1. Large Commercial Banks
Commercial banks are the most common source of business loans. They are friendliest to well-established businesses with large annual revenues.
These banks have the highest standards for creditworthiness and tend not to lend less than $100k.Small businesses might struggle to get a loan through a large bank.Click To Tweet
The average loan from a large bank in 2016 was $483,000. These loans tend to require extensive paperwork and over one month to process.
2. Small or Community Banks
Thirty-four percent of business owners report that a regional or community bank is their main source of capital (HBS).
Small business owners often benefit from being able to establish a personal relationship with a local banker. In small and regional banks, the average loan amount is $155k.
3. Credit Unions
Credit unions are nonprofit institutions owned by customers.
There are over 7,000 in the country, and they operate much like community banks, often with additional services and support.
While large banks have decreased small business lending since 2008, credit unions have been increasing their small business lending every year. The average credit union’s business loan is around $212k.
4. Small Business Administration (SBA)
The SBA does not technically give out loans. But the organization does help facilitate small business lending by partnering with banks and credit unions to guarantee loans for many purposes.
The SBA effectively takes on some of the risk of your loan, making more loans available to small business owners. They have a range of programs, including microlending.
5. Alternative Lenders
Alternative lenders are usually online businesses that leverage digital tools more effectively than most traditional banks, making applications faster and more flexible.
The average loan amount among all alternative lenders lands somewhere between $50k to $80k. But depending on the loan product, you can borrow up to $1 million.
Alternative lenders are striving to fill a financing gap left by traditional institutions, and they’re gaining traction. Business Insider forecasts that alternative lending companies will own over 20% of the small business lending market by 2020.
6. Friends & Family
New businesses often rely on friends and family for startup loans. These loans can be tricky to manage and keep separate from personal life.
They can also be the easiest to access. Decide on and write down the terms of the loan up front, and type payments to cash flow rather than a fixed schedule. Doing so will decrease the chance of issues arising.
7. Non-Profit Microlenders
Nonprofit microlenders are mission-oriented organizations that offer loans under $50k.
Because their goal is usually to help disadvantaged communities, they often operate in specific regions and provide free financial training and consulting.
Also known as P2P and crowdlending, peer-to-peer lending happens through online platforms that match lenders and borrowers.
P2P lenders take a fee for matchmaking and credit checking, but otherwise have very little overhead, making them quite competitive. These lenders are the newest loan option for small businesses.
Tips for Borrowers
While lenders from friends to banks have vastly different offerings and requirements, there are some best practices for preparing yourself for any kind of loan.
If you’re thinking about getting a business loan, make the most of your application and increase your chances of approval with these tips.
- Perform financial forecasting and create up-to-date financial statements.
- Begin to rely on your accountant for insight and advice.
- Put together a business plan, however simple.
- Identify the exact purpose and ideal amount of the loan.
- Check your credit history and increase your credit score.
- Learn key financial vocabulary, including APR, collateral, and debt service coverage ratio.
- Shop different lenders before you choose your loan!