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 TweetThe 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.
8. Peer-to-Peer
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!
Samantha Novick
Latest posts by Samantha Novick (see all)
- 8 Business Loan Basics You Need to Know - May 2, 2017
One thing I know for sure about loan, is that is not Always good to start small business with loan. A small business starter should try to get money from friends and relatives, when the business starts growing, you can now get loan to boost it.
Hi,
Your post is very informative and helpful.
Firstly , banks look for excellent credit, extensive financial history and collateral. Essentially, if you are in a position where you do not need money, then you will qualify. But now a days, Loan Requirement have been tightened from last few years .
These are the loan basics which everyone should be aware of:
1. Loans can take 30-60 days to process.
2. You typically need an excellent credit score and credit history to even be considered.
3. You need to have been in business for at least three years and have documentation to prove your financial stability.
4. The bank requires an extremely detailed business plan. They want to know everything about your business, marketing plan, and your tax and bank records. The process is rigorous.
5. Proof of collateral, or valuable property, is required for them to take if you default on the loan
I hope my information is worth for the users who are reading this .
Thanks
Samantha, Let me join your other readers in saying this is a great overview. One other lending option is what I do, equipment leasing. It’s a great way for businesses to finance the purchase of new or used equipment that will help their business grow. You order from any vendor you choose, we pay the vendor in full upon delivery, and you make monthly payments for 1, 3, or 5 years. The equipment is the collateral, you get to keep your cash-on-hand and leave your bank line of credit open for other needs. At the end of the lease, you own that piece of equipment. In many cases, lease payments are also a tax-deductible business expense.
Hi Jim,
Thank you so much for taking the time to share your tips with my readers. Many businesses may not be aware of or had forgotten about equipment leasing. I assume they would need decent credit to qualify? Even though the equipment is the collateral, no doubt you would still want them to pay regularly.
Is it easier to get financing on equipment that is commonly used by many businesses versus equipment that is fairly unusual (and would therefore be more challenging to sell if repossession were necessary)? Perhaps you would like to write a guest post with a more extensive explanation of how equipment leasing works for my audience?
Gail Gardner would love you to read ..5 Ways to Manage Increases in Deal Flow
Hi Samantha,
I am a BBA student. For preparing my assignment on the business loan. I found your that post. :p Your post helped me to make it done! That’s why, many many thanks.
Maruf would love you to read ..Dutch Bangla Bank SSC Scholarship 2017 Information
In today’s changing world, business loans are the only option small business owners have for acquiring cash to grow their companies. Your post is simply superb which has all the steps for taking it. Thanks for posting it.
This would be an inspiring post for young entrepreneurs.We got to know which banks to approach to get a loan from your article. Large Commercial Banks are the best source of business loans.
Thank you
I think every entrepreneur or business should know about these basic types of loans to help them start new business or an idea or help them grow. Thank you for sharing such masterpiece.
In today’s ever-changing economic landscape, business loans are the only option small business owners have for acquiring cash to grow their companies. With an efficient business loan, almost any enterprise can expect immediate growth as long as they use the borrowed money wisely.
Noelle Addison would love you to read ..One Half’s Offshoring Accounting Services
Thank you for sharing awesome article! We should know these basics before applying for business loan. Good work!!
Nice work defining the different types of loans. Friends and crowdlending was always a personal favourite of mine back when I was looking for loans, more people should take a look at those!
Barry would love you to read ..LOGIES: DIAMONDS DOMINATE THE RED CARPET
I must say the information you provide is really worth it. This article has more than adequate amount of information for the Business Loan Basics.
Thanks Samantha Novick for sharing this information.
Well defined the different types of loans. This post is having enough resource for small business leader. Appreciated for this publication Samantha Novick.
Gurinder P Gaba would love you to read ..The Price Your Business Has to Pay for Poor Letterbox Delivery
If you are will to get business loan you have to read this article, Informative article for them want to loan for your business.
Hi samantha,
Thanks for enlightening people like me who didn’t know better. I will look into the best loan that fits my business scale and re-apply.
Moses Dzarmah would love you to read ..Open Heavens Monday 1st May 2017- OVERRIDING DOUBTS
Thanks for sharing a very informative article Samantha!
Sadly most aspiring small business owners and or start up
entrepreneurs, may not be totally aware of all of their
financial options.
Hopefully your excellent blog post, has made them more
aware of their options.
Thanks for sharing!
Mark would love you to read ..How Your Severely Cash Strapped Small Business Can Stop Wasting 80% Of Your Ad Budget!
Thank you, Samantha Novick, for this article. This Post is very, very useful to small business owners who want to start their own new business. We know by your post which bans to approach to get a loan. Large Commercial Banks are the best source of business loans.
Many many thanks for this post.