Anyone can start a business even without the needed cash on hand by getting a business loan. For many business owners, it’s the first step in making their hobbies a means to achieve financial independence.
What Is a Small-Business Loan?
A small-business loan begins with a lender, usually a bank, agreeing to advance a small business a specific amount of cash as a lump-sum. The small business will then repay that amount including interest on a set schedule.
Small businesses can choose from several different types of financing, the most common being small-business lines of credit, business credit cards and lump-sum lending (also known as installment or term loans).
“Small business loan” in this article refers to a lump sum loan.
The repayment terms of a small-business loan can vary in terms of when to start payment, the payment schedule, interest rate (fixed or variable), interest compounding rate and amortization of payment (installment amount to pay).
Common Reasons for Getting a Small-Business Loan
Small businesses take out a loan for many different reasons, but the three most common are:
- Start a Business – This is the most common reason. The startup cost to lease a place, hire staff, buy machines and materials would be much more than what the average entrepreneur can afford to pay out of personal funds.
- Expand a Business – An expansion is a risk for any business. Most businesses prefer to expand with borrowed money to spread the expense out over a series of years, turning a massive up-front expense into a manageable cash flow.
- Solve a Cash Flow Problem – Finally, a business might take out a small-business loan to stabilize a downturn while waiting for cash to improve. This can be risky if the business does not pick up quickly.
Requirements to Get a Small-Business Loan
To get a small-business loan, the lender may require the submission of a few critical facts about the company and the owner. Among the common requirements are the owner’s personal credit score, as well as the business’ credit score. If available, the business history, collateral, cash flow and business model may also be requested.
Types of Small-Business Loans
As previously noted, this article is only about lump-sum or small business loans. However, even within this lump-sum loan, there is a range of options.
First, there is the Small Business Administration secured loans which are available to qualified businesses. These are low-rate loans secured by the SBA. Find more information about getting an SBA secured loan here.
Then there is an equipment loan or real estate loan. This is a loan taken out to buy capital assets such as vehicles, land and buildings. The loan itself will be secured against the asset that will be bought.
Finally, there is microlending which focuses on very small transactions, typically below $30,000 in value. Microlending is usually easier to secure than a traditional loan, but also usually comes with a significantly higher interest rate.
Types of Lenders
Banks are the major source of small-business lending, including both traditional small-business loans and SBA secured lending.
Government and non-profit grants are also available to entrepreneurs. These programs are usually run by local communities and can provide startup funds for community businesses. Available grants are usually in limited amounts, so they are best used to supplement other sources.
In recent years, online lenders have grown, both as centralized and peer-to-peer institutions that provide funding for entrepreneurs. Borrowers should take note that the terms by these lenders can often be unfavorable.