Takeaways
- A business loan secures capital to pay for business needs and expenses.
- Business loans can fund inventory purchases, expansion, and product launches.
- Business loans are analogous to personal loans but usually have better terms.
- Many types of business loans finance specific business needs and requirements.
- Securing a business loan involves providing a lender with your financial statement, business plan, use of proceeds, and repayment strategy.
What Is a Business Loan?
A business loan is a type of financing designed to help companies cover the costs of business operations. Much like a personal loan, a business loan provides a lump sum of capital you can use as a business owner to cover business expenses, invest in new projects, and manage cash flow. Banks and credit unions issue business loans. They are widely accepted and allow for more straightforward financial planning.
The terms you get for a business loan are linked to your company’s financial health, history, and probability of repayment. When you secure a business loan, you receive a set amount of cash up front, which you repay over an agreed-upon term with a specified interest rate.
Business loans are ideal for significant business expenses such as:
- Purchasing equipment
- Expanding operations
- Covering large-scale projects
- Buying an office
Most modern business loans come with flexible repayment options. The loan agreement includes essential financial details, like the principal amount, interest rate, repayment terms, and fees or expenses you must pay upfront. When you apply for a business loan, you submit your business’s financial statements, credit history, and a detailed business plan to demonstrate how the loan will be used and how to repay it.
Read More: 9 Steps to Start Your Own Online Business
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What Are Business Loans Used For?
As a business owner, nothing is more important than ensuring your business continues to grow. Business growth often requires money for expansion plans. Companies can raise capital through the equity capital markets (issuing stocks), the debt capital market (issuing bonds), or traditional financing options like securing a business loan.
Let’s look at some common reasons you might take out a business loan:
- Startup Costs: You will need capital to cover startup costs and get your business off the ground. Depending on the type of business you are trying to start – C Corp, Limited Liability Company, or Nonprofit – there are varying initial and maintenance costs. Additionally, there are varying degrees of capital demand based on the industry in which you are competing. For example, if you are creating a website or app, you will need funds for coders and developers. Alternatively, if you are starting a cleaning service, you need cash for equipment and cleaning supplies.
- Commercial Real Estate Purchases or Remodeling: Whether renovating existing properties or acquiring new ones, you might need to take out a business loan to establish or expand your business operations. Purchasing the perfect office building can be expensive, especially if you want to own the building. Even renovating your current office space requires cash.
- Cash Flow for Everyday Expenses: Business loans can also help cover day-to-day operational costs, from payroll to inventory restocking. You can secure a standalone loan for a one-time need or create a line of credit with a bank and have a revolving credit facility. Many businesses enjoy the line of credit because you can establish this with a trusted lender and tap the line only when needed.
- Debt Consolidation or Refinancing: You can also consolidate your existing debts with a business loan to make debt payments more predictable and efficient and reduce interest costs. Businesses trying to decrease leverage take this approach and become debt-free. Instead of relying on debt, they manage operations purely with cash flow.
- Business Expansion: At some point, your business may reach a plateau. Suppose you have established a foothold in a market. In that case, you might need to introduce new business lines, expand into new geographic regions, or launch alternative produce lines to grow your business. You must secure debt for quick expansion efforts unless you have the cash reserves or cash flow to fund these initiatives.
Read Also: 9 Ways to Fund Your Startup Business Quickly
Smart Tip:
Public companies on stock exchanges, like Nasdaq or NYSE, issue stock in an initial public offering or additional issuances as an alternative to getting a business loan.
7 Types of Business Loans
There are many different types of business loans, each suited for a specific business need. Let’s take a closer look at the various types of business loans below:
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1. Lines of Credit
A line of credit grants your business access to capital up to a predetermined credit limit. This type of loan works similarly to a credit card. You are charged interest based solely on the amount you draw. Once you have repaid the funds withdrawn, you will regain the ability to re-access your line of credit.
2. Startup Loans
To get your business off the ground, you might need to take out a startup business loan. This type of loan involves more risks for lenders. While you can secure these loans for online businesses, they are primarily used by traditional brick-and-mortar businesses that need inventory, office space, and equipment purchases.
3. SBA Loan
A U.S. Small Business Administration (SBA) loan covers a category of small-business financing. While there are multiple SBA loans, the primary business loan for providing financial assistance to small businesses is the SBA 7(a) loan.[1] Business owners might use SBA loans for business expansion, funding for working capital, commercial real estate acquisition, and more. SBA loans typically range from under $50,000 for SBA microloans to $5,000,000 for 504 loans.[2][3]
4. Traditional Term Loan
With a business term loan, you receive a lump sum of capital upfront, which you repay along with interest over an agreed-upon period. Term loans are one of the most cost-effective choices for small-business financing. However, securing favorable rates and terms can be challenging, especially when interest rates are high. Read about how the Federal Reserve affects interest rates with the federal funds rate.
5. Working Capital Loan
A working capital loan could be a temporary financial solution for businesses trying to maintain sufficient cash flow for their day-to-day operations. They are typically characterized by quick funding and brief repayment terms.
6. Microloan
As the name suggests, microloans are accessible in small amounts. They are sort of like payday loans for businesses. Microloans generally range from $500 to $50,000. While banks will occasionally provide microloans, they are more commonly available through other lenders, like nonprofit organizations.
7. Accounts Receivable Loan
Accounts receivable financing, also called invoice financing or invoice discounting, allows businesses to access funds by leveraging the value of their outstanding but soon-to-be-received funds.
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Improve Your Chances of Getting a Loan
You must organize and prepare your finances to improve your chances of getting a business loan. This is true regardless of your credit history or experience level. Before applying for a business loan, gather essential information about yourself, your business, and your financing needs.
Learn More -> What is Finance? Here's Why it Matters
Remember to communicate your plan with the bank. Let them know your vision for your company’s future. While confidence goes a long way, you must design a well-thought-out business and repayment plan. Focus on developing a realistic strategy to achieve your business goals with the capital provided.
Lenders will also scrutinize your repayment strategy, so you must demonstrate you have already identified reliable loan repayment sources. Do not simply rely on the bank to guide you. Take the initiative and design a solid repayment plan reflecting your understanding of financial responsibility.
Get Smart -> What is Personal Finance?
Pros and Cons of Business Loans
Business loans come with advantages and disadvantages. Let’s take a closer look at the pros and cons of business loans below:
Pros of Business Loans
- Generous Loan Amounts: Banks tend to offer larger loan amounts to borrowers and businesses with solid credit scores and a proven history of managing debt responsibly. While you might take out a business credit card for your C Corp, depending on your business’s financial history, you might have to personally guarantee your credit card. This can be particularly helpful if you try to get your side hustle business off the ground.
- Longer Repayment Terms: Business loans typically come with longer repayment terms than loans from other lenders. While you can certainly get a loan for a short period, ranging from months to years, lenders are often flexible enough to work with you and establish a business relationship.
- Quick Access to Capital: Business can be all about timing and being at the right place and time. When a business opportunity comes your way, you might need to act quickly to take advantage of a growth opportunity, acquire a business, or market to a particular niche audience. A business loan can give you the cash to chase these opportunities and expand your business.
Cons of Business Loans
- Strict Eligibility Criteria: Traditional banks usually require applicants to have healthy financial statements, consistent business revenue, and a track record in business. Banks and credit unions want to lend to companies they know can pay them back over time.
- Time-Consuming Paperwork: The application process for business loans will require you to complete a lot of paperwork. This can be cumbersome, but it might be an essential step to get the funding you need to grow your business. You must gather core documents like incorporation documents, financial statements, bank account information, and a business plan.
- Debt Management: When you take out a loan for your business, you add financial complexity to your business model. Because you must repay your loan with interest, mapping out how you will repay your debt monthly is essential. Additionally, ensure your business generates enough revenue and cash flow to support these payments.
Smart Summary
Starting your own business is hard enough. Getting the right financing level through issuing equity or taking out a business loan can be the catalyst you need to drive your business forward. Explore your capital-raising efforts by researching the best online lenders, talking to local banks, and discussing options with credit unions. Ultimately, the best financing avenue will differ from one business to the next and will depend on the lifecycle of your business, the use of proceeds, and the business trajectory. Securing a business loan could be a smart money move.
You might also like:
(1) U.S. Small Business Association. 7(a) Loans. Last Accessed January 8, 2025.
(2) U.S. Small Business Association. 504 Loan. Last Accessed January 8, 2025.
(3) U.S. Small Business Association. Microloans. Last Accessed January 8, 2025.
