“Cash rules everything around me” is a mantra that small and medium-sized businesses (SMBs) are forced to live by. No matter how long an SMB has been in business, its success and continued future are often determined by how much cash it has available.
Cash flow is much more than numbers on paper. For small and medium-sized businesses, it’s a matter of life and death. That may sound extreme, but it can quickly become the deciding factor in whether or not a business opens its doors the next morning. Without the proper cash flow, there are larger issues than the ability to pay bills on time, meet payroll, and pay rent. People say it takes money to make money for a reason, and nowhere is that more apparent than in the life of a small business.
It’s important to understand that there are options available for small and medium-sized businesses looking to secure funding. With so many different choices, it can be difficult to determine which is right for your business or circumstances.
FundThrough wants to help SMBs have a clear understanding of their options. Different loans work well for different kinds of companies and situations. Our goal is to break down some of the most common types of small business loans. On top of that, we’re going to explain some of the pros and cons of each loan. When you finish reading this, you can move forward armed with the knowledge you need to make the right decision for you and your business.
The first loan we’re going to talk about is probably also the one with which people tend to be most familiar. The classic commercial bank loan is the go-to loan for the vast majority of enterprises in the United States. When someone talks about a business loan, this is likely what they mean. Time-tested and trustworthy, a commercial bank loan is frequently the first stop for a small or medium-sized business.
One of the advantages of a bank loan is that the small-business loan rates are among the best you’re going to find. The security of a bank loan can be a make or break difference when it comes to finding capital. In addition to the low interest rates, the other perk is that bank loans are term loans. That means that you can rely on making the same payment year after year until the loan is paid back. There are no unexpected fluctuations regarding rates and the amount of interest you’re paying.
The catch with a bank loan is that they can be notoriously hard to come by. Unless your business is relatively well-established or you have phenomenal credit, qualifying for a bank loan is a tall order. In fact, the Washington Post estimates that about 75 percent of small business applications are rejected.
The application process is more than stressful on its own. It can also take a long time. We’re talking about waiting for weeks or even months. SMBs looking for a quick injection of cash to fulfill orders or keep the lights on might not want to hold their breath.
Like a bank loan, but on an “as needed” basis, is a line of credit. A line of credit through a bank can be a viable short-term funding option for small businesses that require an influx of cash, fast. In some ways, you could consider a line of credit to be like a business credit card on steroids.
A line of credit taken through a bank provides many of the same securities one can expect from a traditional loan. The main difference is that it functions much more like a credit card. An SMB can borrow up to a certain amount and pay back that same amount later with interest. Because you’re dealing with a line of credit, as opposed to a loan, you can get the cash you need, when you need it.
Furthermore, when done through a large bank, a line of credit will often feature much better interest rates than your average credit card.
You know how we mentioned that a line of credit can feature a lot of the same security as a bank loan? The catch is that a lot of the same restrictions apply. In many cases, a line of credit can be even more difficult to qualify for than a business loan. And even though you can get cash quickly once your line of credit has been approved, you’re still going to have to go through the same long, drawn-out application process. These can both be deal-breakers for young SMBs looking to quickly inject some cash into their company.
Many SMBs find themselves in a bind simply as a cost of doing business. Let’s say that a small business finally lands that big purchase order it’s been waiting for. This is the order from a big box retailer or other whale of a client that can take a business to the next level. The problem is that it takes a sizeable amount of working capital to fund such an order. Few manufacturers are going to undertake an order of that size without cash up front. Fortunately, invoice financing is designed to work in this exact kind of situation.
The key with invoice financing is that it’s not a typical small business loan. Instead, you’re receiving an advance based off capital that you’ve already invoiced. Everyone knows that the money is coming, it might just be a matter of a month or two before you receive that payment. Applying for invoice funding is easy through an online platform, and zero paperwork is required. The result is that the application process is both fast and simple. FundThrough can advance 100% of your invoice value in as little as 24 hours. And because FundThrough doesn’t report to credit bureaus, businesses don’t need to worry about invoice financing affecting their credit scores.
The important thing to remember with invoice financing is that the advance is based on capital you’ve already invoiced. It’s right there in the name. That’s why invoice financing tends to work best for B2B companies or businesses dealing with large client orders that require invoicing. While convenient and continuing to gain in popularity, the practice isn’t as cozy of a fit for business to consumer (B2C) companies that operate without invoices.
For small businesses looking to secure cash fast, who aren’t picky about where it comes from, there’s the merchant cash advance. If your company is unable to qualify for the usual commercial bank loan and you find yourself running out of options, the merchant cash advance can start to look very attractive.
When it comes to new businesses or those with less than stellar credit histories, an MCA can be a valuable resource. The qualifications aren’t nearly as stringent as what you see with a loan or line of credit, and you can get the cash you’re looking for relatively fast. We’ve discussed MCAs before, and while they can prove helpful in a pinch, they also come with a few very serious caveats to consider. The way an MCA works is that you get a cash advance from an outside lender in exchange for a percentage of all your future credit or debit card sales.
This exchange translates to a percentage of your credit or debit card sales for the foreseeable future going toward the MCA until the amount is paid off. This percentage is called a “factor rate.” A typical factor rate could be anywhere from 1.2 to 1.4. Let’s say you were advanced $20k at a factor rate of 1.4. For every dollar you were advanced, you’d be paying $1.40 on top of it. This equates to $28,000 over the life of the MCA. That also means you basically just paid over 28 percent interest. That’s how MCAs can easily take advantage of SMBs. If that wasn’t enough, the lack of regulation has led some to refer to MCAs as the Wild West of alternative lending.
One of the most popular and trusted options for small and medium-sized businesses would be Small Business Administration (SBA) loans. These are long-term small business loans specifically designed to be advantageous for SMBs. Many of these loans are made in the form of what are called (7a) loans, the SBA’s primary program for providing aid to SMBs.
SBA loans are all about fostering small business development in the United States. If you have good credit, there’s a strong probability that you could qualify for an SBA loan. A typical term for an SBA loan can run between 10 and 25 years. This gives SMBs ample time to pay back the loan. Plus, since this is a government loan, the SBA controls the maximum interest that businesses have to pay.
Many of the positive aspects of SBA loans come from the fact that they’re provided by the federal government. Unfortunately, as many SMBs recently found out, the advantage of doing business with the government isn’t always the security. SBA loans ground to a halt during the government shutdown. It’s been estimated that $2 billion in small business loans were put on hold during the shutdown. It took the SBA weeks after the government reopened to get back on schedule. Given the current political climate, SMBs put their faith in the government at their own risk.
If you want something done, sometimes you have to do it yourself. Depending on the size of your business, and what you’re looking for, a personal loan could be a realistic option to get your company the cash it needs.
There’s something to be said about the impressiveness of bootstrapping a small business by yourself. Some entrepreneurs are fortunate enough to have the wherewithal (and credit score) to qualify for a sizable personal loan on their own. While the amount you can borrow is much lower than your usual small business loan, the process can sometimes be easier for an individual, as opposed to a business.
While it’s certainly admirable to use your personal finances to fund your business, a personal loan might not be enough to do it alone. A limit on a personal loan usually maxes out at about $50,000. Unless you have capital coming in from elsewhere, it’ll be tough to finance an entire business from a personal loan. Also, if anything happens, you’re the one on the hook for the loan.
These are just some of the avenues available to small businesses in search of capital to fund their operations. As you can see, each option tends to work best for certain types of businesses and situations. Hopefully, you should now be on your way to knowing which type of loan will work for you. Don’t wait to find the financing you need. Get working capital now for your business when you sign up with FundThrough.