Types of loans for small businesses

1. SBA loans

Currently, the SBA offers four types of small business loans:

7(a) Loan Program: 7(a) loans, the SBA’s primary lending program, are the most basic, common and flexible type of loan. They can be used for a variety of purposes, including working capital; the purchase of machinery, equipment, furniture, and fixtures; the purchase of land and buildings; construction of new buildings; renovation of an existing building; the establishment of a new business or assistance in the acquisition, operation or expansion of an existing business; and debt refinancing. These loans have a maximum amount of $5 million, and borrowers can apply through a participating lender. Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets.

Microloan program: The SBA offers very small loans to new or growing small businesses. The loans can be used for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery, or equipment, but they can’t be used to pay existing debts or purchase real estate. The SBA makes funds available to intermediary lenders, which are nonprofits with experience in lending and technical assistance. Those intermediaries then make loans up to $50,000, with the average loan being about $13,000. The loan repayment terms vary based on several factors, including the loan amount, planned use of funds, requirements determined by the intermediary lender and the needs of the small business borrower. The maximum repayment term allowed for an SBA microloan is six years.

Real estate and equipment loans: The CDC/504 Loan Program provides businesses with long-term, fixed-rate financing for major assets, such as equipment and real estate. The loans are typically structured with the SBA providing 40 percent of the total project costs, a participating lender covering up to 50 percent and the borrower putting up the remaining 10 percent. Funds from a 504 loan can be used to purchase existing buildings, land, or long-term machinery; to construct or renovate facilities; or to refinance debt regarding an expansion of the business. These loans cannot be used for working capital or inventory. The maximum amount of a 504 loan is $5.5 million, and these loans are available with 10- or 20-year maturity terms.

Disaster loans: The SBA provides low-interest disaster loans to businesses of all sizes. SBA disaster loans can be used to repair or replace real estate, machinery, and equipment as well as inventory and business assets that were damaged or destroyed in a declared disaster. The SBA makes disaster loans of up to $2 million to qualified businesses.

2. Loans from conventional banks and alternative lenders

Banks and alternative lenders offer some similar loans to those offered by the SBA, as well as funding options that the SBA doesn’t offer, including the following:

Working capital loans: Working capital loans are short-term solutions for businesses in need of money to fund operations. Working capital loans are available from both banks and alternative lenders. The advantage of a working capital loan is that small businesses can keep their operations running while they search for other ways to increase revenue. Some downsides of working capital loans are that they often come with higher interest rates and have short repayment terms.

Equipment loans:  In addition to the SBA, both banks and alternative lenders offer their own types of equipment loans. Equipment loans and leases provide money to small businesses for office equipment, like copy machines and computers, or things such as machinery, tools, and vehicles. Instead of paying for the large purchases all at once upfront, business owners make monthly payments on the items. One benefit of equipment loans is that they are often easier to obtain than other types of loans, because the equipment being purchased or leased serves as collateral. Equipment loans preserve cash flow since they don’t require a large down payment and may offer some tax write-off benefits.

Merchant cash advance: This type of loan is made to a business based on the volume of its monthly credit card transactions. Businesses can typically receive an advance of up to 125 percent of their monthly transaction volume. Repayment terms vary by lender. Some take a fixed amount of money out of a business’s merchant account daily, while others take a percentage of daily credit card sales. The advantages of merchant cash advances are that they are relatively easy to obtain, funding can take just a few days and the loan is repaid from credit card sales. The biggest downside is the expense: Interest runs as high as 30 percent a month, depending on the lender and amount borrowed.

Lines of credit: Like working capital loans, lines of credit provide small businesses money for day-to-day cash-flow needs. They are not recommended for larger purchases and are available for as short as 90 days to as long as several years. With a line of credit, you take only what you need and pay interest only on what you use, rather than the entire amount. These loans are usually unsecured and don’t require collateral. They have longer repayment terms and give you the ability to build up your credit rating if you make the interest payments on time. The downsides are the additional fees and these loans can put small businesses in jeopardy of building up a large amount of debt.

Professional practice loans: Professional practice loans are designed specifically for providers of professional services, such as businesses in the healthcare, accounting, legal, insurance, engineering, architecture and veterinary fields. These types of loans are typically used for purchasing a practice, real estate, or new equipment; renovating office space; or refinancing debt.

Franchise startup loans: Franchise startup loans are designed for entrepreneurs needing financing to open their own franchise. These loans, offered by banks and alternative lenders, can be used for working capital or to pay franchise fees, buy equipment, and build stores or restaurants.

Invoice factoring: Invoice factoring loans are when an alternative lender advances small businesses money for outstanding invoices. As the invoices are collected, the lender receives the money in addition to a fee. This can be a good option for businesses looking to get funding upfront for invoices that have yet to be paid.