How Do Business Loans Really Work: The Fundamentals
Business loans are well known for feeling overwhelming. They can be confusing. They often lack clarity. And most of all, they can feel impossible to secure. In reality, business loans are similar to personal loans.
The process is much the same. You first apply to the borrower, generally a bank. You request a set amount, go over the details, and wait to find out whether the firm will lend you the money. If they agree, you will then have some requirements or interest rates involved.
This is where the confusion comes in. Interest rates and requirements differ substantially from one lender to another. To complicate matters further, certain business loan types are better suited to some businesses than others. For example, one loan may work better for a startup than a business experiencing cash flow problems.
Secured or Unsecured?
It’s important to note that there are two categories of business loans. Secured loans allow your business to take out loans while keeping an asset as collateral. This opens your business up to the risk of having those assets claimed by the debtor in the event you are unable to repay the loan. Unsecured loans allow you to obtain capital without using assets as collateral. Of course, this means the interest rate will be much higher.
Revealing Your Reasons
Most lenders are going to want you to walk them through the reason why you feel you need a loan. The most important thing to remember is a business loan cannot be spent on personal matters. The most common reasons to take out a business loan include buying assets, relocating, growing activities, day-to-day operating costs, increasing inventory, debt repayment, or recruiting new workers.
Types of Business Loans
With so many different types of business loans available today, it can be challenging to decide which one is right for you. Every business’ situation and goals are unique. Here are a few of the most popular business loans today:
- Term Loan. You and your bank negotiate the total amount of money your company requires. This amount will be paid back in regular installments over a 1-5 year period. (In some cases up to 10 years.)
- SBA Loan. The Small Business Administration (SBA) backs 85% of loans worth less than $150,000. While a popular option, this type of loan can be hard to obtain because of their assurance.
- Invoice factoring. An alternative to traditional financing options, invoice factoring allows your business to sell its outstanding invoices in exchange for an immediate sum of cash – up to 95% of an invoices’ value. This is a good option if your business issues invoices to collect payment and often deals with slow or late-paying customers.
- Merchant cash advance (MCA). This option regards your company’s potential credit card sales as an investment. You receive a lump sum in exchange for a percentage of your future credit and debit card sales. It is ideal for a variety of costs but can affect cash flow. It is also known for being a quick cash solution (in as little as 24 hours).
As you search for a funding solution, make sure you take your credit score, business history, goals, collateral, and investments into consideration. Then choose a solution that best suits your business’ needs and keeps its long-term financial health in mind