Running a small business poses many challenges — paying suppliers, advertising, expanding, or improving an existing location. And for those who own a small business, funding all these challenges can be overwhelming. A small business loan can help.
What is a small business loan?
The Federal Reserve defines a small business loan as “any loan to a business in an original amount of $1 million or less, excluding loans to farms or secured by farm or any residential properties.”
Who provides these loans?
Thousands of lenders service the small business market. Institutions from Local credit unions to major Wall Street multi-nationals all service the small business market.
What are the usual terms of small business loans?
Terms vary widely depending on the institution, but generally, they fall into two types: secured loans and unsecured loans.
Secured loans require the borrower to offer some form of collateral to the lender. They operate similarly to a mortgage. The lender provides access to capital to the borrower, who in exchange agrees to pay back the principal and interest on the loan. If the borrower is unable to pay in time or in full, the lender can stake a claim to the collateral. In the case of a mortgage, this is the house. In the case of a small business loan, the collateral is likely some other asset the borrower owns — inventory, machinery, real estate, etc. Due to their secured nature, these loans typically come with better terms, such as lower interest rates. Secured loans also offer some protection to business owners. If a business falls into bankruptcy, the lender will pursue the business’ assets rather than the personal assets of the borrowers.
Unsecured loans share some similarities with a personal loan. Since they do not involve collateral, the lender is taking on a higher risk in making the loan. Therefore, they will check the borrower’s credit score to determine their ability to pay back the loan. Terms are highly dependent on the borrower’s credit score and history. Unlike a secured loan, an unsecured small business loan is between the lender and the individual borrower. If the borrower terminates the business, they are still responsible for the loan.
What types of loans are offered?
In addition to the secured vs. unsecured, lenders extend various kinds of loans:
Term Loans
These are loans that involve the lending of a lump-sum of cash up front. In exchange, borrowers agree to repay the principal and interest over a set period. Startups often favor these loans, since they allow a new business to get up and running quickly.
Business Line of Credit
These loans are designed to provide businesses with access to cash on a revolving basis. They function similarly to a home equity loan. As an example, a lender might extend a $10,000 line of credit to a business. The borrower can draw on a portion of the line of credit, up to but not over, $10,000. The borrower will then pay back the principal and interest until the balance reaches zero. Businesses who experience seasonal fluctuations in their cash flow or companies who need a failsafe to meet short term funding (think payroll) typically rely on these loans.
For online loans, this is discussed in greater detail here.
