There are thousands of business lenders offering commercial loan products, but nearly all business loans are a variation of a handful of debt financing products — but each with their own individual characteristics. Much of the differences between loan products isn’t the type of loan, but the way in which the loan is approved, financing delivered to the business owner, and the way that these loans are paid-back. Innovation and technology overall has made leeps and bounds in recent years, and no sector has been transformed more by new innovation than financial technology (fintech). Using new technologies, algorithms and outside-the-box thinking, lenders are now able to analyze a company’s financial situation with great speed — leading to an expedited approval and funding process.
With the loan products and the delivery of new sorts of lending changing on an almost daily basis, trying to keep up with the business financing options can be difficult to understand. On top of that, with the increase in alternative lending and lack of regulation associated with it, some product descriptions may be downright confusing. In this article we will take an in-depth look at the most commonly-used types of business loans available to all small and medium-sized businesses and enterprises. The look will compare the rates and terms associated with each financing product, as well as an explanation of how each product works, and what the funding process entails. On tops of that we would like to balance the pros and cons of each product to allow business owners to have a full-understanding of each product before starting the application process.
Debt financing is another term for “loan”. Therefore, when a company is seeking debt financing they’re essentially seeking a business loan from a lender or creditor. The reason loans are considered “debt financing” is because in exchange for financing, the business promises to repay the principal (amount owed) plus interest. Therefore, they owe it to the creditor to repay such debt. This is a much different model than equity financing. Debt financing differs from equity financing in that equity financing is essentially an investment. The investors aren’t guaranteed to get paid-back, therefore they are taking a much bigger risk. But with risk comes larger rewards. A debt financing company will have a structured repayment plan and will make a set amount of return based upon interest rate. With equity, the financer is obtaining a percentage of the company’s ownership. Therefore, if their investment scales, so will their returns. But they are no way guaranteed to be repaid.
No, not all debt financing companies require collateral. But many, if not most, do in fact require some sort of collateral, business guarantee or personal guarantee. Lenders will usually place some soft of lien on business or personal property so as to protect themselves and mitigate losses should the borrower default. With that having been said, there are a number of non-collateralized options. There are some lenders who focus almost solely on the value of collateral for financing, and others will focus almost solely on cash-flow (and everything in-between).
Financing that requires collateral. Secured business lenders usually require assets used as collateral to have a net worth equal or more than loan amount. This is the most common form of financing among all buisness lenders. Collateral used usually needs to be worth more (often times, much more) than the loan amount provided to the business, and may require appraisals and regular monitoring of the collateral. Types of collateral used for secured lending include business or personal real estate, accounts receivable, machinery, equipment, along with all other business and personal assets.
Financing that does not require collateral. Business lenders offering unsecured financing are generally cash-flow driven and focus solely on credit of the business and owner, or focus on future revenue projections. To help mitigate their risks, unsecured lenders may require daily and weekly repayments. While some unsecured lenders don’t require general business and personal collateral, they may purchase current and future business receivables.
|Bank||6-10%||3-7 years||14-30 days|
|SBA||6-10%||3-7 years||10-30 days|
|Line of Credit||5-15%||1 – 3 years||7-30 days|
|Alternative||6-25%||1-5 years||5-7 days|
|Cash Advance||1.16-1.55||3-24 months||1-3 days|
|Invoice Finance||1-2% weekly||1 – 90 days||1-3 days|
Term business loans are the standard and most common type of business financing with a maturity date (usually between 1-25 years). The loan is repaid on a set schedule (usually monthly, but can be weekly) until the principal is repaid plus interest. Term loan interest rates are usually determined using an APR, but may use a factor rate to calculate rates. Fees associated with term loans vary depending upon lenders, with some banks and alternative funding companies charging origination fees, banking fees, and other fees. Uses of a term business loan include purchasing businesses, purchasing commercial real estate, working capital, purchase of business equipment, purchase inventory, along with just about any other business use. Term loans can be both secured against business or personal assets, or may be unsecured. Approval rates of term lenders vary, with traditional term lenders with strict lending requirements having approval rates as low as 20%, and alternative term lenders with approval rates as high as 70%.
The process of getting a term loan requires providing documentation showing how your business has performed over the previous few years, as well as projections moving forward that show the business will be able service the new debt. Such documents include tax returns of the business and of the business owners, as well as financial statements and other business documents.
Asset-based business loans (ABLs) are specialized commercial financing that provides collateralized business loans to small businesses that may be highly-leveraged, have erratic business earnings, or have issues with cash flow. These business loans use business assets as collateral and are structured to provide financing by monetizing assets on the company’s balance sheet. Such assets used in asset based lending include commercial real estate, personal real estate, inventory, accounts receivable, equipment and machinery, invoices as well as any other asset. Asset based loans are provided by both conventional and alternative lenders, with the types of facilities varying greatly. AR-based asset based lenders will purchase future receivables from the company and then forward the company cash minus a discount to the lender.
The process of getting an ABL usually requires the business providing extensive documentation on the collateral (appraisals, title searches, UCC searches, AR & AP aging schedules) as well as supplying the company’s financial documentation including tax returns, income statements, balance sheets and schedule of liabilities.
A line of credit is a preapproved amount of financing that a company can draw-on when they should need it. A LOC fundtions much like a credit card does, being that the lender determines a maximum limit allowed forwarded, and the borrower will have access to instantaneious capital when they should need it. The difference between a line of credit and a term loan is that you don’t pay interest on the total amount that you are preapproved for with a line of credit; you only pay interest on the amount you use. The rate and term of a line of credit depends upon the business revenue performance and/or assets of the company. Lines of credit are often by the company’s account receivable, but may be available by some lenders on an unsecured basis.
The process of getting a line-of-credit depends on if its provided by a conventional lender, SBA lender, asset based lender, or alternative lender. Most will require business financials and tax returns, as well as require asset documentation if secured by AR or other collateral.
Alternative business loans are both plentiful and varying in their characteristics. Generally, when we refer to alternative loans, we refer to loans originated by non-bank lenders with interest rates that fall between bank-rate and the high-interest cash advances. Alternative lenders tend to be institutional based, using investor money to provide business financing. Therefore, the investors supplying the money are seeking to make a return on the funding. Therefore, while they have rates that are higher than banks, its because these investors are willing to take chances on riskier lending opportunities.
A real benefit of alternative lending for the borrower is the easy approval process (which can be completed in hours if not minutes) as well as fast funding. In fact, a small business that is approved for alternative lending can be funded as soon as a week. Alternative lenders rely heavily on future earnings and cash-flow, and are not necessarily credit-driven, so they’ll analyze your recent cash-flow, and project how much debt you’ll be able to service moving forward.
Bridge financing is a short-term business loan that is usually used for capital purposes until a small business secures longer term financing from a commercial lender or payment from a costumer. Bridge loans are usually used for commercial real estate financing, or for working capital purposes. A commercial real estate bridge lender will generally use their facilities to finance commercial real estate while the borrower works on finalizing permanent financing. Working capital bridge lenders generally provide financing to help a company keep operations going while they complete longer-term financing, or until a business payment is received by client or vendor.
Since bridge loans vary in types and uses, the process for obtaining them greatly varies among lenders. What they all have in common is an expedited funding process. Commercial bridge loans may require appraisals of the commercial real estate that can slow-down the process, a working capital bridge lender may be able to provide financing in as little as a day, while only needing an application and a company’s bank statements.
Factoring (or AR financing) is not a business loan, but instead the sale of accounts receivable to third party small business lenders a discount.
Equipment financing relates to any and all forms of financing for the purchase and/or leasing of business equipment. There are a wide range of commercial finance options (including term loans, advances and equipment leasing). With equipment leasing, a commercial lender will purchase the equipment for the purpose of leasing it to the small business for a fixed number of months/years with the option for the business to purchase the equipment at the end of the term.
Merchant Cash Advance business loans are a lump sum payment in return for percentage of future small business sales. Unlike most other types of business loans, repayments are usually through ACH (Automated Clearing House) in the form of a fixed daily payment taken directly from the bank account of the small business during business days. Other forms of business advances include a payback to the commercial lender using percentage of daily deposits instead of a fixed daily payment.