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As your ecommerce business grows, you may decide that the best way to grow your brand is to take out ecommerce financing. If you don’t know where to start, this overview of the nine most common types of business loans will help you understand which form of funding is right for your business.
Comparing the 9 different types of business loans
Here are some of the most common types of loans available to ecommerce businesses.
1. Long-term loans
A term loan is a straightforward form of business financing: A bank or other lender extends you a set amount of funds, which you pay back with interest over a set period.
You can use a long-term business loan for a variety of projects, from renovations to working capital to acquiring another business. These loans are best used for large funding needs that can be paid off over a period of years.
- If you need a large chunk of funding upfront, a term loan — if you qualify — will likely be your best and cheapest option.
- If you own an established business and have a strong credit history, you may be eligible for a loan with an interest rate as low as just a few percent.
- The process of applying for a term loan from a bank can be time-consuming: The qualifications are stringent, you’ll need to fill out lots of paperwork, and the underwriting process can take weeks or months.
- Affordable long-term loans are mainly only available to established businesses with excellent credit.
2. Business lines of credit
A business line of credit (LOC) is a pool of money that a lender extends to a borrower to be drawn on at any time. LOCs can be fixed or revolving: When they revolve, they work similar to credit cards, where the pool is replenished and can be drawn on again each time you pay your loans off.
Because of their flexibility — you can hold on to a line of credit and use it only in case of emergency without accruing additional fees — LOCs are best for businesses that want a financial cushion they can fall back on in case of emergency. Examples include seasonal cash flow droughts or covering expenses after a disaster.
- A line of credit is a flexible funding option that can be accessed nearly any time for any reason once approved.
- LOCs can be secured or unsecured, which means the option is still available to you if you don’t have collateral, but is more affordable if you do.
- Interest rates for each draw are typically higher than for term loans.
- For the most part, only established businesses will qualify for affordable LOCs.
- Not the best choice if you need a large sum of money.
3. SBA loans
The SBA, or Small Business Administration, has a business loan program that partially guarantees loans disbursed by banks. This federal guarantee leads to more affordable interest rates and generous terms, making SBA loans some of the most sought-after funding in business.
There are different types of SBA loans:
- SBA 7(a) loans are traditional term loans that can be used for nearly any business purpose
- CDC/504 loans are for purchasing large capital assets such as real estate
- Microloans are loans to new businesses for $50,000 or less
- SBA loans have markedly low interest rates and long repayment terms.
- Typically up to 85% of each loan is guaranteed by the federal government.
- Additional resources provided by the government include mentorship programs, help writing business plans, and further counseling and education.
- Underserved populations such as women, minorities, and veterans are given special consideration when applying.
- Very stringent qualifications for SBA loans means only business owners with high credit scores and established businesses will be considered (except for microloans).
- A labourious application process means funding time is measured in months, rather than hours or days.
4. Short-term loans
Short-term loans are term loans with repayment terms ranging from 3-18 months. You’ll most often find them offered by online lenders, who make them available to business owners with average credit on short notice.
Short-term loans are also very common in real estate investing. These types of loans are issued by hard money lenders. In non-owner-occupied real estate transactions, borrowers can easily qualify for a hard money loan with even a low credit score making this type of loan very favourable.
If you have a one-time funding need that requires immediate attention, a short-term loan — which can fund in a matter of hours, depending on your situation and the lender — is a convenient option. Examples include purchasing inventory or assets in bulk or temporarily on sale, or covering the occasional workflow gap.
- Some short-term lenders will approve you for funding in as little as one business day.
- Even business owners with just-decent credit scores can be approved.
- Short-term loans have much higher interest rates than long-term loans or SBA loans.
- You may only have a few months or years to pay off your debt.
5. Equipment financing
If you are specifically seeking funding to help you acquire an expensive piece of equipment or vehicle, equipment financing can help you cut right to the chase. Your loan essentially covers the cost of the equipment you’re buying and is sometimes extended by the seller of the equipment themselves.
With equipment financing, the equipment itself acts as collateral for the loan. If you fail to make the payments, the lender can simply take back the equipment to recoup their losses. That makes this type of financing a good choice for new business owners without much credit history.
- No collateral is needed to secure your equipment financing funds.
- Most equipment financing products have affordable interest rates, though the exact rate varies depending on the situation and borrower.
- Equipment financing can only be used for businesses looking to buy or rent equipment.
6. Business credit cards
You may not think of a credit card as a form of business financing, but what is putting a purchase on your business credit card if not taking out a short-term loan?
All business owners should consider a business credit card if they qualify. Not only do they help you rack up rewards and perks that you can reinvest into your business, but some come with low or even no interest rates in the introductory period—which gives you essentially an interest-free loan for the first few months you have the card.
If you have some relatively inexpensive expenses you need to cover — such as office materials or inventory — and you want to build your business credit along the way, a business credit card is an easy way to do both.
- Many business owners can qualify for a credit card immediately.
- Some credit cards come with a 0% interest introductory period to start.
- Credit cards accrue points, rewards, and other perks.
- Business credit cards are only suitable for limited funding needs.
- Interest rates on credit cards are typically higher than for long-term loans.
7. Personal loans
Who says you can only fund your business with a business loan? You can obtain a personal term loan through banks or online lenders that you then apply to starting up or funding a new business.
If you need a little extra money to fund your new business, a personal loan (which typically caps out at about $40,000) can help get you over the hump. If you have larger funding needs, a business loan is a better bet. To make an informed decision, it’s crucial to calculate personal loan payments carefully to ensure they align with your financial capabilities and business goals.
- Only your personal credit report is considered when applying for a personal loan, making it easier to qualify—assuming you have a high personal credit score.
- Personal loans come with a relatively low interest rate depending on your financial situation.
- The funding cap for personal loans is limited compared to what you can get from a business loan.
- If the business fails, you are still personally responsible for the loan.
8. Invoice financing
B2B ecommerce companies often suffer cash flow issues when customers fail to pay their invoices in a timely manner. One way to smooth out those issues is to turn to invoice financing, where a lender loans you money against your outstanding invoice. You pay the lender back once your client pays up, plus interest and fees.
While it would be preferable for your clients to simply pay you on time every month, that just isn’t always the case. Invoice financing gives you the certainty of money in your account every month.
A similar form of financing is invoice factoring, where a lender outright buys the invoice from you and assumes responsibility for collecting the unpaid debt for your client.
- Invoice financing is available to most business owners regardless of credit background since the invoice secures the loan.
- Borrowing against your invoices creates immediate ongoing cash flow you can rely on.
- You’ll limit the profit you make from each client, and you’ll make less and less the longer each client takes to repay your invoice.
9. Merchant cash advancing
A merchant cash advance is when a lender extends you capital in exchange for a portion of your daily credit card sales. The supposed upside is that since payments depend on sales, you only pay back part of what you make each day.
Annual percentage rates for MCAs are astronomical — they can be higher than 100%. Only business owners with no other option should consider a merchant cash advance as a last resort.
- With MCAs, when business is slow, you pay back a little of what you owe; when business is good, you pay back more.
- MCAs charge incredibly high interest rates that can hamper your business.
Factors to consider when choosing your business loan
Here’s what you should keep in mind when choosing the right kind of loan for your business.
Purpose of the loan
The reason you need a loan is perhaps the most important factor to consider when deciding which funding option to pursue.
If you need a large amount of capital to fund an expansion or renovation, which you expect to pay off over a long period of time, a term loan or SBA loan is the way to go. On the other hand, an immediate need such as emergency repairs or to cover a payroll gap is better suited for a line of credit or short-term loan. Credit cards are sufficient for the occasional small expense.
Consider why you’re taking out a loan, how much time you would need to pay it off, and what the return on investment would be like for such a product when exploring your business loan options.
Of course, depending on how long you’ve been in business or how responsible you’ve been with credit in the past, you may not be eligible for the kind of loan you want. If you have a long-established business and an excellent credit report, more options will be open to you; if you are a new business owner with average personal credit, you’ll have a limited selection to choose from until lenders consider you a safer bet to lend to.
When comparing loan options, most people look first at each product’s interest rate. A better, more holistic comparison point is the APR, or annual percentage rate, which combines interest rate plus other fees to give you the total cost of a loan each year.
Some term loans have higher APRs than others, and some funding options will have higher APRs to make up for a lack of collateral or credit history on your part. Be sure to compare apples to apples with APR when deciding.
Related to eligibility, you will need to meet certain criteria for certain lenders and organisations, particularly the SBA, if you want to be considered for a loan. For example, your business must make over $180,000 in annual revenue to apply successfully for an SBA loan. Credit score, collateral, personal debt-to-credit ratio, and how you intend you use your funds will also be considered.
Deciding to take out a business loan
The decision to take out a business loan should never be made lightly. No matter which type of business loan you choose, from a credit card purchase to a long-term SBA loan, make sure you run the numbers and feel confident that you’ll see a return on investment or otherwise improve your business.
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