[Editor’s note: This is a guest post from Priyanka Prakash. Priyanka is a finance writer at Fit Small Business, an educational site for small business owners with dozens of product and service recommendations and how-to articles. Prior to becoming a writer, Priyanka was a business attorney at Summon, a Y Combinator-backed ridesharing startup. She now focuses on writing finance articles for small business owners and others interested in small business finance.]
The options for a small business owner looking for a loan are greater than ever, but you can’t rely on taking the traditional path. Getting a bank loan is no longer a possibility for most small businesses, with over 80 % of small business owners getting denied. Fortunately, a multitude of other types of small business lenders have stepped into the void left by banks. But how do you know which is the right option?
This article takes you through 6 popular small business loan options, their pros and cons, and gives you some advice on how to narrow down your choices.
Pros and Cons of 6 Exciting Small Business Loan Options
1. SBA Loans with a Fast Turnaround
If you’re a small business owner with a strong credit score, one of the least expensive sources of funding is an SBA loan. Normally, applying for an SBA loan takes months. The SBA has tried to remedy this problem with programs such as the SBA Express Loan program, but it is private companies like SmartBiz who are really speeding up the proces. With SmartBiz, you can apply online and get funding within a few weeks.
- Saves you time. Instead of applying to multiple banks for an SBA loan, SmartBiz, if they approve you, will find a bank that’s willing to fund you.
- Inexpensive. SBA loan rates are currently in the 5-8 % range, making this one of the least expensive sources of small business funding.
- Long terms. SBA loans from SmartBiz have 10 year loans, so you can enjoy low monthly payments.
- Hard to qualify. In most cases, you need to have a credit score over 700, a profitable business, and some collateral to receive an SBA Loan.
2. Marketplace Lenders
Marketplace lenders match prospective borrowers with investors. Most appeal to a very specific kind of small business owner. Examples include Funding Circle, StreetShares, and Kickfurther. Funding Circle appeals to prime borrowers with established businesses and good credit. StreetShares also caters to prime borrowers, but their focus is helping veterans. Kickfurther is designed for small businesses that need capital to purchase inventory. There are other marketplace lenders for franchises, real estate businesses, and other kinds of small businesses.
- Speed: Marketplace lenders offer a fast, electronic application process. You can apply, and if approved, get funding all in about 1 week.
- Low Rates: Rates on marketplace loans start as low as 5 % for borrowers with good credit. If you have average credit, be prepared to pay as much 15-20 %.
- Loans may be unsecured: Marketplace lenders require a personal guarantee, and they may place a lien on your business assets. However, they don’t require specific collateral. An exception is Kickfurther, where the investors who fund your loan buy the inventory from you.
- Very specific requirements to qualify. Every marketplace loan has its own set of qualification requirements for credit score, revenue, and type of business. Make sure you do your research before selecting which ones you’d like to work with.
- Shorter terms. Marketplace loans typically terms of 1-5 years or even shorter (the average Kickfurther loan is 6 months long). This means they are not designed for big business investments, such as real estate.
3. Business Credit Cards
When you need money fast, you can’t really beat credit cards. In addition to the convenience factor, they are actually not that expensive as people often think. With APRs averaging around 15-16 %, they are far cheaper than alternative lenders or merchant cash advances.
- Earn rewards. Most business credit cards, such as the popular Chase Ink Plus and Amex Business Gold, offer rewards or cash back for shipping, advertising, travel, and other business related expenses. That’s free money in your pocket!
- Interest rate promotions. Many business cards will also offer 0 % interest for a limited time. If you make purchases and pay off the full balance during the promotional period, you pay no interest at all.
- Carrying a balance can land you in trouble. If you can’t pay off the balance in full each month, it’s easy for balances and interest to pile up.
- Credit limits are constraining. If you want to purchase something big, it may exceed your credit limit. Business credit cards are not covered by the Credit Card Accountability Responsibility and Disclosure Act (CARD Act), which means the issuer can reduce your credit limit without notice if you fall behind on payments.
4. A New Kind of Merchant Cash Advance
A merchant cash advance is when you receive an advance of cash upfront and agree to repay the cash and fees back with a percentage of your daily credit card sales. Ordinarily, small business owners should avoid merchant cash advances because they can be very expensive. However, Square and PayPal offer lower cost merchant cash advances, with APRs around 20-35 %.
- Flexible repayment. Every time you make a credit card sale, Square or PayPal will take a small cut. That gives you more control over your cash flow because you pay more back on good days and less on bad days. There’s no fixed due date by which you have to pay back the advance. PayPal even lets you select the daily repayment percentage.
- No credit check. Approval is based on your volume of credit card sales, not on credit score.
- Not open to all. You have to be an existing Square or PayPal customer to be eligible.
- Tiny amounts of capital. Most Square advances are under $10,000, and PayPal won’t lend more than 15 % of your annual sales on the platform. These companies are not financing companies. They are payment companies, and the cash advance is an extension of their payment products, so they tie the size of your advance to your sales history on the platform.
5. A New Kind of Invoice Factoring
Invoice factoring lets B2B small businesses borrow funds against unpaid invoices. Just like Square and PayPal have revolutionized merchant cash advances, companies like BlueVine and Fundbox are modernizing invoice factoring. Unlike traditional invoice factors, these newer lenders won’t contact your clients to verify invoices or collect payment.
- Plugs cash flow gaps. If slow paying customers are poking holes in your business’ cash flow, invoice factoring is a good way to get some short-term access to capital. With rates starting at 0.5 % of the invoice amount, it’s not too expensive, but it can become expensive if the invoice due date is 60 or 90 days away.
- Quick, easy application. You can apply easily and quickly online and get funding within a few days. In fact, BlueVine and Fundbox will plug into your accounting software so you don’t have to manually submit invoices.
- Recourse factors. Most factors work on a recourse basis. This means that if your customer ends up not paying the invoice, the factor will look to you to settle the debt. This can be a problem if you’ve already spent the funds.
6. Online Alternative Lenders
According to Morgan Stanley, alternative lenders originated about $7.9 billion in small business loans in 2015, up 68 percent from the year before. There’s no sign of that slowing down anytime soon. The growth has been fueled by lenders like OnDeck and Kabbage.
- Speed: Applying with an online lender takes just minutes, and it requires minimal or no paperwork. If you’re approved, the funds can be issued within days. In contrast, traditional loans can take weeks, or even months, to process.
- Easier to qualify: While some online small business lenders say they’ll accept credit scores as low as 500, in practice, your chances of approval are much better if you have a FICO score of at least 600. You should also have been operating for at least 1 year with annual revenues of at least $50,000.
- No Collateral: Alternative lenders require a personal guarantee and may place a lien on your business assets. However, they don’t require you to pledge specific assets as collateral.
- Cost: Alternative loans can be very expensive, with APRs ranging from 20-80 % or more. It’s crucial to find out the APR and all fees before closing on the loan so you can compare it to other loan offerings.
- No Prepayment Savings. While alternative lenders usually don’t charge prepayment penalties, in some cases you won’t get any savings from paying early either. Whether you pay the loan back early or not, you’ll owe the same amount of interest and fees.
How to Decide – What to Ask Yourself
With so many options to choose from and so many pros and cons to evaluate, you’ll need a good way to filter the choices. Asking yourself the following questions can point you in the right direction:
- What’s my credit score? The higher your credit, the more likely you are to qualify for a bank loan or SBA loan. Those with average credit will likely have to pay a higher interest rate for an alternative loan, invoice factoring, or other type of small business lender.
- How good is my business’ credit? Your business has a credit score as well, which lenders will consider in determining whether to loan you money. Paying suppliers on time is a good way to build up business credit.
- How long has my business been operating? Getting a business loan for a startup is very difficult. If you’re a startup, you may want to consider options that aren’t on this list, such as Peer2Peer loans and crowdfunding.
- How fast do I need money? Try to plan ahead. The quicker you need money, the fewer options you have and the more you’ll have to shell out in interest and fees.
- How does my business generate revenues? The way you generate revenue may expand your lending options. For example, a B2B business that bills all its clients with invoices should consider invoice factoring.
These questions are just a guide. Ultimately, every small business is different. It’s a good idea to talk to other small business owners, your accountant, attorney, and other professionals before deciding how to get financing. For a more in-depth discussion of the options mentioned in this article, plus others, read How to Get a Small Business Loan – The Ultimate Guide.
(Disclaimer: Fit Small Business has financial relationships with several of the lenders mentioned in this article).