A Guide to Finding The Right Small Business Loan

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The number of small business lending options has increased over the last several years. The cost, timing, and terms will vary depending on the financing option you choose. Find out what’s available.

As a small business owner, you may need financing for a variety of reasons. Unexpected equipment repairs, market expansion opportunities, economic dislocations (like the COVID-19 crisis), may put you in the market to find a small business loan on short notice.

If you don’t have a chief financial officer (CFO) developing your financing strategy, evaluating the variety of lending options can be a daunting task. Let’s get to work to help you understand your options.

Before you go to the bank

Before making any financial commitment, have a plan for what you’re going to purchase with the money, and how much you can afford to pay back. When you approach your bank with a thoughtful plan, you increase your chances of success and make it easier for your bank to match you with the right product for your needs.

The first thing you must figure out is how long you need to repay the loan. Let’s say you need $20,000 and expect you can repay your lender within a month. You may find short term financing for $900. So, after one month, you would pay the lender $20,900.

That’s 4.5% interest for the short term loan. On an annual basis, the annual percentage rate (APR) would be 54% (ouch). But the 4.5% interest on the one month term is less expensive than a longer term loan with a much lower APR.

Getting started with your bank

Many small businesses don’t have a CFO, but almost all have a banking relationship, making your banking partner a logical first stop for your business lending needs.

COVID-19 Coronavirus Update

For many small businesses during this time of crisis, the best source of financing is theCARES Act lending programs. While these programs are being authorized by the Small Business Administration (SBA), your bank should still be your first stop to explore your CARES Act options. The SBA does not make loans directly and works with banks to originate these loans.

If your bank is participating in the program, they have already done the required Know Your Customer (KYC) and Anti-Money-Laundering (AML) checks on your business and therefore can process your PPP loan more efficiently.

Learn what types of small business lending your bank supports. Many banks only offer larger commercial loans and don’t finance loans less than $250,000.

When it comes to business lending, banks typically look for collateral to backstop their risk -- that means having equipment, real estate or other assets to secure your loan.

These are called “secured loans,” and you should understand if your bank only offers secured loans or if it provides “unsecured loans” ( no collateral required) as well.

If your bank doesn’t offer unsecured loans, and you don’t have collateral for a secured loan, your bank may not provide support beyond more expensive credit card and line of credit offerings.

These may be fine for short term capital needs, but if your loan payback will exceed more than a few months, you’ll want to look elsewhere for your financing needs.

Another potential hurdle with your bank can be their approval and underwriting processes. Many banks haven’t applied technology to their lending operations, and their loan application process requires a lot of paperwork and time-consuming bank analyst review.

Moody’s reports “banks and borrowers routinely cite small business loan processing times of weeks or months from completed application to approval, not including the time to collect application information or fund an approved loan.”

This is why, according to a study (PDF) from The National Small Business Association, only about 15% of small businesses rely on bank financing. So, if your bank doesn’t have the right solution for you, where should you look?

To answer that question, let’s look at the different types of financing products.

Your financing options

1. Business line of credit

A line of credit gives you access to cash up to a maximum amount whenever you need it. You choose when to use the line of credit and only pay interest fees when you do. A line of credit typically has minimum payment requirements to continue to access cash up to the maximum amount.

A line of credit has lower rates than business credit card interest fees and should be a better option for most businesses for short term loans. However, if you don’t qualify for a line of credit or any of the other options we review below, then a merchant credit card could be your best option.

A credit card is essentially a line of credit with higher interest fees on balances carried forward on your monthly statement.

Your bank is the natural place to evaluate a line of credit. Your bank's cost of capital is generally lower than non-bank line of credit providers.

According to a study (PDF) by QED Investors, a bank’s cost of funds is typically in the range of 50-60 basis points (.5-.6%) as compared to 600-1200 basis points (6-12%) for non-bank lenders. So your bank can more easily charge you lower interest rates on a line of credit.

Non-bank lenders include sites like BlueVine, Kabbage, and OnDeck. As you start to look at these alternative platforms, keep in mind that there’s a trade-off between convenience and cost.

Non-bank lenders can make approval decisions within minutes and fund within a day, but you pay for access to fast cash. The APR for lines of credit typically range from 7% to 25% or more. Your bank will have the best rates, albeit with a slower approval and time-to-fund process.

You may find that non-bank lenders promote a very broad range of APRs for their line of credit offerings. OnDeck for example disclosed (PDF) that in 2019, its line of credit APRs ranged from 11% to 61.9%, and its average APR across all loans was 45.5%. Other non-bank lenders will have similar rates.

You’ll note that many lenders promote low monthly interest rates, but look for the APR to understand what their annual interest rates are, particularly if you are not going to repay in a short period of time.

Lines of credit are more expensive than the loans we’ll discuss below. But they provide fast and more flexible access to cash, and are a good option if you can repay the borrowed cash within a few weeks or months.

2. Non-bank line of credit providers

Lender Fees Credit Threshold Loan Amounts Time to Fund Min Time in Business Min Annual Revenue
BlueVine 15% - 78% APR
1.6% - 2.5% draw fees
600 $5,000 - $250,000 Instant 6 months $100,000
OnDeck 19.9% - 61.9% APR
$20 monthly maintenance fee
600 $6,000 - $100,000 Instant 3 years $250,000
Kabbage 24% - 99% APR
1.25% - 10% fee of the borrowing amount per month
NA $2,000 - $250,000 Instant 1 year $50,000 per year, or $4,200 per  month

3. Secured loans

A secured loan is a term loan, and, as we discussed above, requires collateral pledged to the lender in case the borrower defaults on loan payments. Term loans provide a lump sum payment of cash that is paid back on a scheduled basis over the lifetime, or term, of the loan.

Similar to your home mortgage loan, your scheduled repayments include principal and interest.

Secured loans typically provide the lowest interest rates because they are backed by collateral. As with a mortgage loan, rates will be lower for longer repayment terms. If you need several years or more to repay your loan and have collateral to pledge, secured loans are your best option.

If your bank doesn’t provide small business loans, and even if it does, check out Small Business Association (SBA) loans. The SBA is a government program to support small businesses and provides loan guarantees to lenders (typically banks) on their small business loans.

In some cases, businesses that are not able to secure a loan from their bank, can get approval with an SBA-backed loan. The SBA website is a good starting point to explore this financing option whether it is serviced through your existing bank or another banking partner.

4. Unsecured loans

Similar to secured loans, unsecured loans are term loans that provide you with a lump sum of cash that you pay back, with interest, over the lifetime of the loan.

Because unsecured loans are not backed by collateral, they charge higher interest rates than secured loans. Many banks do not offer unsecured loans. Check what your bank offers.

As we noted in the review of lines of credit, non-bank sites like Kabbage and OnDeck offer fast access to cash, and both offer unsecured term loans as well as lines of credit. As with the lines of credit, Kabbage and OnDeck are your best options for same day financing.

Peer-to-Peer (P2P) sites like FundingCircle and LendingClub are also options for unsecured loans. These sites aggregate and match individual investors to fund your borrowing needs and provide similar terms as the other non-banking lenders.

5. Unsecured loan platforms

Lender Fees Credit Threshold Loan Amounts Time to Fund Min Time in Business Min Annual Revenue
OnDeck 0% - 5% origination fee
9% - 99% APR$20 monthly maintenance fee
600 $5,000 - $500,000 Instant 2 years $100,000
Kabbage 24% - 99% APR
1.25% - 10% fee of the borrowing amount per month
NA $2,000 - $250,000 Instant 1 year $50,000 per year, or $4,200 per  month
FundingCircle 3.49% or 6.99% origination fee
8.75% - 32.16% APR1% annual service fees
620 $25,000 - $500,000 ~5 days 2 years NA
LendingClub 3.49% or 7.99% origination fee
6.96% - 35.89% APR1% of monthly payment service fee
600 $5,000 - $500,000 4-7 days 1 year $50,000

6. B2B invoicing and payment networks

Another option is to pull in cash based on your existing invoices and accounts receivable cash flow. B2B invoice lenders look at your current outstanding invoices or historical business cash flows to extend short term loans to you. This type of lending is sometimes called “invoice factoring.”

Essentially, you sell your invoices to the lender and pay interest on the lump sum payment they provide. You pay more the longer you take to repay the lender.

APRs range from 15% to 70% or more annually but can be as low as 1% on a monthly basis, making this potentially an attractive option compared to lines of credit or the fees charged to balances carried forward on merchant credit cards. Bluevine and Fundbox are good options for this type of financing.

Payment processors like Square and Paypal offer lending similar to invoice financing. Both make it easy to get access to cash if they are your payment network, and repayment is simplified through automatic deductions from your daily credit card sales or through automatic deductions from your bank account.

The APRs on these types of loans are hard to calculate, since rates depend on how fast the daily deductions pay off the loan. They are worth considering for their convenience if you are able to repay within a few weeks or months.

7. Invoice factoring and payment network offerings

Lender Fees Credit Threshold Loan Amounts Time to Fund Min Time in Business Min Annual Revenue
BlueVine 13% - 88.4% APR (.25% - 1.7% weekly interest) 530 Up to $5,000,000 1 day 3 months $10,000 monthly revenue
Fundbox 10% - 80% APR (.4% - .7% weekly) 500 $1,000 - $100,000 1-3 days 6 months $50,000 per year
Square 10% - 16% interest on capital borrowed repaid from a percentage (9% - 13%) of daily credit card sales.  Must be paid in full within 18 months. NA $500 - $250,000 1 - 3 days NA (Must be a Square pay merchant) $10,000
Paypal Varies depending on the % of loan you repay from daily sales.  Repayment percentages range from 10% - 30%.  Typically expect 4.5% - 15% interest on capital borrowed NA $1,000 - $125,,000 Instant PayPal Business account for at least 3 months $15,000 in PayPal sales from PayPal Business account

8. Equipment financing

If you need to purchase equipment for your business, you can use any type of business loan. Some businesses use a specialized loan called an equipment lease to obtain equipment for their business.

The decision to purchase equipment via a loan or lease can be influenced by a number of factors, such as the lifespan of the equipment and how equipment purchase and depreciation might affect your company’s tax situation versus the business operating expense associated with leasing.

Consult with a tax professional to determine your best option.

If you proceed with an equipment lease, your lender will provide the capital needed to purchase the equipment. The lender will own the equipment during the term of the lease. As you compare leasing options, make sure you understand your purchase rights at the end of the lease.

A lease that gives you the right to purchase the equipment at fair market value at the end of the lease is typically less favorable than the standard “$1 purchase option,” which lets you take over ownership of the equipment at the end of the lease term for $1.

Some lenders reduce your monthly payments based on the end-of-term purchase price.

If you plan to continue using the equipment beyond the term of the lease, compare your overall costs, including interest, through the term of the lease, along with the end-of-lease purchase price.

A number of firms specialize in equipment leasing, including Crest Capital, SLS Business Lending, and Farnam Street Financial.

Putting things in context

Whether your financing needs are sudden and unexpected or are part of your long-term growth strategy, make financing decisions in conjunction with your overall financial projections.

Your financing needs make it imperative to have a financial model for your business. The better handle you have on your working capital, the more options and longer lead time you’ll have to develop a borrowing strategy.

If you’re faced with a crisis, like the current COVID-19 outbreak, make sure you’re aware of any support or new financing options that may be available to support small businesses during the crisis. See our Guide to Federal Resources to Aid Small Businesses affected by COVID-19.

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