11 Types of Small Business Loans and How They Work

1. Term loans

A term loan provides a lump sum of money repaid in monthly installments with interest over a set term. 

Common use cases: A business term loan is a great way to acquire working capital, expand business operations, purchase equipment, or hire additional staff.

Typical terms: Term loan amounts range from $5K to $500K with a repayment period between six months and 10 years. You can often see that money in as little as 1-3 days. These loans generally have a fixed interest rate, but some lenders may offer a variable rate that fluctuates with the market.

Minimum eligibility requirements: Each lender will have its eligibility criteria. In general, minimum requirements for a term loan include a 600 credit score, $8K in monthly revenue, and one year in business.

Pros:

• Fixed repayment schedule – A term loan offers a clear repayment timeline, which can help businesses plan and manage their budget.
• Lower interest rates – Compared to other types of loans, term loans usually come with lower interest rates.
• Access to larger amounts – Term loans typically allow businesses to borrow larger amounts, which can be beneficial for significant investments or expenditures.
• Building credit – Regular and timely repayments can increase a business’ credit score.

Cons:

• Collateral required – A term loan often requires collateral, which could be a risk if the business fails to repay the loan.
• Strict requirements – The eligibility criteria for term loans tend to be stricter, which might not suit businesses with lower credit scores.
• Long-term commitment – The repayment of term loans spans over a long period which might not suit businesses wanting short-term solutions.
• Early repayment penalties – Some lenders might charge a penalty for paying off the loan earlier than the agreed term.

4. Business cash advances

A business cash advance borrows against your future earnings to secure the financing you need. Once you’ve been approved and the funds are advanced to your account, you’ll repay the funder a fixed daily amount via a withdrawal from your bank account.  Some funders offer a merchant cash advance where you’ll have an agreed-upon percentage of your daily credit card deposits withheld for the lender. 

Common use cases: A cash advance can be used for any business expense. Common use cases include working capital, covering seasonal business needs, and expansion costs.

Typical terms: Business cash advances are known for speedy delivery. You can apply for anywhere from $5,000 to $500,000, and time to funds can be as short as 24 hours. A cash advance comes with a factor rate instead of an interest rate. Factor rates are expressed as a decimal number, such as 1.5. To calculate payback, multiply the total borrowed by the factor rate. For example, $10,000 borrowed x 1.5-factor rate = $15,000 total payback.

Minimum eligibility requirements: Qualifying for a business cash advance is surprisingly simple because the nature and terms of the loan make the risk lower for a lender. Minimum credit score requirements start at 500. You’ll need a minimum monthly revenue of $10,000 and a minimum time in business of three months to qualify for a cash advance.

Pros:

• Fast funding – Business cash advances often provide quick access to capital, usually within a few days.
• No collateral required – Business cash advances are unsecured, meaning you don’t have to put up any assets as collateral.
• Easy approval – Approval is based on business performance, not personal credit, making it easier for businesses with poor credit to qualify.

Cons:

• Costly – Business cash advances often come with high factor rates, making it one of the more expensive financing options.
• Daily or weekly repayments – Daily or weekly withdrawals from your business bank account can impact cash flow.
• Not regulated like loans – Business cash advances are not considered loans or regulated by lending laws, leading to potentially aggressive collection practices.

5. Equipment financing

Equipment financing is a specialized form of financing used to purchase equipment. With amounts available up to $5 million, you can use them to buy any kind of equipment your business might need. 

Common use cases: When most people hear the word “equipment,” they think of heavy equipment like backhoes, trucks, tractors, refrigerators, and trash compactors. But this type of financing can also be used for less obvious equipment, such as payment processing programs, solar panels, or accounting software for your office. The point is, if the purchase will equip your business for its needs, it probably meets the criteria.

Typical terms: Equipment financing is available from $5K-$5M with terms from one to 10 years. After submitting your application, you may see funds in as little as 24 hours. Interest rates start as low as 7.5%. The equipment you purchase will serve, at least in part, as collateral for the loan, so you may need less additional collateral than you would for other loan types. Some funders may require a down payment. 

Minimum eligibility requirements: Qualifying for equipment financing is easier than many other types of loans. If your business has been running for a year or more, brings in $50,000 or more in annual revenue, and has a credit score of 520 or above, you should be sitting pretty. Some equipment financing companies will work with day-one startups. The lender will also evaluate the value and condition of the equipment as part of the approval process.

Pros:

• Less need for collateral – The equipment often serves as collateral, so you don’t need to risk other assets.
• Preserves cash flow – Equipment financing allows businesses to preserve their working capital for other operational expenses.
• Tax advantages – Interest and depreciation on financed equipment can often be deducted as a business expense.
• Access to latest technology – It provides an opportunity to afford the latest technology or higher-quality equipment that might be too expensive to buy outright.

Cons:

• Risk of obsolescence – The financed equipment might become obsolete before it’s fully paid off, leaving you paying for outdated equipment.
• Total cost – The total cost over the term of the finance agreement will be higher than the equipment’s actual purchase price.
• Ownership uncertainty – Depending on the agreement, the financier may hold the title to the equipment until you’ve completed your monthly payments.

6. Commercial mortgages

A commercial mortgage or commercial real estate loan is used to purchase or renovate commercial property such as an office building or warehouse.

Common use cases: A commercial mortgage can be used for just about any property need, whether that’s retail space, an office, a warehouse, or a restaurant. If you’ve been around for decades and want to expand, that’s no problem. Ready to purchase your first location? Perfect.

Typical terms: A commercial mortgage is similar to a home mortgage but with a few key differences. One, you’ll need to provide a down payment. There are typically no options for 100% financing. Two, the terms will be shorter, typically 10-25 years. Three, some commercial real estate loans come with a balloon payment at the end of the term, which is one large payment that pays off the remaining balance of the loan.

This financing option is an asset-based loan, so the amount and rate of your commercial mortgage will be based on your credit and the value of the property you’ll be using as collateral. You can expect amounts ranging from $250,000 to $5,000,000. The interest rates are usually on the lower end, starting at around 6.25%.

Minimum eligibility requirements: Qualifying for a commercial mortgage loan requires a clear plan for how you’ll put the cash to use. For example, if you’ll be making renovations to a property, your lender will want to know how you intend to do it and will also assess the after-repair value (or ARV) of the property.

Lenders will also look for:

• Minimum credit score: 650
• Down payment: Starting at 10-25%
• Time in business: 2 years or more

You can plan on a lender requesting several property-related documents, including the purchase contract, property blueprints, market analysis for the property, project budget, scope of work, and assessment of the property’s existing condition.

Pros:

• Asset ownership – A commercial mortgage allows your business to own an asset that can appreciate over time.
• Stability – It provides a stable location for businesses which could be a significant advantage for customer retention.
• Renting potential – The extra space could be rented out to generate additional income.
• Tax benefits – Interests on commercial mortgages are tax-deductible.

Cons:

• Down payment – Commercial mortgages typically require a substantial down payment, often more than what’s required for a residential mortgage.
• Maintenance costs – Owning a commercial property can bring additional costs like maintenance, repairs, and insurance.
• Lengthy process –The time to fund a commercial mortgage can take anywhere from 4-8 weeks.

7. Invoice factoring

Invoice factoring (sometimes called accounts receivable factoring) is tailor-made for when you need money but cashflow is tied up in outstanding invoices. With this type of financing, you’ll sell your outstanding invoices to a factoring company that will pay you a percentage of the invoice’s value upfront. The factoring company will collect the money from your customer when the invoice comes due and pay you back any remaining balance minus the factoring fee.

Common use cases: Invoice factoring is frequently used to boost cash flow, cover short-term expenses, and manage business seasonality.

Typical terms: The amounts vary, but you can often get up to 80% of your receivables. The money arrives in as little as 24 hours, and the loan term can last up to a year. As for the factoring fee, it starts as low as 3%.

Minimum eligibility requirements: To qualify for invoice factoring, your business must be B2B or B2G, have a minimum monthly revenue of $10K, and operate in the funder’s preferred industry.

Pros:

• Immediate cash flow – Accounts receivable factoring provides immediate cash, improving business liquidity and enabling timely handling of operational expenses.
• Reduce time spent on collections – One of the main benefits of accounts receivable financing is it relieves you of the burden of tracking down those who owe you money to collect on outstanding debts. Instead, the lender will do the work for you.
• Credit score irrelevant – This type of financing generally depends on the creditworthiness of your customers, not your business. Therefore, businesses with lower credit scores can still qualify.
• Flexible terms – The financing volume can grow with your sales, providing flexibility for businesses with seasonal demand fluctuations.

Cons:

• Factoring minimums – Some factoring companies may require you to factor a minimum amount with them over a set period. 
• Loss of control – You may lose some control over customer relationships, as the financing company may interact directly with your customers during the collection process.

10. Short-term loans

Short-term loans are repaid in a term of six months to three years. They can be structured as a term loan, a cash advance, a line of credit, or invoice factoring. Be aware that many term loans with short term lengths will require a daily or weekly payment similar to a business cash advance.

Many entrepreneurs use short-term loans when they need quick solutions to pressing circumstances. So whether you need to pay for unexpected expenses, hire new staff, endure a sales slump, replace a broken piece of equipment, or take action on an exciting business opportunity, a short-term loan can be a solid option.

Pros:

• Quick access to funds – Short-term loans are usually processed quickly, giving immediate access to the funds needed.
• Easier approval – The approval process is often less rigorous compared to those for long-term loans, allowing businesses with less-than-perfect credit scores to get approved.
• Short repayment period – As the name suggests, short-term loans are repaid quickly, which can be an advantage for businesses not wanting long-term debt.
• Less interest over time – Since the loan term is shorter, the total interest paid over the lifespan of the loan might be less than a long-term loan (despite higher interest rates).

Cons:

• Higher interest rates – Short-term business loans usually have higher interest rates compared to long-term loans.
• Frequent payments – These loans often require daily or weekly payments, which could be a strain on your business’s cash flow.
• Less money – Generally, short-term business loans offer less money than long-term loans, which might not be sufficient to cover larger financial needs.

11. Business credit cards

Of all the types of small business financing out there, the business credit card is the most user-friendly. If you’ve had a personal credit card, you know how it works. You can access amounts up to $500,000 with a business credit card, with interest rates from 8-24%. It’s not unusual to get a 0% introductory rate. There’s very little paperwork required compared to many loans, and the time to funds rarely exceeds 2 weeks.

This option is excellent for those who don’t feel ready to pursue a business loan or have been repeatedly turned down for them in the past. You’ll boost your working capital with fast access to cash, plus get the added benefits of leveraging a card rewards program and building your credit.

Business credit cards can be used for just about anything related to your operations. Whether you need to buy a new dump truck, add inventory, expand your office, take a client out to lunch, or hold an off-site staff event, this financing can be just the ticket.

Qualifying for a card isn’t difficult, which makes it a good match for those who are new to business. As long as you’ve got a credit score above 680 and have a decent business history, you should be in good shape.

Pros:

• Reward points – Many business credit cards offer reward points or cash back on purchases, which can be reinvested into the business.
• Building credit – Regular and responsible use of a business credit card can help build your business’s credit rating.
• Separate business and personal expenses – Business credit cards make it easier to keep business and personal expenses separate, simplifying accounting and tax filing.
• Emergency funds – Business credit cards can be used to manage cash flow during lean periods or to cover unexpected expenses.

Cons:

• High interest rates – If the balance is not paid off each month, the interest rates on business credit cards can be high, increasing the cost of borrowing.
• Dependence on credit – Over-reliance on business credit cards can lead to excessive debt and negatively impact the business’ credit score.
• Personal liability – In many cases, business credit card debt is personally guaranteed by the business owner, putting personal assets at risk.