What Type of Small Business Funding Do You Need?

Small business owners have a number of funding options to choose from in 2021. From SBA and traditional bank loans to alternative online lenders, it can be difficult to determine what kind of funding will help you achieve your business goals. Every type of lender offers different forms of funding, and each form of funding is ideal for helping you achieve a different objective.

In this article, we’ll explore the differences between three of the most common types of lenders and the various small business funding options they offer to help you determine what type of funding you need.

3 Types of Small Business Lenders

Before considering the specific type of funding you want to apply for, it helps to understand the types of lenders who grant small business loans. There are three main types of lenders, each with different funding options and different qualification criteria:

1. Business Development Bank of Canada (BDC) or Small Business Administration (SBA) in the United States

While they are both government-operated institutions, the BDC and SBA operate very differently. In Canada, the Business Development Bank of Canada (BDC) offers advisory services alongside small business funding, including venture capital, equity, growth, and business transition capital, as well as project-based financing. Unlike the SBA, the BDC does not guarantee loans—instead, funds are borrowed on the money market like other commercial banks then provided to small business owners, typically in the form of a term loan.

Unlike the BDC, the Small Business Administration (SBA) in the United States doesn’t actually provide the funding—instead, the loan is granted by an intermediary lender such as a bank and is guaranteed (usually up to 85%) by the SBA. This reduces the risk to the lender and encourages them to grant more loans.

2. Traditional lenders

Lenders such as banks and credit unions offer a variety of small business funding options, including term loans, lines of credit, real estate loans, and equipment financing. Similar to BDC or SBA loans, the application process is lengthy and intrusive, and most applicants are rejected, especially if you don’t have an existing relationship with your lender or are seeking a small loan amount.

3. Alternative lenders

Also known as online lenders or direct lenders, alternative lenders offer small business funding that is supported by new technologies and online platforms that help streamline the application and underwriting process. These lenders offer a variety of funding options, including long- and short-term funding, but typically alternative funding is ideal for shorter terms and smaller loan amounts. The application process is considerably less intrusive and detailed than SBA or traditional loans, with more flexible application requirements and faster approvals. For this reason, rates are typically higher than other forms of funding.

9 Types of Small Business Funding

There are many forms of funding available for small business owners. The right funding will ultimately depend on your business’s financial history, how much funding you need, and what you intend to use the funding for. Here are 9 of the most common types of small business funding:

1. Term loans

A term loan is a lump sum loan that is repaid at regularly scheduled intervals over the course of the length of the loan, plus interest accrued at a fixed rate. Terms are longer—usually between 1-5 years—and rates are typically lower than other forms of funding.

These loans are available from the SBA and traditional lenders. Business owners will need to complete an in-depth application, often including up to a year’s worth of detailed financial information and will need to meet or exceed high standards in order to qualify.

Term loans are commonly used for:

  • Buying real estate
  • Purchasing another business
  • Renovating or remodeling your space
  • Planning long-term business expansion

Who should apply for a term loan?

  • Established businesses with a strong financial history and a clear idea of how they’ll use their funding

2. Short term loans

Short term loans are similar to term loans, but with shorter term lengths between 3-18 months. These loans are available from traditional and alternative lenders, and typically have a less rigorous application process with less paperwork and faster approval, especially if you are applying for funding from an alternative lender. Rates tend to be higher because terms are shorter, with more frequent payments (often weekly or even daily).

Short term loans are commonly used for:

  • Funding short-term needs such as purchasing inventory or marketing your business
  • Covering immediate or emergency costs

Who should apply for a short term loan?

  • Applicants who would not be approved by traditional lenders, such as businesses with low credit scores
  • Businesses who need immediate funding and fast access to working capital

3. BDC or SBA loans

In Canada, the BDC offers loans up to $100,000 in as little as 48 hours. Multiple types of long-term funding are available, including real estate financing, equipment financing, working capital financing, and more. Your business must be based in Canada and have been in operation for at least 24 months to be eligible.

In the United States, SBA loans are provided by intermediaries like banks, credit unions, or Commercial Development Companies, and are guaranteed by SBA up to 85%. SBA loans often take the form of term loans with longer term lengths and the lowest rates available. Multiple types of SBA loans are available, including the popular 7(a) Guaranteed Loan Program, 504 Local Development Company Loans, Microloans, and Express Loans. The application process for SBA funding is the most arduous, often requiring years of business and personal financial information. It can take weeks or months for a decision to be made and there’s no guarantee of approval.

SBA or BDC loans are commonly used for:

  • Purchasing or upgrading real estate
  • Purchasing machinery or equipment, inventory, or supplies
  • Responding to natural disasters such as hurricanes or pandemics

Who should apply for a BDC or SBA loan?

  • Business owners with exceptionally strong credit seeking a long-term loan

4. Merchant cash advance

A merchant cash advance (MCA) is a non-loan form of short-term funding called an “asset purchase”. With a MCA, a lender will purchase a portion of your business’s future revenue in exchange for cash up front. You’ll receive working capital when you need it, and your lender will receive a portion of your daily credit and debit card sales till the advance has been repaid.

Merchant cash advances are available from alternative lenders. The application process is much shorter with less restrictive qualification criteria that focuses on the overall strength and potential of your business rather than your credit score.

Because of their shorter terms and easier qualification criteria, MCAs usually have higher fees based on a factor rate rather than regular interest or APR rates. Payments are typically drawn right from your business bank account, and the exact amount will depend on your earnings—when business is slow, your payments will be lower. When business is booming, your payments will be higher.

Merchant cash advances are commonly used for:

  • Purchasing inventory or raw materials
  • Boosting marketing and advertising campaigns
  • Investing in training or continuing education
  • Taking advantage of short-lived opportunities to grow

Who should apply for a merchant cash advance?

  • B2C businesses who need smaller amounts of cash fast
  • Businesses with lower credit scores
  • Businesses who need fast access to working capital
  • Businesses seeking smaller loan amounts and shorter terms

5. Invoice financing and invoice factoring

Invoice financing is another form of asset purchase. It’s available from both traditional and alternative lenders and can take many forms, including invoice factoring and invoice discounting.

  • With online invoice factoring, a lender will provide you with an advance equal to a percentage of an outstanding invoice’s value, usually up to 85%. Your lender is responsible for collecting payment from your customer, and you’ll receive the remaining percentage when the invoice is settled.
  • With invoice discounting, a percentage of an unpaid invoice is paid to the small business. In this case, the business owner is responsible for collecting payment. Once you collect payment, the loan is repaid along with any accumulated fees and interest.

Invoice financing typically has shorter terms that correspond to the length of the accounts receivable period (typically 60-120 days). In all cases, the invoice acts as collateral, so this type of funding may be easier to obtain than other forms of small business funding.

Invoice factoring is commonly used for:

  • Covering recurring operating expenses
  • Filling in cash flow gaps while you wait for clients to pay outstanding invoices

Who should apply for invoice factoring?

  • Businesses with cash flow problems caused by unpaid invoices
  • Businesses with long accounts receivable periods

6. Business line of credit

Instead of offering a lump sum of working capital, a business line of credit provides a source of funding from which funds can be drawn and repaid as needed up to a maximum credit amount.

Lines of credit are available from traditional and alternative lenders and are one of the most flexible forms of funding, similar to a business credit card but with higher credit limits and more favorable rates. You only ever pay interest on the amount you borrow, with payments typically scheduled monthly to cover both the interest and principal.

Lines of credit can be secured or unsecured depending on the strength of your application and the credit limit you are seeking. They can also be fixed or revolving. With a fixed line, the term length is set in advance and the credit line will not reset when you pay the balance. With a revolving line, the credit line resets when you pay the balance in full.

Business lines of credit are commonly used for:

  • Covering recurring operating expenses
  • Managing costs of unexpected emergencies
  • Purchasing inventory
  • Filling gaps caused by seasonal cash flow shortages

Who should apply for a business line of credit?

  • Businesses with strong credit history who want a cushion to fill in cash flow shortages or manage emergency costs
  • Businesses who need flexible access to working capital

7. Equipment or inventory financing

Equipment or inventory financing is a specific type of loan uniquely designed to finance the purchase of equipment or inventory. This form of funding typically provides 80-90% of the total cost of the equipment or inventory up front, allowing the business owner to spread payments out on a monthly basis similar to a car loan.

Available from traditional and alternative lenders, equipment financing can be used to cover the purchase of many types of equipment, including heavy machinery, computers, vehicles, appliances, store fixtures, and more. The equipment or inventory acts as collateral, so rates may be lower than other forms of funding. Rates and terms will depend on your business and credit history and your financial statements.

Equipment or inventory financing can only be used to purchase the specific equipment or inventory for which the loan is being sought.

Who should apply for equipment or inventory financing?

  • Businesses with significant or immediate equipment needs

Who should apply for equipment or inventory financing?

  • Businesses with significant or immediate equipment needs

8. Microloan

A “microloan” technically refers to very small loan amounts between $250-$1,500, but is often used to describe any loan under $50,000. Microloans are primarily available from non-profit lenders, including the SBA, who receive government grants which are then awarded as microloans.

Microloans typically have shorter terms and higher rates. They also often have flexible qualification requirements and will consider alternate forms of collateral, making this an ideal funding option for start-ups, businesses in higher risk industries, and businesses with low credit.

Microloans are commonly used for:

  • Covering start-up costs and other recurring operating expenses
  • Purchasing equipment or inventory
  • Boosting marketing and promotions

Who should apply for a microloan?

  • Businesses in underserved entrepreneurial communities such as women-, minority-, or veteran-owned businesses
  • Start ups, smaller businesses, or sole proprietorships

9. Commercial real estate loan

A commercial real estate loan is a loan granted for the express purpose of purchasing or improving commercial real estate. The property acts as collateral to secure the loan, with the size of the loan depending on a “loan-to-value” measurement that compares the size of the loan to the value of the property.

Commercial real estate loans are available from banks and credit unions, and occasionally the SBA. They can take on different structures depending on the lender and the amount of the loan. Because they are for longer terms (typically 20-30 years) and for larger amounts, application requirements are strict and the approval process can be challenging. However, since the property acts as collateral, rates may be lower than other forms of funding.

Commercial real estate loans can only be used to purchase or improve commercial real estate.

Who should apply for a commercial real estate loan?

  • Businesses looking to purchase or renovate a building or another commercial property

What type of funding do you need?

The type of small business funding you need depends on:

  • How much funding you need
  • Your business’s financial history and credit score
  • What you need funding for. Some funding is designed for specific purposes, such as equipment financing or a commercial real estate loan.
Working Capital Loans

For fast working capital loans, you should apply for funding from an alternative lender. These lenders can approve and deposit funds in as little as 24 hours, while SBA and bank loans can take months with no guarantee of approval.

Long-term Funding

For long-term funding, SBA loans or traditional lenders will offer the best rates and terms but are the most difficult to acquire. Alternative lenders also offer long-term funding like small business loans and collateral business loans for newer businesses or businesses with lower credit scores.

Short-term Funding

For short-term funding, merchant cash advances and online invoice factoring can provide a fast infusion of working capital with shorter repayment terms.

Businesses With Lower Credit Scores

For businesses with lower credit scores, your best bet is always an alternative lender. These lenders have more flexible approval requirements and are more likely to grant funding to businesses with bad credit.

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Alfredo Rosing

Alfredo Rosing is the Vice President of Marketing at Greenbox Capital®. With over 25 years of combined experience in marketing and financial services, Alfredo is an expert on innovative financial technologies with a passion for connecting consumers and businesses with socially responsible funding. Prior to joining the Greenbox Capital team, Alfredo launched an award-winning online lender that was recognized as the winner of the 2017 Fintech Awards US Firm of the Year for Lending Innovation Award. Alfredo is a graduate of Southern New Hampshire University with a BS in Marketing.