This is a guest post by Sara Amato, Lendio.
When your business is strapped for cash, it’s stressful. And though there are a host of options for borrowing the money you need, there are also a host of factors to consider. How do you know which type of financing is right for your business needs? What is it going to cost you? Will you even qualify? To help you understand the benefits and downsides of two of the most popular borrowing options, a loan and a cash advance, here’s a breakdown of the best uses, costs, and requirements of each.
When you’re in need of capital, you probably immediately think of taking out a business loan. A loan will provide you and your business a lump sum in exchange for monthly payments over a term period. The terms of the loan are determined by your credit history and your business standing. But there’s more than just one option: you can apply for a long-term or short-term loan.
Long-term business loan
If your business is established with a good business credit history and you’re looking to expand, a long-term business loan probably makes sense for you. Businesses that receive a long-term business loan typically receive a lump sum and must pay back the loan with interest over the term of the loan. The minimum term length for a loan to be considered long-term is one year.
In most cases, long-term business loans are used to purchase something specific that will help the business grow and make more money. That can be anything from vehicles to real estate to machinery.
Rates for long-term business loans usually range between 6 and 8 percent, but can differ based on the lender and timing of the loan. Closing costs and processing fees also vary depending on the lender.
Many factors go into applying and qualifying for a long-term business loan including your business credit, financials, and future financial needs. Business loans can be fairly negotiable and will depend on the lender you choose.
Short-term business loan
If you’re a small business owner just starting out or you don’t have a well-rounded business credit history, you may consider a short-term business loan. Short term loans are generally smaller amounts with higher interest rates and shorter repayment periods, and they tend to be based on your personal credit. Short-term loans are schedule to be repaid in less than a year.
Short-term business loans can be used to cover cash flow gaps, expand operations, or cover any unexpected expenses and/or emergencies. It’s not uncommon for lenders to request borrowers pay back the loan on a weekly or daily basis.
Short-term business loans tend to be higher in cost than long-term business loans because of the higher interest rates associated with receiving the cash faster. The greater the risk the lender believes the company poses, the higher the interest rates.
Most companies can qualify for a short-term business loan, even if they can’t qualify for a long-term loan. Lenders typically look at business owners’ personal credit scores and the business’s cash flow projections to determine whether they qualify. If small businesses are able to demonstrate consistent monthly revenue, they are more likely to be approved.
Secured vs. Unsecured loan
A short-term or long-term business loan can be secured or unsecured. This means you might need to put up collateral to receive the funds. If the loan is secured, you’re putting up assets to ensure repayment. If you default on the loan, the lender can seize those assets. An unsecured loan does not require you to put up collateral, but the loans are heavily based on your credit score and they are typically more expensive.
It’s important to remember that a cash advance is not a loan. It provides your business with a lump sum upfront, but without a repayment structure. The money is repaid in exchange for a percentage of future credit card and debit card sales.
Cash advances are quick and unsecured, which means you won’t have to forfeit any personal or business assets if business is bad. Because there is no fixed term with cash advances, they can be a great solution for businesses that need to pay less during slower months. However, cash advances are not perfect for every business.
Cash advances generally come with a high annual percentage rate, depending on the provider, and this can make them far more expensive than a traditional business loan. Businesses should proceed with caution to fully understand the terms and properly vet any cash advance provider before jumping in. Make sure you understand the provider’s interest rates, how the rates compare to other loan products, and how they compare to other providers’ rates. Ask if the provider has worked with other businesses in your industry, read the online reviews, and thoroughly review all of the contract terms with the provider to ensure you understand the fine print. Read more about the important questions you should be asking any time you apply for a loan or cash advance.
So what’s right for my business?
Small business funding isn’t a one-size-fits-all situation. The best fit for your business depends on your business needs, your personal and business credit history, your revenues, what kind of repayment schedule works best for your current financial situation, and what you need the capital for. If you’re an established business looking to grow, look into a long-term business loan first. If you’re just starting out and need fast cash you can pay back in a short amount of time, a short-term business loan may be for you. If you’re comfortable borrowing against your future earnings and need quick access to capital for an immediate growth opportunity that’s too good to pass up, explore the terms of a cash advance.
Sara Amato is a graphic designer, writer, and contributor to the Lendio blog. The leading marketplace for small business loans, Lendio provides business owners with loan options from a number of different lenders, as well as free consultations to answer questions and help them find the best fit for their needs. Currently based in Colorado, Sara was born in New Jersey and has lived in Indiana, California, Arizona, and Illinois. When she’s not designing or writing, she’s probably watching TV or eating pizza.