How Does a Small Business Loan Work?

Small business loans are a great way for companies to access immediate financial support in order to help themselves thrive. They can be used to fix issues with machinery, or they can be used to jumpstart a period of growth and development. There are many different types available, and each one offers slightly different support, depending on the needs of the company. But how do they work?

What is a small business loan?

A small business loan is a sum of money that is loaned to a company in order to help them function or grow. Most types of loans offer this money in a lump sum, while others offer it as a revolving line of credit (like a credit card, where the business can reuse the loan provided it has been paid back).

Business loans work the same as any form of a loan. A financial institution such as a bank or online lender will offer the business a sum of money. The total amount the business can receive will be dependent on a number of factors, including:

  • How much they are requesting
  • What the loan will be used for
  • The business’s ability to pay it back (based on credit history, income, assets, etc.)

Business loans can be a great asset to any company, provided they are used correctly and for the right reasons. If a business needs cash in order to improve or expand, taking a loan offers that cash up front, so the business doesn’t need to spend time-saving. They are able to upscale immediately and see the financial benefit of this immediately.

Different types of small business loans:

There are a number of different loan types that businesses can access, each designed to provide slightly different, tailored support. It’s important to understand the differences so that you can find the option that works best for your business.

Term Loan

A term loan is a more traditional loan type that many people think of when discussing small business loans. A financial institution will offer you a sum of money, to be repaid over a period of time with regular repayments according to an agreed-upon schedule. These types of loans can vary in size from a few thousand dollars up to $5,000,000, and the repayment terms can be years long. These funds can also be used for a diverse range of purposes, which fits the needs of most businesses. Lenders will determine whether a business is eligible for such a loan by checking their credit history, personal finances, as well as annual revenue for the business.

These loans are popular based on their usefulness, but they can also be some of the hardest to apply for. Many lenders, especially traditional institutions such as banks, can have very strict eligibility requirements. This can be an issue for very small or new businesses that may not qualify. Fortunately, the financial market has diversified enough that there is a wide range of reputable lenders who may still be able to offer support if traditional routes are not successful.

SBA Loan

A Small Business Administration (SBA) loan is a loan that is funded by the federal government. Businesses can access these through private financial institutions such as banks, but they are backed by the government. They have a wide range of purposes, such as growth and development, covering the cost of starting up, and real estate.

As these are backed by the government they are reliable and straightforward, and businesses can feel confident they are not going to be affected by any predatory behavior from the lender. Businesses that already have a strong financial history, can offer competitive interest rates, long repayment terms, and high maximum loan amounts.

The only downside to these loans is that they can be relatively difficult to be eligible for, compared to other loan options. Many small businesses, especially relatively new ones, may not be eligible for this support.

Business Line of Credit

A business line of credit is a revolving credit loan that a business can repay and reuse as often as they want, within the loan term. It works in a similar way to a credit card – a lender offers the business a line of credit up to a specified amount. The business can do whatever they want with the available funds, and then pay it back as soon as it is convenient. As you pay it back, you can reuse it as necessary.

This type of loan is ideal for businesses with ongoing financial needs, where cash flow might be an issue. It allows your business to make necessary purchases immediately, without having to wait for the money to be available. It’s also favored by many businesses because you only need to pay interest on the outstanding funds, not the loan total.

One of the only downsides to this form of loan is that they are relatively small, compared to some of the others on this list. Business lines of credit are usually for smaller, day-to-day costs, as opposed to larger payments for things like expansions or business development. This works fine for some businesses, but may not be ideal for others.

MCA

A merchant cash advance (MCA) is a type of loan where a financial institution will offer a business a sum of money, in exchange for a percentage of their future credit or debit card sales. These sales can often take time to be credited to a business, so an MCA helps to smooth any cash flow issues in this process. As the business receives the credit and debit card payments, the agreed-upon portion goes straight to the lender. Many businesses prefer this repayment method because it means they can always afford the repayments, even if they have had a slow day or week.

MCAs are also a good choice for some companies because they can be easy to obtain. Lenders will focus more on the amount of credit and debit card sales the business is likely to process, as opposed to credit history. Companies with a less-than-stellar credit history may still have to complete a credit report, but their score will not automatically make them ineligible.

MCAs are designed to be very short-term, and they can have very high interest and factor rates. This is fine for companies who have the capacity to pay them back swiftly. Businesses that require longer repayment terms may end up spending more on this type of loan compared to some others.

Invoice factoring and invoice financing

Invoice factoring involves selling all of your invoices to a financial institution. The financial institution will give you the cash value of these invoices, so your business has the funds upfront, instead of having to wait for the invoices to get paid. The lender then receives all the payments for the invoices in order to repay the loan – your clients pay the lender directly, not you. Invoice factoring can work by selling all of your outstanding invoices, or just a percentage of them.

While this type of small business loan is a great way to alleviate short-term cash flow constraints, many businesses may struggle with the concept of handing over payment collections to a lender. It means that your client liaises directly with the lender, and this can create some potential issues with your relationships, especially if the lender has to chase the payment.

A very similar set-up that alleviates this issue is invoice financing. Again, a lender will provide you with a sum of money that totals all, or a percentage, of your outstanding invoices. However, your business is still in control of receiving payments for the invoices, and you forward this to the lender to repay the loan. Many businesses prefer this method as it offers more control over your business’s finances and relationships with clients.

How to apply for a small business loan

Applying for a business loan may be different depending on the type of institution you are trying to engage with. Traditional lenders such as banks may still require you to provide the necessary paperwork in person, and it can take days or even weeks to process. Although this can be a timely process, there is reassurance in the validity of these institutions which many businesses appreciate. Conversely, many online lenders will accept applications online, which can be submitted any time of the day. Generally, these are also faster to be approved, some in as little as 24 hours. While this convenience can be appealing, it does require businesses to do thorough research into the lending institution. Online services can afford to lower their eligibility thresholds which can be appealing to businesses in need, but sometimes loans can be given inappropriately, ultimately causing longer-term financial strain.

Looking for a small business loan? Let the New York Tribeca Group help you

The New York Tribeca Group is an online financial institution that specializes in providing small businesses with the loans they need to help their business thrive. All services are tailored to the specific client and their needs, ensuring that the business needs are met and all clients are able to make educated and informed decisions. Loans range in size from $10,000 to $5,000,000, with repayment periods of up to 2 years, and financing costs as low as 8%. For urgent needs, some loan types can be approved in as little as 24 hours after submission, allowing businesses to keep on top of their financial needs as they arise.

The New York Tribeca Group is focused on delivering services that are transparent and supportive, without causing further financial strain. Clients are supported throughout the loan process, from applying, accepting, and even after during the repayment period. If your business is in need of financial support and you are unsure of where to start, consider reaching out to the team at the New York Tribeca Group.

FAQs

What is a business loan?

A business loan is a lump sum of money given to a company to support its financial needs. The loan is paid back in regular installments across an agreed-upon loan term.

What can a small business loan be used for?

Different loan types have different purposes. For example, equipment financing would be specifically for purchasing machinery or equipment for a business. Some loans are less specific, such as an SBA, which allows companies to use the funds for real estate, covering the cost of daily operations, paying staff, etc. When seeking out a business loan, it’s important to search for ones that can be used to fund your specific needs.

How big can a small business loan be?

Small business loans can vary in size, based on a number of factors. These can include the type of lender you are working with, the loan type you are trying to receive, your business’s financial needs, revenue, and credit history. Typically small business loans can start as small as $5,000 and be as large as $10,000,000.

What do I do if a bank denies my loan application?

Banks are some of the strictest loan providers, and have relatively high eligibility requirements for small business loans. If your application gets declined, you may wish to access non-traditional lenders, such as online financers such as New York Tribeca Group. Online lenders tend to have more flexibility, and may be able to work with you to find a solution that meets your needs, and that your business can afford.

Will I need to do a credit check in order to apply for a small business loan?

Yes, most business loan applications require you to provide a credit rating. There are some loan types, such as MCAs or invoice factoring, where you may be required to provide a credit rating, however, this is not a significant factor in determining eligibility. Therefore these loan types may be great choices for business owners who have slightly lower credit scores.

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