Small Business Loans: 5 Questions to Find Your Best Fit

Small Business Loans: 5 Questions to Find Your Best Fit.

You’re a small business owner looking to grow your business, but you are frustrated at having to hoard cash for the next 6 months so you can finally buy the equipment you need to grow. Or maybe you just celebrated finishing that big project, but while you were high-fiving and smiling you were secretly wondering how to meet payroll until the client pays you in the 60 days.  In both scenarios, you decide that you need to find financing for your business.Need money

You’re familiar with the primary forms of consumer credit: mortgages and home equity loans, car loans, and credit cards.  Now, as a business owner, you face a lot more financing options.  What applies to you and what doesn’t?  How much will it cost, and how much time and paperwork will each require?  Term loans or merchant cash advances?  Invoice factoring or a bank line of credit?

As we were first trying to answer these questions we thought, “Why isn’t there a flow chart that helps small business owners choose the best option?” So we created the flow chart that we wish we’d had and repackaged it as the interactive set of questions below, all in hopes of saving you a painful learning curve.

The recommendations from this tool are based on two criteria:

  • What options are realistically available for your business? Sure, a bank may give a loan to a business open only one month, but 99% of the time it would be a waste of time to even try.
  • Within the available options, what has the lowest typical cost? Alternative (non-bank) financing can get pricey.  We assume you want to invest that in your business, not in your financier.

First, we’ll walk through the questions and why they matter.  After that, we’ll walk through each potential result to give a brief overview and resources for further investigation.

What is the financing for?
You don't want to pay for more financing than you need. If you just need to restock so you can make a new sale next week, a long-term loan doesn't make sense. The key thing to remember: Is the need long-term (equipment, property, etc.) or short-term (bridging a payroll, restocking inventory, etc.)?

There you have it. In five or fewer questions, you have found the best type of financing for your business, so now you can spend your afternoon making more customer calls instead of doing research.

Maybe you aren’t familiar with the recommended financing, or you want to compare it to alternatives? Here’s an overview of each type of financing.

Invoice Financing:

Have money tied up in invoices that your customer hasn’t yet paid? Invoice factoring solves that. Invoice factoring (also known as invoice financing or receivables financing) has been around for thousands of years, and works like this: you did work for XYZ Corp, and you have an invoice that says they will pay you for the work – but later.  (Usually in 30, 60, or 90 days.) You take that invoice to an invoice factoring company; they pay you cash now, and then they get paid directly by XYZ Corp when the invoice is due later. Usually a factor will give you 85-90% of the invoice value upfront, and then when your customer pays, they give you the remaining 10-15% minus the fee. Factoring is frequently cheaper for a business than an equivalent cash flow loan or merchant cash advance because there is a real asset (the invoice) and because they hold a little bit back in “reserve” — both of which make it less risky for the financing partner.

Pro:

  • Can be very quick to get cash — approval in 24 hours, and same-day funding after that
  • Generally lower rates than cash flow loans or merchant cash advances
  • Great for cash flow: you keep the financing the entire time – no installment payments or credit-card skimming

Con:

  • You don’t usually get the whole 100% of the invoice value upfront
  • Many traditional factoring companies will want a contract that locks you into working with them for a period of time
  • Usually your customer is notified that they need to reroute their invoice payment to the factoring company; this requires an extra customer touch point. If you want this to be hidden from your customers, look for “non-notification” factoring

Want a Ph.D. in factoring? Check out this handy accounts receivable financing guide or learn about the different types of factoring companies. If you think factoring is the right solution for you, we invite you to learn more about BlueVine, a factoring company.

Merchant cash advance:Merchant Cash Advance graphic

Merchant cash advance financiers will give you financing based on your historical credit card volumes, then they will repay themselves by deducting from your credit card volume until the financing plus interest is paid off. For example, if you finance $100 and the agreement is to deduct 10% from your volume, then if you make $100 via credit card on Monday, the credit card processor will only send $90 to your bank (since they took 10% or $10). This will happen until your financing plus interest is paid off.

Pro:

  • Matches your cashflow: if you have a low-revenue day, your loan repayment for that day drops accordingly
  • Easily available to B2C businesses that have few assets or credit history and are credit-card dependent

Con:

  • Very high interest rates – generally the highest of all options profiled here, and much higher even compared to credit cards

Cash flow loan:Cash flow loan graphic

A cash flow financier uses your past financial history and other metrics (sometimes even including Yelp reviews) to judge the stability of your cash flow. Based on this, they will extend a loan (technically an “advance”) and then be repaid from your cash flow. Depending on the financier, the repayment increments might be based on how much business you did in a period (similar to a merchant cash advance) or may be on set installments (similar to a term loan).

Pro:

  • Available to businesses who may not qualify for a bank loan
  • Generally cheaper than a merchant cash advance
  • By shopping among lenders, you may be able to choose between repaying in set installments or repaying in line with your cash flow

Con:

  • Generally more expensive than a secured loans like a term loan or invoice factoring
  • Approval is based on your history, so cash flow loans can require a longer business history

Term loan (bank or alternative):Term_loan

A term loan is a classic business loan. You borrow a certain amount and repay it in fixed payments over time until the principal plus interest is paid off. Term loans are typically available for 6 months or more. Term loans are offered both by banks and alternative financiers; banks generally have lower interest rates, but also have more hoops to jump through and are stricter on credit and business history. “Equipment financing” is a certain type of term loan that is offered specifically to finance equipment.

Pro:

  • Bank term loans are generally the lowest-priced form of financing
  • Alternative term loans are easier to get, though generally have higher rates
  • The long-term nature makes it a good match for large, long-term investments

Con:

  • Not a good fit for everyday expenses – just for longer-term assets
  • Generally requires more paperwork than other shorter-term options

Business Line of Credit:Revolving line of credit logo

A revolving business line of credit or “revolver” is essentially a pre-approval to borrow up to some amount of money, at any amount up to the max, at any time, for any reason. The cost is usually calculated on a daily basis, and the interest rate is applied to the amount you have withdrawn for each day or week. Many different financing options will talk about a “credit line,” but don’t be confused.  When other financing types talk about a credit line, they mean the maximum amount you can have financed with them at any time, but you generally can’t take out the money at any time for any reason. Business lines of credit give you this flexibility and are therefore a great option for working capital needs.

Pro:

  • An easy, ongoing source of temporary cash

Con:

  • Because of the unsecured nature of a line of credit, the approved amount is generally small relative to your business’ revenue or cash flow
  • Longer, more difficult application process

If you think a business line of credit is the right solution for you, try BlueVine’s simple business line of credit.

In Summary

Our goal with this widget was to bring some simplicity and transparency to the entire small and medium business financing industry. These aren’t necessarily your only options, and every financing company’s offering will vary slightly. But for the vast majority of businesses and situations, these are your top options.

Now take all the time you saved by not repeating this research process for yourself and invest it in growing your business instead.

Preparing to seek financing? Read more on the impact of liens.