The most common type of loans come from banks, which exist to lend money, so it's no surprise that banks offer a wide variety of ways to fund a business's growth. Here's a look at how lenders generally structure loans, with some common variations:
Line-of-credit loans. The most useful type of loan for a small business is the line-of-credit loan. This is a short-term loan that extends the cash available in your business's checking account to the upper limit of the loan contract. You pay interest on the actual amount advanced from the time it is advanced until it is paid back. Line-of-credit loans are intended for purchases of inventory and payment of operating costs for working capital and business cycle needs. They are not intended for purchases of equipment or real estate.
Installment loans. These bank loans are paid back with equal monthly payments covering both principal and interest. Installment loans may be written to meet all types of business needs. You receive the full amount when the contract is signed, and interest is calculated from that date to the final day of the loan. If you repay an installment loan before its final date, there will be no penalty and an appropriate adjustment of interest.
Balloon loans. These loans require only the interest to be paid off during the life of the loan, with a final "balloon" payment of the principal due on the last day. Balloon loans are often used in situations when a business has to wait until a specific date before receiving payment from a client for its product or services.
Interim loans. Interim financing is often used by contractors building new facilities. When the building is finished, a mortgage on the property will be used to pay off the interim loan.
Secured and unsecured loans. Loans can be secured or unsecured. An unsecured loan has no collateral pledged as a secondary payment source should you default on the loan. The lender provides you with an unsecured loan because it considers you a low risk. A secured loan requires some kind of collateral but generally has a lower interest rate than an unsecured loan. The collateral is usually related to the purpose of the loan; for instance, if you are borrowing to buy a printing press, the press itself will likely serve as collateral. Loans secured with receivables are often used to finance growth, with the banker lending up to 75 percent of the amount due. Inventory used to secure a loan is usually valued at up to 50 percent of its sale price.
Although the SBA doesn't actually loan money itself, it does provide loan guarantees to entrepreneurs, promising the bank to pay back a certain percentage of your loan if you're unable to. Banks participate in the SBA program as regular, certified or preferred lenders. The most basic eligibility requirement for SBA loans is the ability to repay the loan from cash flow, but the SBA also looks at personal credit history, industry experience or other evidence of management ability, collateral and owner's equity contributions. If you own 20 percent or more equity in the business, the SBA asks that you personally guarantee the loan. After all, you can't ask the government to back you if you're not willing to back yourself. Here's a quick look at the numerous loan programs offered by the SBA for growing businesses:
The 7(a) Loan Guaranty Program. This is the primary SBA loan program. The SBA guarantees up to $750,000 or 75 percent of the total loan amount, whichever is less. For loans of less than $100,000, the guarantee usually tops out at 80 percent of the total loan. A 7(a) loan can be used for many business purposes, including real estate, expansion, equipment, working capital or inventory. The money can be paid back over as many as 25 years for real estate and 10 years for working capital. Interest rates are a maximum of 2.75 percent if over seven years.
The SBA LowDoc Program. This is a special 7(a) loan promising quick processing for amounts less than $150,000. "LowDoc" stands for "low documentation," and approval relies heavily on your personal credit rating and your business's cash flow. LowDoc loan proceeds can be used for many purposes. Applicants seeking less than $50,000 are required to complete only a one-page SBA form. Those seeking $50,001 to $150,000 submit the same short form, plus supply copies of individual income tax returns for the previous three years and financial statements from all guarantors and co-owners. The SBA guarantees a 36-hour turnaround on these loan requests.
The SBA Express Program. This is a close cousin of the LowDoc, also offering loans of up to $150,000. However, SBA Express gets you an answer more quickly because approved SBA Express lenders can use their own documentation and procedures to attach an SBA guarantee to an approved loan without having to wait for SBA approval. The SBA guarantees up to 50 percent of SBA Express loans.
CAPLine loans. These provide working capital through a selection of revolving and nonrevolving lines of credit. CAPLine loans are guaranteed by the SBA up to $750,000 or 75 percent of the total loan amount, whichever is less. The CAPLine program includes variations for seasonal businesses, companies that need credit to complete a large contract, and builders and small companies that can't meet requirements for other financing.
The SBA's Minority and Women's Pre-Qualification Loan programs. These help women and minority entrepreneurs pre-qualify for loans of up to $250,000. Private intermediary organizations chosen by the SBA help eligible entrepreneurs complete a loan application. With the SBA's guarantee attached, the bank is more likely to approve the loan.
The Microloan program. This program helps entrepreneurs get very small loans, from less than $100 to as much as $25,000. The loans can be used for machinery and equipment, furniture and fixtures, inventory, supplies and working capital, but not to pay existing debts. Microloans are administered through nonprofit intermediaries using SBA funds. Terms are usually short, and application turnaround time is less than a week.
The CDC-504 Loan program. This program provides long-term, fixed-rate loans of up to $1 million for financing fixed assets, such as land and buildings. CDC-504 Loans are made through nonprofit Certified Development Companies. The program is designed to enable small businesses to create and retain jobs.