Securing Financing for Your Small Business
Applying for a loan can be a stressful experience on any given day, but is especially so now, as more and more business are facing financial hardships as a result of the COVID-19 pandemic. Though the Paycheck Protection Program (PPP) has provided the largest stimulus in U.S. history for small businesses, with 30 million businesses eligible for loans under the program, applying for these loans has proved challenging. The Small Business Administration stopped accepting PPP loan applications May 4, 2021, from most lenders. However, funding might remain for lenders designated as community financial institutions.
To improve your business’ chances of obtaining the financing it needs during this difficult time, consider these PPP loan alternatives.
What Are Your Small Business Financing Options?
Small business owners have a variety of creative financing options to keep their businesses well-funded and operating smoothly. Traditional lenders have expanded their application processes to approve business funding that would have been rejected in the past, and other nontraditional lenders are taking advantage of emerging technology to offer financing in ways that weren't prevalent even 15 to 20 years ago.
Business owners should research solutions that apply to their unique business and industry, but most small business financing options can be grouped into the following categories:
- Term loans
- SBA loans
- Main Street Lending Program options
- Business lines of credit
- Personal loans
- Merchant cash advances
- Equipment loans
1. Term Loans
The traditional loan process involves securing a term loan from a bank. Funds from term loans are borrowed under very specific terms at the outset. The bank outlines in the loan contract the interest rate at which the funds are borrowed and the repayment schedule that the borrower must adhere to. Any deviation from the terms typically results in penalties and additional interest. A borrower who can no longer adhere to the terms may also have to refinance the loan under new terms or face serious damage to their business credit. Depending on the amount financed, loans can be either short-term or long-term.
Long-term loans are a type of traditional term loan that is expected to be repaid over a year or longer; most long-term loans are generally issued for periods between three and 10 years. Long-term loans typically have lower interest rates than short-term loans, which is due to more stringent credit and approval requirements associated with long-term loans. These loans are more difficult to obtain, and the longer repayment schedule allows lenders to recoup a significant amount in interest, even at a lower interest rate. Borrowers can also secure more capital through a long-term loan, so they are ideal for well-established companies that need large amounts of capital for major projects or purchases.
Short-term loans are another type of traditional term loans, but these are generally expected to be repaid within a year or less. Short-term loans have less stringent credit and income requirements, but these can come at a cost. Short-term loans have higher interest rates and less flexible repayment options. These loans are ideal for businesses that need a modest amount of capital quickly.
2. SBA Economic Injury Disaster Loans (EIDL)
The Economic Injury Disaster Loan (EIDL) was intended to provide low-interest federal disaster loans for eligible businesses that have been negatively impacted by COVID-19. Funds were exhausted quickly, but under the American Rescue Plan Act enacted March 11, 2021, the Targeted EIDL Advance was infused with additional funds so businesses could access additional nontaxable funds.
How does the Targeted EIDL Advance work?
There are two groups targeted for this specific advance: businesses that received an EIDL Advance of less than $10,000 have first priority while second priority goes to those who applied for a EIDL help before Dec. 27, 2020 but never received funds because the program was exhausted. Businesses must wait for an invitation email from the Small Business Administration (SBA) before applying.
Businesses in low-income communities that have 300 or fewer employees and a loss in revenue of 30% or greater qualify fo apply for an EIDL Targeted Advance.
The SBA also will continue to make payments to businesses that received between $1,000 and $9,000 under the original program if they meet the same criteria stated in the above paragraph.
An additional $5,000 in supplemental payments are available to certain businesses who were hit hardest if they have 10 or fewer employees and experienced revenue losses greater than 50%.
Is the EIDL program available?
Yes. Businesses and nonprofit organizations that sustained financial losses due to the CIVID-19 pandemic can apply for a regular EIDL.
3. Main Street Lending Program
The Federal Reserve established a Main Street Lending Program (MSLP) to support lending to small and medium-sized businesses that were in sound financial condition before the onset of the COVID-19 pandemic. This program included lowering the minimum loan size for new and priority loans, as well as increasing the term for each loan option and extending repayment periods.
The MSLP expired Jan. 8, 2021.
4. Business lines of credit
While traditionally structured loans may work for many businesses, some companies may be looking to secure funds that may not be needed immediately. If your business needs more flexible funding options, a business line of credit may be ideal. Business lines of credit are opened for a certain amount — $100,000, for example — but the business may draw upon those funds as needed. Once the line of credit is opened, the monthly payments and interest are determined based on how much of the open line of credit is used. This small business financing option is ideal for companies wishing to improve cash flow management or be better positioned to handle surprise expenses.
5. Personal loans
Personal loans are structured much like business loans and have similar interest rates and application processes. But using a personal loan to finance your business is a fairly non-traditional approach to securing the capital you need. Nevertheless, there are some circumstances where a personal loan can be helpful, namely if your business is relatively new and can't provide income history, or if your business credit is not well-established. In these cases, you may want to consider using your personal credit history to get your business off the ground. However, use this option with caution, as the loan will be tied to your personal credit history, which allows lenders to come after your personal assets if the business can't repay it.
6. Merchant cash advances
If your company has consistent, documented income and a large portion of your income comes from credit card transactions, you may want to consider a merchant cash advance. Under this arrangement, a financing company provides you the cash needed and takes a portion of your daily credit card sales in return. Merchant cash advances typically offer a quick, easy approval process and less stringent credit and documentation requirements. Repayment is also painless, since it's typically automated through your credit card processor. Unfortunately, these advances are usually limited to $250,000 or less, making them undesirable for businesses looking to fund large projects. Companies should also expect to trade the easier application requirements and quick approval process for higher loan fees and less flexibility for refinancing.
7. Equipment loans
Companies in a variety of industries will need to purchase, upgrade, or replace equipment at some point during the lifetime of their business. Heavy machinery in the construction or farming industries, large medical devices, restaurant ovens, or commercial vehicles can all cost well over $100,000, making these purchases a severe burden on company cash flow. Equipment loans can help companies secure the equipment needed to continue business operations without allocating all the funds necessary for the new equipment up front. Equipment loans typically require a 20 percent down payment, and the repayment terms vary depending on the amount financed.
Different Lender Options Available for Financing Your Small Business
1. Financing through a big bank
According to an article in Forbes, big banks' approval rates for small business loans reached record highs of 27.3 percent in March 2019. But the types of loans granted by large banks may not be a good fit for every small company. Big banks provide solid financial backing and often become a trusted partner for growing companies.
2. Financing through institutional lenders
When shopping around for business financing, institutional lenders may not be the first funding source that comes to mind, but organizations such as insurance companies, hedge funds, and other non-bank lenders are increasing their small business loan volumes. Many lenders in this category offer attractive terms and longer payback periods than traditional banks.
3. Financing through small banks
For a more personalized approach to lending, try a local community bank. Often, the lending officers will take the time to get to know their clients personally. Small banks and credit unions also offer other helpful services to small business owners, such as checking accounts, business credit cards, and merchant services.
4. Financing through SBA loans
The core SBA loan program is the 7(a) loan program. Through this program, the SBA will guarantee loans up to $5 million, with no minimum amount. SBA 7(a) loans can be used for all business purposes, including working capital, real estate, equipment, and inventory. There are also specialized programs available under 7(a), such as the CAPLines program, which is frequently used by construction companies, seasonal service businesses, and manufacturers. CAPLines provides financing for the seasonal buildup of inventory or materials needed by companies in these industries.
5. Financing through an internet marketplace
The internet has increasingly become a source of business funding. Peer-to-peer lenders pair private investors with small businesses in need of financing. Newer lending companies are assessing small business risk by creating their own models, which differ from the typical credit scoring models used by banks. Online lenders also tend to offer smaller loan amounts and more flexible repayment terms along with quicker decision times, faster loan closings, and better customer service throughout the loan process.
As with any lender, it's critical to read the fine print carefully to understand the process, fees, interest rates, any prepayment penalties, and liens on your business assets. To compare options, use a resource center for small business loans that allows you to see online lenders for various types of loans, special circumstances (veteran status, for example), or types of businesses.
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This article was originally published June 17, 2021.