There are a variety of small business loans available to meet these different needs. In this guide, we’ll explain the most common types of small business loans and take a closer look at their interest rates and repayment terms.
What Are Small Business Loans?
The Small Business Administration (SBA) defines a small business as any company with fewer than 1,500 employees and less than $40 million in annual revenue. But the US Census Bureau found that most small businesses have fewer than five employees.
Small business loans can fund a one-person sole proprietorship, a local business like a restaurant or retailer, an online company, or even fast-growing businesses with hundreds of employees.
In effect, a small business loan is a catch-all term for loans catered to businesses that aren’t large enough to get funding from venture capitalists or public markets.
What Are Small Business Loan Terms?
Small business loan terms include a few different aspects:
- Loan amount: Most small business loans have a minimum and maximum size. Within this range, small businesses can borrow the right amount for them.
- Interest rate: The interest rate on a small business loan is the cost of borrowing. Small business loans must be paid back with a percentage-based interest rate.
- Loan fees: Some small business loans carry additional borrowing costs, such as origination fees.
- Repayment terms: A loan’s repayment term is the amount of time the small-business owner has to repay the loan with interest. Longer repayment terms require smaller installment payments, but also accrue more interest over the life of the loan.
Common Small Business Loan Terms
There are many different types of small business loans, each with its own loan terms. We’ll take a look at seven of the most common types of small business loans and explain how they differ.
1. Term loans
Term loans are one of the simplest and most common forms of small business loans. A business receives a lump sum of money and then makes monthly payments until the loan is fully paid.
The advantage of taking out a term loan is that they typically offer lower interest rates than business lines of credit, business credit cards, and other types of financing. Small businesses have many options when it comes to repayment terms, too.
Term loans are offered by various lenders, including banks, credit unions, and online lenders. Qualification requirements vary widely. Some lenders require the business owner to have a good to excellent credit score and to be established for two to four years or longer. Other lenders offer term loans to new businesses, although usually with higher interest rates.
- Loan amounts: $1,000-$1 million or more
- Repayment terms: Three months to 10 years or longer
2. SBA loans
SBA loans are a specific type of term loan offered by the US Small Business Administration. Compared to conventional small business term loans, SBA loans offer lower interest rates and longer repayment terms. Businesses can also borrow up to $5 million through an SBA loan.
Businesses that struggle to qualify for conventional loans, such as new businesses or businesses owned by individuals with fair credit, may be able to qualify for SBA loans. However, SBA loans are highly competitive and the application process can be lengthy. SBA loans often take up to three months to fund, compared to hours or days for many conventional term loans.
- Loan amounts: Up to $5 million
- Repayment terms: Up to 25 years
Microloans are another type of small business term loan. They’re usually offered by community banks and credit unions and can provide funding ranging from $1,000 to $50,000.
Microloans may restrict how the funds can be used, but they typically offer flexible repayment terms and low-interest rates.
- Loan amounts: $1,000-$50,000
- Repayment terms: Three months to six years
4. Business lines of credit
A business line of credit is a type of revolving credit for small businesses. Businesses are approved for a maximum lending amount, and then they can borrow as much or as little as they need up to that maximum. Businesses can borrow cash and make repayments multiple times as long as they remain below their maximum credit limit.
A business line of credit can be helpful for businesses with delays between when they pay for inventory and when they receive revenue. It can also help businesses with seasonal cycles to make it through the slow season. In practice, a business line of credit is like a business credit card, but lines of credit typically offer lower interest rates.
Businesses can apply for a business line of credit and receive funding in as little as 24 hours from some lenders. The line of credit typically has an expiration date several months or several years into the future.
- Loan amounts: $1,000-$250,000
- Repayment terms: Three months to five years
5. Merchant cash advances
A merchant cash advance is a type of loan in which businesses can receive early payment for their outstanding invoices from a lender. This can be a helpful loan option for businesses whose clients take 30-90 days to pay invoices from when they are first issued. Merchant cash advances can sometimes be funded on the same day.
Merchant cash advances can pay up to 100% of the value of outstanding invoices. Lenders typically charge a percentage of the invoice amount, known as a factor fee, rather than an interest rate. The factor fee may be charged weekly until the loan is repaid, which means merchant cash advances can be somewhat expensive.
- Loan amounts: Up to 100% of outstanding invoices
- Repayment terms: One week to three months
6. Inventory financing
Inventory financing offers loans based on the value of a small business’s inventory. This type of loan is helpful for businesses that need cash to purchase inventory in anticipation of a large influx of orders, for example, ahead of the holiday shopping season.
Inventory financing loans can be expensive. Interest rates are typically higher than for term loans and the maximum loan amount is usually less than the purchase cost of the inventory.
However, inventory financing loans can be issued the same day a business applies to a lender. Lenders typically require that businesses have an inventory management system in place before approving inventory financing.
- Loan amounts: Up to 65% of the inventory’s value
- Repayment terms: One week to one-year
7. Equipment loans
Equipment loans are large, long-term loans that can be used to buy vehicles, manufacturing equipment, computer infrastructure, and other expensive business equipment. Unlike term loans, equipment loans are backed by the purchased equipment itself. Since these loans are collateralized, they typically come with lower interest rates.
Businesses may be required to make a down payment of up to 20% on the equipment being purchased. Repayment terms for equipment loans depend on the expected useful lifespan of the equipment itself.
- Loan amounts: Up to 100% of the equipment cost
- Repayment terms: Up to the expected useful lifespan of the equipment
8. Prepayment Penalties
Paying off a loan early can save you money on interest. Therefore, it’s often an advantage to make extra payments if the business is booming.
However, some lenders charge prepayment penalties. These are fees incurred if you pay off your loan early so that lenders can make up for lost interest revenue.
When taking out a small business loan, be sure to check whether your loan terms include prepayment penalties.
Small businesses in need of cash have a lot of options. Different types of small business loans, such as term loans, SBA loans, microloans, business lines of credit, merchant cash advances, inventory financing, and equipment loans, all come with different terms, including loan amounts, repayment terms, and interest rates. It’s important to understand what terms are best for your business to get the right loan for your needs.