Borrowing Alternatives for Businesses: Your Need for Capital will Color Your Financing Choice
You may be ready to walk into your banker’s office and apply for a loan to expand your business, buy equipment or just stay afloat. Or you may be considering an alternative to a bank loan. But exactly what type of financing should you pursue?
Bank loan types vary
Bank loans come in a variety of shapes and sizes, but most fall into one of several broad categories. Lines of credit are the most common small business loan, primarily because of their simplicity and flexibility. Once your business is approved for a line of credit, you can borrow up to your credit limit whenever you like without having to reapply. It’s often a good idea to apply for a line of credit before you need capital. That way, you can easily tap your line when a need for capital arises.
As the name suggests, term loans are issued for a specific period of time. They’re repaid with interest over a set number of years and used mainly to buy fixed assets like property, plant and equipment.
Commercial mortgages are a specific type of term loan used to buy new or existing commercial real estate. Examples include retail store space, industrial warehouses and office buildings.
Government loan programs are also used for raising capital. Among the most popular programs are the Small Business Administration (SBA) loan programs, such as the SBA 7(a), SBA 504 and SBA Express loan programs. The SBA guarantees a portion of these loans, enabling banks to lend to companies that might not ordinarily be able to use normal underwriting criteria.
It’s important to know why you need capital so your banker can suggest the right type of loan to meet your financing needs. For example, if you need a capital infusion to meet periodic cash flow shortfalls or fund accounts receivable, a line of credit is probably the right source of capital. But you typically wouldn’t use a line of credit to buy equipment or real estate — a term loan or commercial mortgage is the right type of loan for these capital needs.
Other places to look
In addition to banks, some businesses today are seeking capital from alternative sources, such as commercial finance companies and peer-to-peer lenders. The former provides alternative financing solutions such as factoring. In this scenario, you receive an advance against uncollected receivables and asset-based and accounts receivable loans, in which real estate, equipment, inventory and receivables are pledged to secure capital.
Meanwhile, peer-to-peer lending is becoming popular as a way for businesses to access capital via the Internet. Sometimes referred to as “crowdfunding,” it allows businesses to borrow money from individuals or Internet lenders that focus on lending to small businesses.
Finally, when it comes to acquiring equipment, leasing is often a better capital option than borrowing. This is especially true for equipment with built-in obsolescence like computers, because they can be replaced or upgraded when the lease is up. Equipment leasing is 100% financing, which frees up cash flow. And it also may offer tax benefits which would otherwise only be available when purchasing an asset.
You may need capital because your company is going through a tough economic stretch. Or you may want it to grow your business, remodel or buy new equipment. Whatever the reason, you have a wide variety of lending sources to which you can turn. And it’s usually smart to “shop around” before making a commitment.