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How to Find the Financing Option That Best Fits Your Small Business

Hometap
By Hometap
January 7, 2020

If you’re ready to launch or grow your business, the financing options can feel overwhelming. The first step to securing capital is knowing the different types of loans available for small business owners—and the pros and cons of choosing one over the other.

Small Business Administration (SBA) 7(a) Loan

This small business loan program is the main way the SBA, a U.S. government organization, offers financial assistance to small business owners. Within the program are several loan types, with some eligibility decisions made by your lender and some made by the SBA. Loan amounts, terms, fees, interest rates, and more vary by the loan. For example, there are Veterans Advantage SBA loans that come with reduced fees and SBA Express loans that reduce the turnaround time for SBA review. You’ll want to find an SBA-approved lender who can help you determine the best option for you.

Pros:

  •  Because the program is backed by the government, it decreases the risk for the lender, making them more likely to work with you.
  •  Decreased lender risk also means you may be able to secure a longer repayment term, resulting in lower monthly payments.

Cons:

  •  Some lenders put restrictions on how you can use the funds.
  •  You’ll want to make sure if you’re using funds for things like fixed assets (equipment, remodeling) or to hire more employees, that your loan allows you to do so.
  •  SBA loans may take longer than another type of loan—often 60 to 90 days—and you’ll need a full business plan, financial statements, and business licenses, among other documents.
  •  Certain industries—gambling, firms involved with lending, and religious organizations, for example—don’t qualify for SBA loans.

Read 'Grow Your Small Business While Avoiding Debt'

Merchant Cash Advance (MCA)

A merchant cash advance, also known as a merchant loan, is designed for businesses with credit scores that may have a difficult time securing a traditional loan. You get a sum of cash in exchange for a share of your future credit or debit card sales, or you can repay it with set withdrawals (plus fees) from your bank account.

Pros:

  •  Compared to your other options, an MCA is fast and requires minimal paperwork.
  •  You don’t have to back an MCA with collateral.

Cons:

  •  Depending how fast you pay it back, you may face massive APR—as high as a whopping 350%.
  •  If you’re paying back with a percentage of debit and credit card sales, you can face higher APR if your sales skyrocket.
  •  It’s hard to really determine what the MCA will cost you—and if it’s worth the risk of falling into deeper debt.

Crowdfunding Loan

Crowdfunding allows you to set up a campaign online with your fundraising goal and request money for a specific project. Typically, you’ll offer something to supporters in exchange for their contribution. That may be your product or service, or it may be a share of stock in your company.

Similar to crowdfunding, peer-to-peer lending sites like Lending Club help connect established businesses to investors. It works somewhat like a loan in that you’ll pay interest and have a three- or five-year repayment period. However, instead of financing your loan, Lending Club simply services it. The site’s investors choose whether or not to invest in your loan.

Pros:

  •  Some crowdfunding sites allow you to repay investors with products or services instead of with cash.
  •  Depending on your project, there may be fewer barriers to entry and the process is often quicker than traditional loan processes.

Cons:

  •  You may face tax obligations.
  •  While you can promote your campaign via your social and professional networks, there’s no guarantee your campaign will succeed.
  •  For some platforms, if you don’t reach your goal, you don’t access the funding.

Equipment Loan

If you need an expensive piece of equipment or machinery—for example, manufacturing lines, company cars, or restaurant ovens—you may look into an equipment loan. Equipment loans are designed to help you cover the cost of adding new equipment and/or replacing old, outdated equipment that is too costly to repair.

Equipment loans are available through traditional lenders like banks, as well as online lenders. Some SBA 7(a) loans, as well as its 504 loan program, offer loans for equipment.

Pros:

  •  Often better rates compared to other loans.
  •  Tax benefits, like deducting the interest you’ve paid and claiming depreciation.

Cons:

  •  Some lenders may require you to have been in business for a set period of time before offering this type of loan and will likely want to see cash flow statements.
  •  Your equipment serves as loan collateral, so you can lose it if you default on the loan.

If the equipment you need will likely become outdated fast, you may find leasing is a better option. The Equipment Leasing and Finance Association recommends leasing only if you plan to use the equipment for three years or less.

Looking for Options Specific to Your Business? Read: The Best Small Business Loans for Niche Entrepreneurs

Using Your Home Equity to Fund Your Business

If you are a business owner and a homeowner you have an additional option: Tapping into your home equity. Many business owners think twice about options like a home equity line of credit because there is the possibility of losing your house. This is particularly true if you’re just launching a business, as there’s no guarantee it will take off.

But a home equity investment can give you the capital you need now in exchange for a share of the future value of your home. Since it’s an investment, not a loan, you have no monthly payments or interest. Once the term is up, you can either buy out the investment or simply repay it when you sell your home.

No matter what option you use to start or grow your small business, you’ll want to carefully weigh your options and get the help of an expert to make sure you're choosing the one that will best position you for personal and professional success.

Take our 5-minute quiz to see if a home equity investment is a good fit for you.
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LEGAL DISCLAIMER

The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, consult with a licensed advisor.