“Cash is king!” states a common business axiom. And this is generally true: Without strong cash flow and healthy operating funds, most businesses will struggle to meet day-to-day overhead and working capital expenses. Many owners find that they need to seek outside sources for the capital required to keep their companies running smoothly. Not surprisingly, the first place they turn to is their bank. Before approaching your bank, it’s a good idea to get up to speed on the different types of capital, or business loans, that banks typically offer. All business loans aren’t the same — different types of business loans are designed to meet different capital needs.
Different types of business loans
Small business capital comes in a variety of shapes and sizes, but most business loans fall into one of these five broad categories:
Lines of credit. This is the most common small business loan, primarily because of its 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 so you can easily tap your line when a need for capital arises.
Term loans. 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. This is a specific type of term loan that’s used to buy new or existing commercial property, including retail store space, industrial warehouses and office buildings.
Government loan programs. Among the most popular government programs for raising capital are the Small Business Administration (SBA) loan programs, such as the SBA 7(a), 504 and SBA Express loan programs. The SBA guarantees a portion of these loans, enabling banks to lend to companies they might not ordinarily be able to using normal underwriting criteria.
Equipment leases. When it comes to acquiring equipment, leasing is often a better capital option than borrowing money to buy equipment. This is especially true for equipment with built-in obsolescence like computers, because they can be replaced or upgraded when the lease is up. Leasing is 100% financing, which frees up cash flow, and it also may offer tax benefits.
It’s important to know why you need capital so your banker can suggest the right types of business loans 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.
Tips for landing a loan
This credit-tight environment makes it hard for some businesses to obtain capital from their bank. Thus, it’s more important than ever to be well prepared when you approach your banker about any one of these types of business loans. Here are four tips to help you succeed:
1. Remember the “five C’s” of credit. When analyzing potential borrowers, most banks look closely at the borrower’s character, capacity, collateral and capital, as well as current market conditions.
2. Perform a critical self-assessment. Assess your business from your banker’s perspective. In particular, most banks are looking for management stability, consistent profitability and strong cash flow to help ensure that you can repay the loan.
3. Be honest about your strengths and weaknesses. Banks don’t like surprises. It’s better to tell your banker upfront about any problems you’re facing than to have your banker find out later.
4. Work in tandem with your accounting professional. Your CPA can help you prepare the financial information your bank will want to see in evaluating your capital request.
Alternative financing solutions
In addition to banks, some businesses today are seeking capital from alternative sources, such as commercial finance companies and peer-to-peer lenders. Commercial finance companies provide alternative financing solutions like factoring, in which 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. Also sometimes referred to as “crowdfunding,” this allows businesses to borrow money from individuals or Internet lenders that focus on lending to small businesses.
Choose the right financing avenue
If you need to access capital for your business, there are several different avenues you can pursue. Make sure you know why you need capital so you can choose the right type of financing to meet your needs. We can help you navigate the different types of business loans and determine which one is right for you – contact us.