Small business loans let you borrow large sums to invest in your business and repay in fixed installments of principal and interest.
They are widely available and offer predictability in repayment, making it easy to fit them into your budget and measure ROI.
However, they are not your only option and may not be suited for all purposes. That’s why this article explores four financing alternatives to small business loans and examines some situations where they may work better.
1. Business Line of Credit
A business line of credit is a flexible way to finance your business. It lets you borrow money up to a predetermined limit and repay at your leisure. Interest accumulates on outstanding balances.
These offer more flexibility than small business loans since you can tap into the credit line whenever you need.
However, when you apply for a business line of credit, remember that they offer less structure than small business loans. You must manage your outstanding balance to pay down balances before accumulating too much interest.
Meanwhile, small business loans provide a predictable payment schedule that is easier to fit into your business financial planning.
2. Equipment Financing
Equipment financing is a specialized loan used to lease or purchase equipment for your business needs. Equipment can include any physical asset besides real estate, such as:
- Manufacturing machinery
- Company vehicles
- Medical equipment
- Office furniture
- Computers/computer equipment
Regardless, equipment financing uses the equipment itself as collateral. This can result in lower interest rates and more favorable terms than small business loans.
This also ties the equipment directly to its financing. That way, you can more easily compare the financing cost to the revenue the equipment generates for your business to measure ROI.
You can also lease the equipment with equipment financing instead. Although leasing means you won’t own it, it also may also let you secure lower monthly payments to maintain stronger cash flows.
All that said, equipment financing won’t work for broader business needs. You can only use it for the equipment. That means you may need a separate business loan to purchase equipment and cover short-term cash shortfalls.
3. Invoice Factoring
Invoice factoring entails selling outstanding invoices to a factoring company for immediate cash. This helps you cover shortfalls or take advantage of limited-time opportunities.
Plus, invoice factoring is not a form of financing. You sell invoices like any other asset. You won’t have to worry about approvals, monthly payments, or hard credit checks that impact your credit score.
The drawback is that you won’t receive the full value of your invoices. You sell them at a discount up front. The company charges a percentage, called a factoring fee, for how long it takes the customer to pay.
For example, you sell $10,000 of products on credit to a customer, then sell the invoices to a factoring company for 80%, or $8,000, of the total value.
The company charges a 2% factoring fee per 30 days it takes the customer to pay. The customer pays on day 30. Thus, the factoring company pays you 18% of the remaining 20%. You receive $1,800 and the factoring company keeps $200.
Overall, you received $9,800 of your $10,000 in invoices.
Factoring is typically better for short-term cash needs, whereas small business loans are ideal for longer-term investments or debt refinancing.
4. Merchant Cash Advance
A merchant cash advance is an advance on future sales, as the name implies. It lets you trade a percentage of your future sales for a lump sum of capital.
First, you decide how large an advance you want. Then, the merchant cash advance provider multiples that by a factor rate to determine.
For example, imagine you want a $50,000 advance. The merchant cash advance provider has a 1.3 factor rate. Multiply $50,000 by 1.3 and you get $65,000, the total amount the provider will collect.
You then repay the merchant cash advance as you make sales. Many may require daily repayment, although some allow weekly. Repayment ends when you have paid $65,000.
Like invoice factoring, merchant cash advances are not technically loans. They don’t impact your credit nor require monthly payments that are independent of revenues.
Overall, merchant cash advances can help you get significant cash quickly, similar to invoice factoring.
However, merchant cash advances can hamper cash flows more than small business loans depending on the sales amount and factor rate. Plus, if sales slow, you’ll be stuck in a merchant cash advance for much longer than some small business loans may last.
That means merchant cash advances may work better if you have significant sales volume.
The Verdict: Is a Business Loan Best for Small Businesses?
The predictability of small business loans makes them helpful for broad business needs, such as refinancing or investments in big projects. However, they are not the best option for everything.
Lines of credit offer short-term and ongoing flexibility for working capital and limited-time opportunities, while equipment financing can help you make significant investments in hard assets.
Meanwhile, invoice factoring and merchant cash advances offer ways to access significant cash without debt by leveraging your invoices or sales.
Every type of funding has its pros and cons, so consider your financing’s purpose carefully and assess your current financials to help decide the best form of funding for you.