Small Business Loans

A small business loan is the lending of money from a lender to a borrower with the understanding there will be interest upon repayment. Interest is payment given from borrower to lender that exceeds the original amount of the loan. Interest is calculated as a percentage of the principal sum, which is simply the original amount of the loan. The numerical percentage of interest is called the interest rate. The total amount of the loan, between the principal sum and interest, is the borrower’s debt.

What are they for and how do they work?

Business loans are aptly named, as they are intended to be used for the borrower’s business expenses only. There are four categories of business loans, all of which can either be secured or unsecured. (See below for information on the four categories). Note that within these business loan categories are multiple types of business loans.

Secured loans involve the borrower using assets as collateral against the debt. Assets can be anything of monetary value, including market stock, vehicles and equipment. Collateral is used as repayment if and when the borrower cannot produce enough money. Unsecured loans involve no collateral, and upon failure to be repaid, the lender may seize the borrower’s assets.
Generally speaking, unsecured loans have lower interest rates than secured loans because in failure to repay the lender, unsecured lenders seize fewer assets than secured lenders.

Bank Loans

You guessed it. Bank loans are issued by a bank to a borrower. This is the most common type of business loan. If a secured bank loan is taken out, collateral will be required. Before approval by the bank, the borrower should be prepared by preparing the following: the business’ accounts, balance sheet, business plan, and business credit report.

A business’ accounts consist of its checking and/or savings accounts, as well as any other bank accounts that allow withdrawal of funds. A balance sheet consists of assets, liabilities (funds going out), and ownership equity (the difference between the two). The balance sheet lists these three amounts for specific dates. Think of a balance sheet as a picture of the business’ financial standing.

A business plan is a document that summarizes the goals of the business, and how those goals will be reached. Think of it as a blueprint for the business’ strategy. Lastly, a business credit report is the same as a consumer credit report, except that the scores will be for the business itself.

To be approved for a bank loan, business bank accounts should reflect consistent cash flow and remain in the positive, balance sheets should reflect a profit, business plans should be thorough and concise, and the higher the business credit score, the better.

Mezzanine Loans

Put simply, a mezzanine loan replaces collateral with part-ownership in the business. The lender assumes a predetermined amount of ownership if the borrower cannot repay the loan. Mezzanine loans often yield high amounts for borrowers, but this is because of the great risk involved.

Asset-based Finance

For businesses that may not be approved for traditional bank loans or mezzanine loans, due to poor credit, a bad track record, or simply being new or smaller, asset-based finance is a popular option. Essentially, it consists of a business borrowing against one or more of its assets, the worth of which being the focus of the lender, rather than the business’ financial standing. If the loan is not repaid, the asset then belongs to the lender.

Invoice Finance

The fourth category of business loan is invoice finance. An invoice is a bill, and is given from a seller to a buyer, indicating services rendered and the cost thereof. Business’ have the option to borrow against their own invoices, essentially selling them to a lender for less than their total worth, and thereby receiving a loan for the business. Two types of invoice financing exist: factoring and discounting.

Factoring involves the lender charging interest and fees on the loan as well as assuming control of repaying the invoices. Discounting involves the business maintaining control of repaying its debts.

It’s Up to You

Whichever path to a business loan one takes depends on many variables. Use the information above to determine the best path for your business. Remember that within each category of loan, there are many other more-detailed options.

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