Every business, especially startups or those in a growth stage, can benefit from a cash infusion. There are various ways to access this capital, including crowdfunding and personal investments, but one of the most common methods is through financing.
Understanding Short-Term and Long-Term Financing
Small-business financing provides assistance in managing payroll, purchasing equipment, and expanding operations. There are two main types of financing available: short-term and long-term financing.
Short-term financing involves borrowing and repaying the loan over a shorter period, typically one to two years. These loans are commonly used to cover immediate needs like inventory or cash flow fluctuations.
On the other hand, long-term financing has multiyear repayment terms. For instance, if you opt for a 7(a) loan from the Small Business Administration, the repayment terms can range from 10 to 25 years. Long-term financing is suitable for substantial purchases such as equipment or a new facility.
Advantages of Short-Term Financing
One significant advantage of short-term financing is its accessibility for small businesses. Usually, there are no collateral requirements, and businesses with poor credit have a higher chance of qualifying.
Short-term loans also have an easier and quicker application process. Once approved, you can receive the funds within a day or two, particularly when applying with a nonbank lender. However, it’s important to note that short-term loans come with higher monthly payments due to the shorter repayment period.
Advantages of Long-Term Financing
One notable benefit of long-term capital is the higher funding amounts compared to short-term loans. With longer repayment periods, monthly payments are spread out and more manageable.
However, long-term financing often necessitates stricter financial requirements. Excellent credit is typically required, and collateral or personal guarantees may be necessary.
Contrary to popular belief, long-term borrowers end up paying more interest than short-term borrowers, despite the technically lower interest rate. The extended schedule translates into more payments and, consequently, more interest paid by the end of the loan term.
Considerations when Choosing a Lender
Once you understand the different types of business financing, you need to decide on the type of lender to work with. You can apply for financing through a bank, credit union, or nonbank lender.
Banks and credit unions generally offer the lowest rates, although they often have strict eligibility requirements and a slower approval and funding process.
If you face difficulty qualifying for a loan from a bank or credit union, you might consider nonbank lenders such as online lenders, lending marketplaces, or peer-to-peer lenders. These lenders tend to have more flexible eligibility requirements and offer faster funding, although typically at higher rates.
Comparing quotes from multiple lenders is advisable to identify the best deal. Consider factors such as:
- The loan amount offered by each lender.
- The lender with the lowest APR.
- Whether you will have a fixed or variable interest rate.
- Whether the lender charges origination fees.
- Whether there are any collateral requirements.
Determining the Best Option for Your Business
The “best” financing option depends on your specific needs and business goals. Short-term loans are useful for seizing short-term revenue opportunities or resolving immediate financial challenges.
However, if you have a more substantial purchase, such as acquiring another business or investing in real estate, long-term financing is a better choice. Long-term financing is suitable for higher investments that won’t yield an immediate return on investment.
Regardless of the loan you choose, it’s important to find a lender experienced in working with small businesses. Working with a lender that understands your business’s needs and challenges will help you determine the type of funding you need.
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