Whether you’re considering a small business loan or simply want to find out everything there is to know about business financing – our comprehensive guide will reveal all.
What are Small Business Loans?
A business loan is similar in nature to a personal loan, however the acquired funds must be used purely for business purposes. As with other types of loans, a business loan involves borrowing an amount of money, before having to repay the loan with added interest. This total repayment amount is broken down into smaller repayments which are usually due on a weekly or monthly basis.
The Different Types of Small Business Loans
There are many different types of business loans, all designed to cater towards your venture’s specific financial needs. The most common small business loans are outlined below.
Secured Business Loans
A secured business loan means the borrowed finance is supported by a form of collateral – usually a person’s home. Collateral can take the form of other owned assets too, including cars, cash, invoices, other forms of real estate (i.e. investment properties) or inventory. This collateral is used to ‘secure’ the loan, therefore allowing it to be pledged as security for repayment. Although a secured loan can offer lower interest rates and longer terms, it poses a risk for the business owner if they are unable to make repayments. Small business owners who do not want to risk losing a valuable asset, such as their property, should consider an unsecured loan instead.
Unsecured Business Loans
Unlike secured loans, unsecured business loans can be obtained without providing collateral. In other words, the lender can’t seek repayment by going after your assets. Instead, lenders may ask for a personal guarantee from the directors of the business. When applying for an unsecured business loan, you still need to meet income and credit requirements, however many business owners love the flexibility that unsecured finance provides.
Short Term Business Loans
Just as the name suggests, a short term business loan is paid off within a short time frame – usually between 3 to 18 months. Because of this, business owners may want to borrow a smaller amount of financing than they would consider with a long term loan. Short term loans can be secured or unsecured and they offer the applicant a quick boost in cash when they need it most.
Long Term Business Loans
Unlike their shorter counterparts, long term business loans can carry repayment periods between 12 months to 30 years. Because of this, they often give the applicant a chance to borrow a larger sum of money – typically anywhere from $250,000 to a whopping $50,000,000. Long term loans carry a set maturity date, along with either a fixed or variable interest rate.
Business Credit Card
Business credit cards can be used by businesses of all types and sizes and they operate in a very similar way to a personal credit card. The key difference is that a business credit card can only be used for business-relating expenses and they are issues to those with an ABN. This type of financing keeps business transactions separate from personal transactions, making the tax time process a whole lot easier. Business credit cards also have higher credit limits than personal credit cards, plus their credit limits and cash transaction limits can be set for each cardholder. Additionally, business credit cards often offer more generous reward benefits than those available through personal credit cards.
Invoice financing (also known as accounts receivables financing) allows business owners to use money owed to them as a loan asset, meaning they can get paid for outstanding invoices immediately. It is essentially a secured loan, as you are using your outstanding invoices as collateral. The loan amount you are able to apply for largely depends on the amount owed to your business, as well as the creditworthiness of your customers.
Equipment financing is a type of small business loan designed specifically for the purchase of business equipment. The loan amount is determined by the cost of the equipment, however once approved, you can purchase and start using the equipment right away. The equipment itself will be used as collateral, however with regular repayments over time, the equipment will eventually be paid off in full.
A business microloan is essentially a small loan, ranging anywhere from $100 up to around $50,000. Due to these smaller loan amounts, a business microloan is more likely to be a short term loan, with repayment periods between 3 to 18 months. Microloans are often unsecured, due to their smaller nature, however secured microfinance options are also available from some lenders. This type of loan can offer small business owners, entrepreneurs, and start ups a quick injection of cash to help them grow their venture.
Merchant Cash Advance
A merchant cash advance works with the lender purchasing a business’s future cash flow, so future transactions are used to repay the borrowed funds (in addition to a fee charged by the lender). The lender will take a percentage (usually up to 20%) of each future sale the business makes until the debt is fully repaid. This is called a ‘holdback’.
Merchant cash advances are particularly useful for those working in retail or hospitality, as a large portion of their payments are made via credit card or EFTPOS. This type of loan can be referred to as a short term loan, as repayment periods are often up to 12 months. With a merchant cash advance, a business owner can borrow anywhere from $5000 up to $500,000.
Business Line of Credit
A business line of credit is a very flexible small business loan option that allows you to borrow a certain amount of capital annually, whilst only making payments on the credit you’ve used. While monthly payment amounts will fluctuate, there’s usually a minimum monthly payment required to keep you on track. Additionally, a business line of credit can be secured or unsecured.
Unlike a traditional loan, a business overdraft is connected to your existing bank account, allowing you to spend more than you’ve put into it. While an overdraft can be more expensive than other forms of small business financing in the long run, it can provide you with a business safety net, as you only pay interest on what you borrow. Like many types of small business funding, a business overdraft can be either secured or unsecured, depending on your lender and individual preferences.
Types of Small Business Loan Lenders
When it comes to business finance, there are two main types of lenders: traditional lenders and alternative lenders.
What is a traditional lender?
Put simply, a traditional lender is a financial institution such as a bank. While these once served as the only source of business finance, growing frustration among SMEs have seen alternative, non-bank lenders emerge.
What is an alternative or non-traditional lender?
An alternative lender (also known as a non-traditional lender) is essentially a company that is aiming to disrupt the traditional model of business financing. They do this by utilising technology and real-time data to make the process of applying for a loan and acquiring funds much easier. Here at Lumi, we’re proud to be an alternative lender shaking up the fintech industry.
What Can Small Business Loans be Used for?
There are a number of business-related expenses that a business loan can be used for. The most common include:
- Purchasing equipment
- Maintaining inventory
- Managing daily expenses
- Paying employee wages
- Moving to another business location
- Product development
- Marketing and promotions
Key Questions to Ask Yourself Before You Apply for a Small Business Loan
As with any exercise concerning your business, applying for a loan shouldn’t be a snap decision. Here’s some important questions you should ask yourself before you begin your loan application process:
- How much money does my business need to borrow?
- What will the money be used for? How will it help my business in particular?
- What will my monthly repayments be? Can I afford these?
- Do I want a short-term or long-term loan?
- Do I need to put up collateral for the loan? If so, what asset should I use?
- Is my credit score good enough to obtain a loan?
- Do I want to seek funding from an alternative or traditional lender?
What Do I Need to Apply for a Small Business Loan?
The business loan application process will largely depend on whether you seek financing through a traditional or alternative lender. At Lumi, we make our application process as easy as possible and only require the following to process your application:
- Driver licence
- Credentials for your online business bank account
How to Apply for a Small Business Loan
If you own an Australian-registered business, have been in operation for 6 months or more, and have a minimum annual turnover of $50,000, then you can apply for a small business loan online with Lumi in as little as a few minutes.
- Simply fill in our application form
- Receive a lending decision within 24 hours
- Obtain your funds in your nominated business bank account the following business day
It’s that simple!
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Get started with Lumi Finance today.