9 Types of Small Business Loans

tarting your own business is an exciting — and potentially nerve-wracking — adventure. As you start planning, one of the first challenges you might face is affording your overhead costs. Average startup costs can range up to $40,000 in the first year. If you can’t afford those costs out of pocket, you need a small business loan.

In this article, we’ll cover nine different types of business loans to help you decide which is best for your business. You'll also learn about eligibility requirements and the pros and cons of small business loans.

What is a small business loan?

A small business loan is an amount of business funding that you borrow from a lender and pay back over time, usually with interest. There are several types of small business loans, as we’ll discuss below. Some are traditional loans with strict terms and others offer more flexibility.

Do you need a small business loan to start your business? Not necessarily — in fact, only around 34% of small businesses applied for a loan in 2023. Many business owners opt for out-of-pocket funding, private loans, or other funding options. However, a small business loan is still a reliable option for new businesses of all sizes. Many banks and fintech platforms offer flexible terms to help business owners afford their startup costs.

‍

The different types of small business loans

There are several different types of business loans available to new business owners in the U.S. Below, we’ll cover nine of the most common.

1. Term or traditional loans

A term loan, also called a traditional loan, is a standard loan from a bank that you must repay within a set term. There are three types of business term loans:

• Short-term loans: Repayment in one to two years
• Mid-term loans: Repayment in two to five years
• Long-term loans: Repayment in up to 25 years

When compared to other funding options, such as credit cards or a business line of credit, traditional loans offer relatively low interest rates . However, they often have strict eligibility requirements. Depending on your lender, you may need a credit score of at least 670 and six months to one year of business history.

#2. SBA loans

The Small Business Administration (SBA) partners with financial institutions to provide funding for small businesses. These loans can range from $500 to over $5 million, and offer repayment terms up to 25 years.

The SBA doesn’t provide funding for business loans, but it backs the funds provided by lenders. That way, lenders are inclined to loan larger amounts to small business owners, as they know their investment is insured. The two main types of loans offered by the SBA are:

• 7(a) loans: These loans have guaranteed amounts and capped interest rates.
• 504 loans: These long-term loans have fixed rates for equipment, real estate, and other business assets

SBA loans are ideal if you need to borrow a large amount. However, like traditional loans, they have strict eligibility requirements. As a borrower, you must do business in the U.S. and have good credit and a sound business plan. You're also required to have already used alternative financial resources.

#3. SBA microloans

Along with 7(a) and 504 loans, the SBA also offers microloans up to $50,000. The maximum repayment term for an SBA microloan is six years, and interest rates are generally between 8% and 13%. Eligibility requirements vary for each lender, and many lenders require collateral.

An SBA microloan can be a great choice if you need funding for repairs, expanding your business, ordering more inventory, and other expenses. Keep in mind that you can't use microloans to buy real estate or pay off other debts.

#4. Equipment financing

Equipment financing is a special type of loan for business equipment. These loans are secured by the equipment, similar to an auto loan. Interest rates and repayment terms depend on your lender and the type of equipment you’re buying.

Most lenders require a down payment of around 10% to 20% on the equipment. This can be a helpful loan option for a restaurant, agricultural company, or other business that relies on expensive equipment.

#5. Business line of credit

A business line of credit is not a set loan amount, but an open credit line that businesses can borrow from as needed. This is currently the most sought-after type of business funding, as it's a flexible option for a startup owner who doesn’t know exactly how much they need to borrow as they get their business off the ground.

The terms and requirements vary for each lender, but interest rates are generally higher than with traditional funding options. Most lenders require borrowers to have a minimum monthly revenue and time in business. Once you open a business line of credit, you can borrow and repay money repeatedly until the term ends.

#6. Merchant cash advance

A merchant cash advance is a lump sum that you repay with a portion of your credit card sales over time. Instead of making monthly payments, you'll repay the lender through fixed daily or weekly sums.

This lending option is ideal for retail businesses that want to drive credit card sales. Traditional lenders and fintech platforms offer merchant cash advances with varying rates and terms.

#7. Business credit cards

Like a business line of credit, a business credit card is a revolving funding option. After opening their account, a business owner can borrow and pay back money as needed throughout the term period. Many business credit cards offer rewards for regular spending.

Credit cards can be helpful for ongoing payments throughout the year. However, most business credit cards charge higher interest rates than loans, so a loan might be a better option when you need to borrow a large lump sum.

#8. Invoice factoring

Invoice factoring lets you get advanced cash for unpaid invoices. The lender provides cash for a portion of unpaid invoices — generally around 80% to 90% — then sends you the rest once the invoices have been paid. The invoice factoring company keeps a portion of the payments as a fee for its services.

Invoice factoring is not technically a loan and doesn’t create debt. It will cause you to lose part of your payments but can solve cash flow problems if unpaid invoices are slowing down your business.

#9. Inventory financing

Inventory financing is similar to equipment financing, but in this case, the loan is secured against the value of your inventory. This is another helpful option for businesses with cash flow problems. If you already have an established customer base but need funding for a large inventory order, inventory financing can help.

Interest rates depend on your lender, but can be high, especially for a new business without extensive sales history. Most lenders require a credit score of at least 600 to qualify for inventory financing.

‍

Who is eligible for a small business loan?

Every funding option comes with its own eligibility requirements. To qualify for an SBA loan, for example, business owners must be based in the U.S., have sound credit, and have exhausted their other financing options.

Other common loan requirements include:

• Minimum credit score: A credit score of at least 670 is considered “good” credit. While some lenders accept credit scores as low as 500, a higher credit score generally leads to better loan terms.
• Business history: Many lenders prefer working with borrowers who have been in business for at least six months or longer.
• Revenue: Your lender will want to see consistent revenue as evidence that you can pay back the loan.
• Business plan: Most lenders want to see a comprehensive business plan that shows promising growth.
• Collateral: Some types of loans require a guarantee, such as a physical asset, equipment, or property.

‍

Small business loan pros and cons

Again, you don’t need a loan to run your business, but it can be a helpful option for new business owners with limited resources. Here are a few pros and cons to consider.

Pros

• Funding for large expenses: A business loan gives you funding for large purchases that you can’t afford out of pocket, such as your storefront, equipment, or inventory.
• Improved cash flow: Funding options like inventory financing and a business line of credit can prevent cash flow problems, providing flexible funding when you need it.
• Better credit: Paying off your business loan on time will boost your credit score, improving your future funding options.

Cons

• High interest rates: Many business loans come with high interest rates or fees.
• Strict requirements: As a new business owner, you might not meet the eligibility requirements for the type of loan you want.
• Possible debt: If your business fails or you can’t pay off your loan, it can lead to serious debt and harm your credit score.

‍

Takeaways

When it comes to funding your startup or new business, you have plenty of options. A small business loan can help get your business off the ground and fund the big expenses you can’t afford out of pocket. However, the wrong loan can also lead to debt — that’s why it’s important to take your time, compare options, and choose the small business loan that fits your budget and timeline.

Novo is a fintech platform that provides funding, including merchant cash advances, to new business owners in all industries. If you’re interested in flexible financing for your small business, get started with Novo today.  

Novo Platform Inc. strives to provide accurate information but cannot guarantee that this content is correct, complete, or up-to-date. This page is for informational purposes only and is not financial or legal advice nor an endorsement of any third-party products or services. All products and services are presented without warranty. Novo Platform Inc. does not provide any financial or legal advice, and you should consult your own financial, legal, or tax advisors.

The Merchant Cash Advance is provided by Novo Funding LLC, PO Box 311092, Miami, FL 33231. Novo is the marketing name for Novo Platform Inc. and its subsidiaries and affiliates. Novo Funding LLC is a wholly owned subsidiary of Novo Platform Inc. Credit and Merchant Cash Advance products and services are offered by Novo Funding LLC. The information and materials contained on this website - and the terms and conditions of the access to and use of such information and materials - are subject to change without notice. Not all products and services are available in all geographic areas. Your eligibility for particular products and services is subject to final Novo determination and acceptance.

‍Novo is a fintech, not a bank. Banking services provided by Middlesex Federal Savings, F.A.: Member FDIC.