Business Financing
Business loans come in more forms than most owners realize, and not all of them are priced the way they're presented. Here's how to evaluate them properly.
A term loan gives you a lump sum upfront, which you repay over a fixed period with interest. Terms range from one year to ten or more. The rate can be fixed or variable. These are the most straightforward type of business loan, and for many established businesses with decent credit, they offer the best combination of rates and terms.
SBA-guaranteed loans are government-backed products offered through approved lenders. Because the government guarantees a portion of the loan, lenders can offer lower rates and longer terms than they'd otherwise extend to small businesses. The trade-off is paperwork and processing time. SBA loans are not the fastest option, but for qualifying businesses they're generally among the least expensive.
A line of credit gives you access to a set credit limit that you draw from as needed and repay as you go. Interest accrues only on what you draw. This works well for managing cash flow gaps. It's less suitable for one-time large capital expenditures.
A merchant cash advance (MCA) isn't technically a loan. A funder buys a portion of your future receivables at a discount and collects repayment as a percentage of daily sales. The cost is expressed as a factor rate rather than an interest rate. A factor rate of 1.35 on a $50,000 advance means you repay $67,500 total.
The problem is that factor rates don't translate to APR in an obvious way. When you convert the actual repayment cost to an annualized rate, MCAs routinely carry effective APRs in the 40-200% range. They're marketed aggressively to businesses that can't qualify for conventional financing, which is exactly the profile of a borrower who can least afford high costs.
Equipment loans are secured by the equipment itself. Rates tend to be lower because the lender has collateral. Terms typically match the useful life of the equipment. If you need to buy a specific piece of machinery, equipment financing is often the right tool.
Factoring lets you sell outstanding invoices to a third party at a discount in exchange for immediate cash. It's useful when your customers pay slowly and you need cash now. The cost depends on the discount rate and how long invoices remain outstanding.
Business loans have fewer consumer protection regulations than personal loans. That gap gives lenders more latitude to structure products in ways that can harm borrowers. Here are the main issues to watch:
The cleanest comparison method is to look at total cost of capital, the total dollar amount you'll repay minus the principal. Then express that as a percentage of the principal on an annualized basis. That's your effective APR, and it's the only number that lets you compare a term loan, a line of credit, and a merchant cash advance on the same footing.
The blog post on comparing business loan offers side by side walks through a specific example.
Pressure to sign within 24 hours. No clear APR disclosure. Confession of judgment clause. Personal guarantee for an amount you can't cover. Stacking encouragement. If you see more than one of these, slow down and get a second opinion.