Debt financing can be a helpful option for getting the capital you need to run your small business. There are many different types of debt financing you can consider, and each one has its own set of qualifications you must meet. In this article, we discuss what debt financing is and how you can better understand the most common types that are available to business owners.
What Is Debt Financing?
Debt financing describes the borrowing of money for your business from an external entity. In exchange for the borrowed capital, you must pay back the principal, interest, and any fees over time. Debt financing can come in both short-term and long-term forms.
Short-term debt financing is typically used for operational expenses such as meeting payroll or buying inventory. These loans usually must be paid off within a year. Moreover, short-term loans typically have higher interest rates than long-term loans.
Long-term debt financing is most often utilized for large purchases such as real estate or equipment. The length of time to pay off these loans is usually a year or more.
Understanding Different Types of Debt Financing
There are many different ways you can use debt to finance your business. In no particular order, here's a closer look at some of the most common types that you may want to consider for your business.
1. Business Line of Credit
A business line of credit (LOC) is a type of revolving business financing that allows business owners to draw capital when they need it up to a preset maximum credit limit. Business LOCs provide you with the option to use, repay, and reuse your available credit. Plus they can be a great option for short-term financing or working capital needs.
Idea Financial Lines of Credits for small businesses received a 5-Star Rating from Trustpilot. These LOCs offer up to $250,000 in funding and 36-month payment terms with no origination fees or pre-payment penalties. Draw fees typically range from 1.99%- 2.99%, and every draw made restarts the repayment period. Moreover, you can apply in minutes and get approved today, thanks to our fast and cost-free application.
Indeed, an LOC can also be a great option for entrepreneurs who need working capital to help them grow their business, as it can help you invest in marketing campaigns, open new locations, purchase new inventory or cutting-edge equipment, and more!
2. Traditional Bank Loans
Traditional bank loans are offered by a variety of financial institutions such as banks, credit unions ,and other commercial lenders. These loans usually charge low interest rates. Therefore, if you qualify and require a large amount of capital, this type of loan could be a great option. However, qualifying for these loans can be a challenge. You will be evaluated based on your credit scores and business details, including your company’s financial statements and even a written business plan. Additionally, these loans often have long approval times, which can be frustrating for some small business owners.
3. SBA Loans
Often a preferred choice for many small business owners are loans guaranteed by the Small Business Administration (SBA). SBA loans offer low interest rates and favorable repayment terms. Some SBA loans require collateral, but not all of them do. Generally speaking, collateral requirements are lower on SBA loans compared to traditional bank loans.
4. Business Credit Cards
Business credit cards usually don’t have minimum annual revenue or time in business requirements, so they’re easier to qualify for. Moreover, you don’t need to have a long credit history on your business to qualify. Instead, qualification is based on your personal credit history. While business credit cards are easier to qualify for, it’s important to understand that they can charge very high interest rates. For this reason, it’s vital to pay your balance in full each month to minimize your interest expense.
5. Equipment Financing
Many small businesses take advantage of equipment financing. When your business buys a vehicle or another piece of equipment, this equipment is used as collateral on the loan. It’s important to keep in mind that although this is a type of secured financing, lenders will still have additional qualification criteria that you’ll need to satisfy in order to get the loan.
6. Merchant Cash Advances
Another debt financing option for small businesses is a merchant cash advance (MCA). While MCAs are often one of the most expensive types of debt financing, they are useful for businesses that don’t qualify for other types of financing due to low credit scores or not enough time in business. Repayment of MCAs typically occur over weeks or months and the payments are taken from your credit card revenues.
7. Invoice Financing
Invoice financing is an option for businesses that have money tied up in unpaid invoices. With this type of business financing, you get the capital you need by selling your purchase orders and accounts receivable to the lender. With invoice financing, you can qualify even if your credit isn’t great. Moreover, you aren’t required to provide any collateral.
Ultimately, the type of debt financing you select will influence the path for your business going forward. Therefore, it’s vital to carefully consider what you want the capital structure of your business to look like before making a final decision.