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The pros and cons of small business loans

Whether it's a major equipment purchase or for an expansion project, getting an additional influx of working capital is something all businesses need at some point. As either a small, large or startup business, there are a number of different paths available when you’re seeking finance, each with their own set of advantages.

To discover if your business could benefit from a small business loan we have outlined your options along with the pros and cons of each. Hopefully this will help you to decide the best option for your individual circumstance.

One of the main things to remember is that a small business loan should always contribute to the financial success of your company and you should be comfortable with the repayment plan. Don't over-stretch yourself or seek finance when long-term survival is questionable.

So, what different types of finance are available?

Traditional term loans

A term loan follows the same principles as traditional loan products, such as a mortgage on your home and the usage restrictions are limited. They have a specified repayment schedule and a fixed or floating interest rate. Term loans can be used for a variety of uses, but more often than not, they are used to purchase fixed assets such as equipment, machinery or inventory.

It would be advised not to apply for a term loan if your business is currently experiencing severe financial problems. A term loan is likely to be anything from 1-5 years.

You may wish to use a term loan if you are experiencing:

  • a temporary cash flow struggle
  • wanting to push your business to the next level
  • or need to finance an equipment purchase

The pros:

  • Lower APR and payments
  • Loans can be larger
  • Longer term repayment period
  • Helps to build your business credit

The cons:

  • Variable interest rates
  • Early repayments won't save you much
  • Not all businesses will qualify for a term loan, it requires a strong credit rating
  • Often a lengthy process involving paperwork
  • Many term loans are secured against assets – collateral is required
  • Won't always agree the full lending amount requested
  • Many small business owners are rejected

Unsecured business loans

Unsecured business loans are well suited to industries that do not have high-value assets. Those such as retail and leisure who are prone to having unexpected expenses which require short-term finance to bridge the gap. An unsecured loan requires no personal or business asset as collateral.

You may wish to apply for an unsecured business loan if:

  • You have shaky credit
  • Don't have much collateral
  • Aren't willing to offer up your assets

The pros:

  • Quicker and less complex application process
  • Reduced risk for the borrower
  • Don't need a good credit rating

The cons:

  • A guarantor is required
  • Higher interest rates

Working Capital loans

A working capital loan is a short-term business loan used to finance the everyday operation of your business. They aren't used to finance long-term assets or investments but to cover daily expenses. Different from conventional commercial loans which are approved only for specific uses, working capital loans are granted without specification of purpose.

You may wish to apply for a working capital loan if:

  • You need fast money to pay wages, invoices, or purchase inventory
  • You operate a seasonal business
  • Free up cash for business growth

The pros:

  • Low interest rates
  • Easy to obtain and fast
  • Short term and often repaid by the time business picks up

The cons:

  • Collateral may be required to secure the loan
  • Expensive form of paying operational costs

Invoice finance

This type of financing converts sales into immediate cash flow rather than waiting for uncollected invoices. A third party provides you with the full or partial amount you are waiting payment on. Financing is often determined by the financial strength of your customer rather than your business services. Invoice factoring involves use of a debt collection provider chasing up unpaid invoices, whereas invoice discounting is handled internally and can be arranged confidentially.

You may wish to apply for invoice finance if:

  • Your company experiences late payments or a long debtor days
  • Your business needs help retaining a steady cash flow
  • You need short-term help maintaining cash flow

The pros:

  • It allows you cash immediately on future sales
  • With factoring you can free up time whilst someone else chases invoice payment
  • You don't need to provide a business plan or credit statements

Short-term repayment plans

The cons:

  • Invoices over 90 days old are unlikely to get financed
  • Fees, plus interest rates mean you could end up paying much more over time
  • Invoice factoring may affect the image of your company

Written by Carl Faulds

Carl is a business recovery specialist. He started work in the business recovery profession in 1990 and has continued to pursue an ethos of working with distressed businesses to help them overcome their financial problems. As managing director of Cashsolv, he offers advice and support to overcome cash flow problems and addresses any other issues to ensure a positive future for your business.

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