How Do Small Business Loans Work?

Small business loans are a form of debt financing and can come in many shapes and sizes. When a business borrows money, the business owner is required to repay the funds to the lender over a predefined period with interest

For What Purposes Are Small Business Loans Used?

Small business loans can be used for a wide variety of purposes. According to the Small Business Administration, 63% of small businesses have loans, with firms employing more than 50 workers having a significantly higher usage rate (75%).

7 Most Popular Reasons for a Small Business Loan

  1. Starting a new business
  2. Business expansion
  3. Buying a franchise
  4. Purchasing capital equipment
  5. Funding inventory
  6. Increasing working capital
  7. Acquiring real estate

What Types of Small Business Loans Are Available?

There are many options from which to choose, depending on the businesses' needs and health and, in many cases, the business owner's financial wherewithal and professional qualifications.

6 Most Popular Types of Small Business Loans

  1. Small Business Administration-backed loans (SBA loans)
  2. Term loan
  3. Line of credit
  4. Capital equipment loan
  5. Factoring, also known as invoice financing
  6. Short-term / emergency loan

Where Can I Get a Small Business Loan?

Small business loans are offered by a wide range of lenders, most of which have their own specific underwriting standards, processes, risk tolerances and – consequently -- terms.

The 5 most active small business lenders

  1. Banks and credit unions (traditional financial institutions)
  2. Non-bank alternative lenders
  3. Peer-to-peer lending platforms (P2P)
  4. Friends and family
  5. Credit card companies

What Happens If I Can't Repay a Business Loan?

Business loans can come with significant teeth. What those teeth might look like depends on whether a loan is secured and backed by a personal guarantee. Depending on how stringent a lender's policies may be, a loan can go into default as soon as one day after a payment is missed. For a small business owner, a loan in default can be highly problematic.

3 Types of Small Business Loan Defaults

  1. Defaulting on a Secured loan. If a business owner has pledged business or even personal assets as collateral against a small business loan, the lender can seize those assets to repay the debt.
  2. Defaulting on an Unsecured loan. Although the lender cannot pursue the borrower's assets, it can charge exorbitant late fees, increase interest rates and even sue the small business and its owner.
  3. Defaulting on a Personal Guarantee. Failure to repay a small business loan backed by a personal guarantee allows the lender to pursue repayment from the borrower personally, a scenario that often involves significant legal costs as well.

When small business owners become concerned about their ability to repay a business loan, they should immediately contact the lender. Seizing assets and suing small businesses and their owners is time-consuming and expensive for lenders, as it is their objective to help small businesses grow and succeed, not destroy them. As such, lenders will often make every effort, within reason, to restructure a loan that might be headed for default.

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