The 10 business financing options every business owner should know

Business owners who understand their financing options can create a more resilient business—one that can survive downturns, pivot when needed, and grow faster. Business financing is a complex topic, and one that many business owners need help navigating. This blog post lays out the 10 main financing types and outlines the pros and cons for each.

Cash (flow) is king

Cash flow is a priority for every business owner. Without enough cash flowing through the company, owners will struggle to meet both day-to-day obligations and long-term goals.

But few businesses can sustain cash-flow requirements through revenues alone. For most, some type of financing will be needed, whether to fund growth plans, navigate an unexpected setback, or just provide a little flexibility and breathing room.

Fortunately, there has never been a wider range of financing available to businesses, even those that don’t have the advantage of a high credit rating, lengthy credit history, or valuable capital assets to borrow against. Here are the 10 most popular ways for business owners to free up the cash they need to keep their business healthy and strong.

Term loans

One of the most common financing options for businesses, term loans are also one of the oldest and best-known. The business owner applies directly to a bank and, if they qualify, they receive a lump sum to be paid back, with interest, over a specific period of time.

Pros

• Lower costs and rates than some other types of loans
• Some offer rewards (such as rate discounts or lower fees) if you meet specific account requirements

Cons

• Usually take several months to process
• Not available to businesses with a shorter operating history
• Limited to a company’s present situation and assets, not future growth or receivables
• Potential for hidden charges, up-front costs, and surprise fees
• Late payments will negatively affect your company’s creditworthiness
• A one-time cash infusion (not a longer-term solution)

Term loans are also known as:

• Fixed-rate loans
• Short-term loans
• Long-term loans
• Debt financing

Learn more about the pros and cons of bank loans.

Online loans

Online loans are a relatively new form of business financing that are similar to bank term loans, with many of the top online lenders having been in business for less than a decade.

Online loans are a popular option for many businesses because online lenders have less stringent lending criteria and deliver funds faster than traditional banks. They’ve become so popular that even some e-commerce companies, including Shopify, have recently begun to offer online loans.

Pros

• Faster access to cash (sometimes less than 24 hours)
• Less stringent application criteria than traditional banks

Cons

• Typically have much higher interest rates
• Often include additional (and sometimes surprise) fees such as origination, service, referral, and late payment fees
• A one-time cash infusion (not a longer-term solution)
• Weekly (if not daily) payments

Learn more about online loans.

Small Business Administration (SBA) loans

An SBA loan is a type of business loan that is guaranteed by the Small Business Administration. While the SBA itself is not generally a lender, it works with banks and online lenders to partially guarantee certain business loans by setting relatively strict borrowing requirements. This reduction of lender risk is designed to stimulate business loan activity.

Several SBA loans exist, including SBA 7(a) loans for working capital and SBA CDC/504 loans for major fixed assets such as real estate or equipment.

Pros

• Very low interest rates
• Up to $5 million in working capital available to the borrower
• Long-term payment period (up to 25 years in some cases)

Cons

• Difficult to qualify—an excellent credit rating is required
• Long and sometimes frustrating application process
• Can take significant amount of time to receive funding
• A one-time cash infusion (not a longer-term solution)
• Guarantee, packaging, servicing and other fees

Business lines of credit

Business lines of credit provide access to a specific amount of cash that can be drawn from and paid back at the borrower’s discretion. Banks and online lenders both offer business lines of credit.

There are two main types of business lines of credit. Non-revolving lines of credit are one-time arrangements that conclude once funds are paid back, which means that repaid funds are no longer available to the business owner. Revolving lines of credit, on the other hand, keep funds available to the business owner (subject to annual reviews). Borrowers can dip into the funds any time, borrowing a little or a lot, and they pay interest only on the amount they have borrowed.

Both types of lines of credit can be either unsecured or secured. A secure loan is guaranteed by collateral, such as a home or another asset, while an unsecured loan is exended in good faith to those with excellent credit.

Pros

• Provides an always-available liquidity cushion for emergencies, operating expenses, and cash flow issues
• Borrowers don’t pay interest until they withdraw funds

Cons

• Failure to manage credit lines prudently can negatively impact your credit utilization rate
• Interest rates on unsecured lines of credit can be high
• Available credit is subject to review and can be reduced or closed at any time

Business lines of credit are also known as:

• Revolving credit

Merchant cash advances

A merchant cash advance (MCA) is a type of business funding that the business receives in exchange for a percentage of its future credit card sales. Because the advance is based on future sales, lenders need to see that the business has a strong history of consistent sales paid by credit card. As a result, MCAs are usually a better fit for retail businesses than for business-to-business (B2B) companies. MCA terms are typically fixed, meaning that faster repayment won’t reduce your interest charges, but they often provide funding within 24 hours. Because they’re costly, MCAs are usually considered a last-resort option.

Pros

• Fast access to capital
• Minimal paperwork required
• High approval rate
• No collateral is usually required

Cons

• One of the most expensive types of borrowing (up to 350% annual percentage rate)
• Weekly or even daily repayment schedules can be disruptive
• Some lenders charge penalties for faster repayment
• Only available to businesses that process a consistently high volume of credit card payments

Learn more about MCAs.

Equipment financing

Equipment financing is a way for companies to acquire expensive equipment without making a big cash outlay.

Equipment financing can take the form of a loan, a lease, or a leaseback.

For an equipment loan, the equipment to be purchased serves as collateral, with the lender able to take possession of the equipment if the business defaults on the loan. This type of financing can be used to make any capital purchase other than real estate, including furniture, computers, electronics, machines, medical equipment, trucks, and trailers.

For an equipment lease, the lender requires users to make periodic payments in exchange for the use of the equipment, similar to an equipment rental. At the end of the lease term, there may be an option to purchase the equipment from the lender. However, if the equipment being leased is likely to become obsolete quickly, this may not be the best option.

For a leaseback, businesses that own equipment can free up cash by selling it to a leasing company and then leasing it back to regain ownership over time.

Pros

• Lower up-front capital expenditures on equipment
• Easier to upgrade to better equipment
• Relatively low interest rates

Cons

• Difficult for new business owners to qualify
• Companies ultimately end up paying more (via interest) than the item is worth

Equipment financing is also known as:

• Asset-backed lending
• Collateral loans

Invoice factoring

Invoice factoring is a type of financing that enables a company to borrow against its outstanding invoices, or accounts receivable (AR). It provides debt-free working capital to companies of all types and is available to companies with poor credit or no credit rating, even if they have no business assets to borrow against. As a result, factoring is used by a wide range of business types, including service-focused businesses such as digital marketing companies and healthcare staffing agencies.

Depending on the factoring company they work with, businesses may be able to factor all their receivables or just a small percentage of them, making this a very flexible borrowing option suitable for short-term or long-term use.

Pros

• Easy access to debt-free working capital
• No collateral required beyond outstanding invoices
• No credit history required
• Fast approvals and cash received within days
• No restrictive terms, conditions, or covenants
• No restrictions on how the funds are used by the company
• Affordable, predictable fees as low as 1%
• Fees include credit and collections services
• An ongoing source of capital for longer-term or recurring cash-flow issues

Cons

• Companies must sell to either business or government customers (not retail consumers)
• May require the business to factor all their invoices*
• May require a minimum contract of up to two years*
• May incur an up-front, non-refundable administration fee*

*Note that AR Funding does not charge admin fees, offers flexible contracts as short as 90 days, and lets clients choose which invoices to factor.

Invoice factoring is also known as:

• Accounts receivable financing
• Commercial financing/factoring
• Asset-based lending/factoring
• Government contract/contractor financing
• Payroll funding/factoring
• Debtor in possession (DIP) financing

Purchase order financing

Like invoice factoring, purchase order (PO) financing can help companies who are selling goods faster than their cash flow can handle. In order to fulfill confirmed orders, they need additional cash to pay for the materials required.

In the case of PO financing, a cash advance is paid directly to the company’s suppliers before a sale is finalized to facilitate the order.

Pros

• Fast turnaround (typically measured in days)
• Available to companies with poor or no credit rating (approval is based on the creditworthiness of the company’s suppliers and customers)

Cons

• The company’s profit margin must be 15% or higher
• Companies must sell to either business or government customers (not retail consumers)
• Companies must sell tangible goods, not software or services
• Less flexible than invoice factoring because cash can only be used to pay your supplier
• Business owners must have experience in fulfilling large orders and maintaining strong supplier relationships
• Rates are between 1.8% and 4% for the first month, with additional costs in the following months)

Purchase order financing is also known as:

• Mobilization funding

Inventory financing

Inventory financing is a short-term loan or line of credit that a company can obtain by using their product inventory as collateral.

Inventory financing may be a good fit for companies that have not yet issued invoices or received purchase orders for their products, but are confident that these products will find buyers once they are available for sale. It can also help companies with a seasonal or highly variable sales cycle to smooth out cash flow. For some companies, it’s a way to optimize future sales volumes by acquiring more inventory.

Pros:

• No collateral other than inventory required
• No credit history required
• Funds are repaid as the inventory is sold

Cons:

• Funds can only be used to purchase inventory
• Loans are limited to smaller amounts (generally 30% to 50% of inventory cost)
• Typically have higher interest rates

Investor financing

Angel or seed capital, venture capital (VC), and private equity (PE) financing are similar in that they each involve investors providing business capital in exchange for a share of equity in the business. However, each financing type focuses on companies at a different stage of maturity.

• Angel and seed investors finance young companies that may not even have customers or generate revenue yet.
• VC investors focus on companies that have a proven product/market fit and revenue/customer acquisition model. Funding is usually provided to help the company scale its activities and grow.
• PE investors work with mature companies that have stable cash flows and established margins, giving them funding and guidance to help them expand operations and improve margins.

Pros

• Angel and VC funding can save a young company with no other financing options
• Investor financing provides valuable expertise, resources, and industry connections as well as funding
• Investor financing provides the significant funds required for rapid growth or market expansion

Cons

• VC and PE investors typically take a large equity stake in the company, often 50% or more. Angel investors also take an ownership stake, but usually smaller (between 20-50%).
• Angel, VC, and PE investors often exert a significant influence on the company’s direction and operations
• Funded businesses must usually meet aggressive growth and ROI targets

Know your options

When it comes to financing your business, there are many options, and no single financing type is fundamentally better or worse than any other. The important thing is to understand how each of these options works so that you can choose the one that best fits your business needs.

Some business owners have valuable collateral they can use as security. Some have a stellar credit rating. Others have invoices or purchase orders that represent unrealized cash. And still others have a business with growth potential that appeals to investors. By knowing how to turn these various assets into cash, you can protect and grow your business—even during challenging times.

If your business has invoices that could be turned into cash, apply today.