Types of Short-Term Business Loans: The A-Z for Small Business Owners

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If you need business funding quickly, you may be considering a short-term business loan. Whether you need cash to deal with an unexpected issue, to take advantage of an opportunity or to bridge a cash flow gap, these loans can help.

However, navigating the various types of short-term business loans can be challenging. There’s a lot to consider, but there’s no need to feel overwhelmed. We’ve created a comprehensive guide to help you understand the different types of short-term business loans, the advantages of each option and how to select the funding solution that’s right for your business.

What Is a Short-Term Business Loan?

Short-term business loans help business owners get a quick infusion of capital into their businesses when they need it most. Typically, these loans are repaid within a period of up to one year. In contrast, traditional business loans have a longer repayment period, with some as long as 25 years. Depending on your needs, there are many types of short-term business loans available.

Based on factors like your credit history and your business’s financial status, the interest rates for these loans will vary. Interest rates on short-term loans may be higher than traditional business lending alternatives, but the shorter repayment period may mean business owners will pay less over the life of the loan.

Short-term loans also offer a variety of other benefits, from faster funding to simpler application processes. Let’s take a closer look at why opting for a short-term business loan may be the right strategy to meet your cash flow needs.

The Advantages of Short-Term Business Loans

Before diving into the different types of short-term business loans, it’s helpful to understand why people choose them.

Consider the case of Charlie, a small business owner in the construction field. When the perfect storm of a late customer payment and the need to replace a key piece of equipment hits his business, a short-term funding solution can help. Since Charlie knows he’ll be able to repay the loan within a few months, he doesn’t want to commit to a multiyear repayment schedule. Shorter repayment time can also mean less interest paid overall, no origination fees and no prepayment penalty. It’s the right option for his business on many levels.

Other business owners, for example, may be facing a tight cash flow month or want to make a one-time investment in equipment that will quickly pay for itself. The idea of getting tied down to a long-term loan isn’t a good fit for their needs. Instead, they’re looking for solutions that will help them with a temporary cash flow deficiency.

There are several advantages for small business owners who choose short-term business loans:

Shorter repayment period: When you’re budgeting for repayments, thinking about having monthly payments for 10 or 20 years can be daunting. Accessing capital for your business and repaying it within a short period of time can keep you moving toward your goals while eliminating the stress of long-term debt. You may feel more comfortable taking on a payment for a short-term business loan that fits your business’s long-term plans.

Lower total interest paid: Many business owners assume that short-term loans have high interest rates — and some do. Yet when you consider paying interest for just 12 months instead of over 10 years, for example, your total costs and interest paid may actually be less. Consider a business owner who takes out a $10,000 loan to boost their inventory when goods are running low. A short-term loan with a 10 percent annual interest rate paid over one year would have a monthly payment of approximately $879, with the business owner paying $549.91 in total interest throughout the year. The same loan — with identical terms — spread out over ten years would have a lower monthly payment of $132 but would include $5,858.09 paid in interest over the life of the loan. That’s a significant difference in total costs.

Fewer fees: Depending on the lender, many types of short-term business loans have fewer fees than traditional loans. For traditional business loans, a lender will often charge a percentage of the loan for processing. This origination fee can add one percent or more to your total cost. Other lenders will charge a prepayment penalty to business owners who want to pay off their loans early.

Simpler application processes: Applying for a business loan can be a lengthy process, requiring years of business documentation and months of consideration. Lenders that specialize in different types of short-term business loans usually have simpler application processes. It’s often possible to apply online, supply basic business documentation and receive an answer within hours or days — instead of weeks.

Higher approval rates: Many types of short-term business loans are often easier to qualify for than long-term loans. In addition to a simpler application process, short-term loan lenders may look at your business through a different lens than traditional lenders. Your sales, successful history in business and other factors will come into play. As a result, these types of loans have higher approval rates than traditional loans.

Faster access to funds: The reality for business owners is that when you’re considering a business loan, you typically don’t have months to wait. There’s often an immediate need for cash, whether you’re covering for late customer payments, employee payroll is due, or a growth opportunity is ripe for the taking. Depending on the lender you end up choosing, a short-term business loan can mean money is put into your account within days, rather than weeks or months.

Why Do People Take Out Short-Term Business Loans?

Even when considering the advantages of short-term loans, you may be wondering why business owners take out this type of funding. The reality is, when you start a small business, it’s often impossible to imagine the full range of scenarios you’ll encounter. From market fluctuations in customer demand to delays in receiving payments, many factors can impact how much money you have in the bank on any given day.

Some common reasons people take out various types of short-term business loans include:

Dealing with the unexpected: A business owner might have an emergency that requires on-hand capital to fix. For example, a small factory owner might have a key piece of equipment break down. Paying for the needed parts and service can get expensive. With a short-term loan, the production line can be back up in no time, and customer orders can quickly be shipped out.

Seasonal cash flow fluctuations: Some businesses have seasonal surges and declines. A local heating business, for instance, might be in demand seven days a week from fall until spring. When summer arrives, however, their revenue can fall, making it a challenge to cover payroll and other ongoing costs. A short-term funding solution can help bridge the gap until their cash flow is back on track.

Late customer payments: A local construction company with a healthy client base may make an impressive annual income. Delays in client payments or a change in credit terms, however, could mean there aren’t enough funds in their bank account to cover monthly expenses. Different types of short-term business loans can help cover costs until accounts receivable catches up.

Changes in credit terms: If your business relies on credit terms, a change in those terms can have devastating consequences. For example, a mechanic who has a 60-day term to pay suppliers for spare parts can often use the cash flow that comes in from customer repairs. When their parts supplier changes the terms to 30 days, it can become more difficult to stay on top of monthly bills. Tapping into different types of short-term business loans can cover immediate needs, while the mechanic builds up a cash buffer or looks for a new supplier with better terms.

High employee turnover: A retailer might be struggling with high employee turnover and needs funds on hand to recruit and train new workers for the busy season. Perhaps a seasonal surf shop plans to lose most of its workforce after the peak season ends; the owner will need to invest in hiring and training before the next rush begins. Short-term funding can provide the cash flow needed to post job ads, provide training and cover payroll.

Low inventory: Sometimes demand for key products is higher than planned, and getting more inventory on-site can require cash for an upfront investment. Applying for different types of short-term business loans can help. A computer company that gets an order to provide laptops for a new customer can apply for a loan, purchase the inventory and then repay the loan when the contract is complete.

Leasing equipment: Leasing equipment can get expensive, yet it may be essential to completing a job. A construction company might have a chance for a lucrative contract, but needs access to a bulldozer or other expensive equipment. An equipment leasing loan or other types of short-term business loans make it easier for the business owner to lease the equipment and close the deal.

Taking advantage of a discount: Sometimes business owners have a chance to cut their expenses by buying in bulk, but doing so requires having cash on hand. For example, a dentist might be able to take advantage of a significant discount by buying a year’s worth of medical supplies in advance. A short-term business funding solution can provide the cash needed to do that, and the savings can quickly be put toward repaying the loan.

Funding an immediate project: Your vision for growth might be ahead of your cash flow and customers. For example, a lunch café that’s doing well might want to jump at the chance to open a second location. The right type of short-term business loan could provide the capital needed to rent the space, buy inventory and lease equipment until the new restaurant can cover these expenses.

Female business owner pays bills at her coffee table

What Are the Different Types of Short-Term Business Loans?

There are many different types of short-term business loans. Here’s a quick overview of some of the funding options on the market today:

Short-term business loans: A short-term business loan functions like a traditional business loan. Once approved, you’ll receive a set amount of money and then repay that over the life of the loan, in addition to interest. Short-term repayment plans can range anywhere from 12 to 18 months. A store owner who’s struggling with unexpected repairs might choose this option. Not only are the funds quickly available, but the annual interest rates tend to be lower than other forms of credit, and it’s easier to budget for set daily or monthly payments.

Lines of credit: A line of credit operates as a short-term loan that you’re approved for, up to a maximum amount, and then can be used as needed. It’s a cash alternative to a business credit card. When a bakery owner decides to apply for a line of credit to fuel a planned expansion, however, they may run into different frustrations. Lines of credit are usually available through traditional lenders, and they can have lengthy application and approval processes. It can help build your business’s credit, though, and it restricts interest payments only to the funds that are used. Lines of credit typically require a strong business history, good personal credit and, in some cases, collateral.

Merchant cash advances: A merchant cash advance is an advance against future sales — specifically, future credit card sales. Repayments are then made through your point-of-sale system as a percentage of all sales made. Every day, a percentage of the sales you make is paid back toward the loan, until it has been fully repaid. For example, a clothing store owner might take a merchant cash advance to purchase the inventory needed to get merchandise on the rack. Often, business owners turn to this option due to lower credit scores and easier approval as long as there is a healthy track record of sales. However, these types of advances are expensive, they cut into your revenue until they’re repaid, and it’s hard to predict what your repayment schedule will look like since it’s dependent on future sales.

Invoice factoring: Invoice factoring is a financial option when your cash flow is hurt by late payments. Invoice factoring companies will purchase your unpaid invoices from you, advancing a fraction of the cash value in exchange for the outstanding payment. When your customer pays the invoice, the factoring company will usually collect the payment directly. The factoring company will then pay you the remaining balance, minus a fee. A graphic design company with numerous outstanding client invoices might choose this option to meet immediate needs. The fees can be steep, however, and the longer clients take to pay — something that’s often entirely out of your control — the more expensive this option becomes.

Business credit cards: Many business owners will rely on business credit cards to help bridge their cash flow challenges. Business credit cards have advantages, such as rewards or travel points. However, they can have a high annual percentage rate for interest paid on balances. In addition, the limits or available credit on a card may not be enough to meet your cash flow needs. In some cases, business owners need access to cash — and credit cards typically charge a premium for cash advances.

What to Expect When Applying for a Short-Term Loan

For many business owners, the idea of applying for any type of short-term business loan can be daunting. After the lending crisis of 2008, many traditional lenders tightened up their regulations even further, making it more difficult for those seeking short-term operating funds. Applying for even a small loan with a traditional lender often requires detailed financial statements, banking documents, years of tax returns, a business plan for repaying the money and an in-depth personal financial and credit assessment. Unprepared business owners are less likely to receive funds, and even those who are well prepared for the process may be subjected to additional requests during underwriting.

As alternative lenders have come into the space, it’s been a breath of fresh air for business owners. Alternative lenders often consider a wide range of factors when determining loan eligibility, from sales history to your personal credit score. In particular, small business owners looking into different types of short-term business loans have found simpler application processes and higher approval rates. It’s often possible to apply online and receive answers quickly.

While every lender has different requirements, getting the following items together before you apply can simplify the process:

  • The basic information of the business owner, such as contact information and social security number
  • Identification, such as a driver’s license, to verify the business owner’s identity
  • Details on the last year of sales and revenue figures
  • Your business bank account information
  • Any supporting documentation

Beyond that, it’s often helpful to have your tax information and other business records. Consult your prospective lender’s individual requirements before starting the application process. If you have questions, reach out and speak to a loan specialist to get specific advice on what you’ll need and steps you can take to increase your chances of approval.

How to Budget for Different Types of Short-Term Business Loans

Considering how you’ll pay for your short-term loan before you apply, will help you get the best value from the process. Here are some strategies successful business owners can use to budget for a short-term loan:

Plan your payments: When deciding what type of short-term business loan to apply for, don’t just think in terms of the loan amount and the interest rate. Calculate what the daily or monthly payment will be, and put together a clear plan for how you’ll meet this obligation. Understanding how the payments will impact your finances and having a strategy in place for making the payment will help alleviate the stress associated with repaying the loan.

Set aside at least one payment: It’s a smart strategy to have the equivalent of at least one month’s payment set aside in a bank account for emergencies. That way, if you run into a future cash flow crunch, you’ll have the security of knowing that your payments will be covered.

Choose a due date: Some lenders will allow you to select a due date each month. Choose a due date — or ask for one — that coincides with your business. For example, if a software company that operates on a subscription model collects all its customer payments on the first of the month, choosing a payment date a few days later will ensure that the revenues have cleared. Understand the cash flow cycles of your business and work around them. Discuss due dates with a lender during the application process to choose a solution that’s right for your business.

Explore options for early repayment: In many cases, you’ll be evaluating the different types of small business loan payments available to you because you expect to repay the loan quickly. If that’s the case, be sure to assess the terms for early repayment. Some lenders will charge a prepayment penalty, but many don’t. Understanding how this will affect your budget and when you’re likely to make that payment can help further reduce the interest you’ll have to pay.

Understand payment options: Depending on the type of short-term business loan you select, there may be different repayment options available. Does the lender offer direct withdrawal from a bank account, for example, or do you need to send a check every month? Some lenders offer automatic, daily payments so you don’t have to worry about the lump sum at the end of the month. Determine your options and be on the lookout for discounts offered for certain types of repayment, such as automatic payments.

When you need short-term funding to achieve your goals, there are solutions that can help. Whether you’re facing an unexpected emergency or just looking for the capital to fuel your growth, a lack of cash on hand doesn’t need to be a barrier. Business owners who understand the different types of short-term loans and funding solutions can make the right long-term decision for their companies.

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