There are thousands of business lenders offering commercial loan products, but nearly all business loans are a variation of a handful of debt financing products — but each with their own individual characteristics. Much of the differences between loan products isn’t the type of loan, but the way in which the loan is approved, financing delivered to the business owner, and the way that these loans are paid-back. Innovation and technology overall has made leeps and bounds in recent years, and no sector has been transformed more by new innovation than financial technology (fintech). Using new technologies, algorithms and outside-the-box thinking, lenders are now able to analyze a company’s financial situation with great speed — leading to an expedited approval and funding process.
With the loan products and the delivery of new sorts of lending changing on an almost daily basis, trying to keep up with the business financing options can be difficult to understand. On top of that, with the increase in alternative lending and lack of regulation associated with it, some product descriptions may be downright confusing. In this article we will take an in-depth look at the most commonly-used types of business loans available to all small and medium-sized businesses and enterprises. The look will compare the rates and terms associated with each financing product, as well as an explanation of how each product works, and what the funding process entails. On tops of that we would like to balance the pros and cons of each product to allow business owners to have a full-understanding of each product before starting the application process.
Debt financing is another term for “loan”. Therefore, when a company is seeking debt financing they’re essentially seeking a business loan from a lender or creditor. The reason loans are considered “debt financing” is because in exchange for financing, the business promises to repay the principal (amount owed) plus interest. Therefore, they owe it to the creditor to repay such debt. This is a much different model than equity financing. Debt financing differs from equity financing in that equity financing is essentially an investment. The investors aren’t guaranteed to get paid-back, therefore they are taking a much bigger risk. But with risk comes larger rewards. A debt financing company will have a structured repayment plan and will make a set amount of return based upon interest rate. With equity, the financer is obtaining a percentage of the company’s ownership. Therefore, if their investment scales, so will their returns. But they are no way guaranteed to be repaid.
- PROS: Keeping control of your business. While you won’t get any strategic help from debt lenders, you also won’t lose any of your company’s equity in exchange for financing. With equity financing you may lose a large chunk of your company’s ownership, which may be beneficial if the equity investor offers strategic help to assist in scaling the company. But that also means the investor will earn a large percentage of future profits for perpetuity. This can end up making the original amount of financing look miniscule in contrast to their profits. But with debt financing a business owner can rest assured that they will not have to share any profits with the lending company.
- CONS: Set repayment schedules. Debt lending has set repayment schedules, regardless of profitability. With equity, an investor only expects to share the company’s future profits, and doesn’t see any money if the company isn’t pulling a profit. With debt financing, you must repay the loan on a fairly inflexible payment schedule (with exceptions). Another downside is that debt financing is usually collateralized with business and personal assets. If you fail to repay the loan the lender can seek legal action to seize and liquidate such assets.
No, not all debt financing companies require collateral. But many, if not most, do in fact require some sort of collateral, business guarantee or personal guarantee. Lenders will usually place some soft of lien on business or personal property so as to protect themselves and mitigate losses should the borrower default. With that having been said, there are a number of non-collateralized options. There are some lenders who focus almost solely on the value of collateral for financing, and others will focus almost solely on cash-flow (and everything in-between).
Secured Business Loans:
Financing that requires collateral. Secured business lenders usually require assets used as collateral to have a net worth equal or more than loan amount. This is the most common form of financing among all buisness lenders. Collateral used usually needs to be worth more (often times, much more) than the loan amount provided to the business, and may require appraisals and regular monitoring of the collateral. Types of collateral used for secured lending include business or personal real estate, accounts receivable, machinery, equipment, along with all other business and personal assets.
Unsecured Business Loans:
Financing that does not require collateral. Business lenders offering unsecured financing are generally cash-flow driven and focus solely on credit of the business and owner, or focus on future revenue projections. To help mitigate their risks, unsecured lenders may require daily and weekly repayments. While some unsecured lenders don’t require general business and personal collateral, they may purchase current and future business receivables.