Which Loan Is Best for Starting a New Business?

Starting a new business is an incredibly exciting venture. However, it’s also very expensive and requires significant upfront investment, often beyond what’s in your bank account.

That’s where loans come in.

Getting funding can kickstart your growth—but not all loans are equal. The right one fuels your momentum. The wrong one drags you down with high interest and harsh terms.

So how do you choose wisely?

In this guide, we’ll break down the most common types of small business loans, what they’re best suited for, and how to find the right fit for your startup and strengthen your small business management.

Understanding Your Business Financing Needs 

Before you jump into financing options, you need to understand how much money you actually need to borrow. Arguably more importantly, you also need a very clear idea of how much you can afford to pay back each month.

Begin by carefully assessing your startup costs. This should encompass everything from premises, inventory and equipment to licensing and permits. Also, don’t forget to factor in expenses like salaries.

Next, create a detailed budget and cash flow forecast. When you approach investors, they’ll want to see how you’re currently using your funds and how you plan to use the loan in the future.

Also, pinpoint the purpose of the financing. Do you need working capital to cover running costs, or are you looking to secure upfront cash to pay for equipment? The reason matters, because many loans are tied to specific uses.

Types of Small Business Loans 

Traditional Bank Loans 

The first place many new business owners turn to is their current banking institution. Indeed, traditional banks are well established and generally have a trusted reputation.

Banks also offer other financial products, such as credit cards and insurance, which can simplify financial management for your company.

Traditional loans often come with lower interest rates and fixed payment terms, making your repayment schedule predictable and easy. Variable rates can be offered with even lower interest. 

On the downside, the approval process can take a long time, and it usually comes with strict eligibility criteria, including a stellar credit score.

Best for: Established businesses with strong credit history. New businesses may also qualify if backed by solid financials or a proven track record from a previous venture.

SBA (Small Business Administration) Loans 

An SBA loan is a widely used option for many small businesses. These loans are specifically for small businesses and are partially backed by the federal government, which makes it easier for you to qualify. This is because the risk of default is reduced for the lender.

There are a couple of SBA loan types on offer, including:

• SBA 7(a): For working capital and equipment purchases
• SBA 504: For purchasing fixed assets

Repayment terms are flexible, and the interest rates are generally competitive. Plus, you can borrow up to $5 million (in some cases, even more).

You don’t need a perfect credit score to qualify, and the down payments can be lower in comparison to traditional loans.

However, be prepared for a lot of paperwork and a lengthy application. The government requires a clear, complete paper trail, so every detail must be accurate.

Best for: Startups and small businesses with strong business plans. 

Business Lines of Credit 

These are financing tools that work similarly to a credit card. A business line of credit is often a type of unsecured business loan, meaning you don’t need to put up collateral to access funds. You can quickly access a predetermined amount of funds when needed, and you pay interest only on the borrowed amount.

While credit limits are typically lower than other loan types, you get flexibility over how the funds are used. You can borrow, repay and borrow again (known as “revolving credit”).

This is a great option for short-term expenses or having emergency funds on hand when needed.

Like a standard credit card, expect the interest rates to be high, and there may be other fees for withdrawal and maintenance. The repayment terms may also be short, so it’s not the best option for businesses who need to make big purchases but have limited cash flow.

Best for: Businesses that want a convenient way to manage cash flow and fund short-term expenses. 

Equipment Financing 

As the name suggests, this is a special type of funding used only for the purchase of equipment such as machinery, vehicles and tools.

It’s usually offered as collateral-based financing with the equipment itself acting as the collateral. Payment terms are flexible and can be tailored to your cash flow circumstances.

The good news is that the approval process is fast and can come with the option to upgrade the equipment as and when the technology evolves.

Given the interest rates and depreciation, you’ll pay more for the equipment than if you purchased it outright. Leasing could be a more affordable alternative.

This is also not a flexible choice. Since you are limited to equipment only, you can’t use the funding for other business needs.

Best for: Businesses that rely on equipment and machinery to operate, such as those in the agriculture or manufacturing industries.

Invoice Financing

This is a unique short-term option that gives you access to cash tied up in unpaid invoices. 

Essentially, you receive between 70% and 95% of the invoice value upfront. The invoices themselves act as the collateral and the lender collects the payments directly from the customers.

This gives you quick (often within 24 hours) access to cash without taking on additional debt.

However, there are additional transaction fees and maintenance charges to pay. If the lender acts aggressively during collections, it can quickly diminish customer relationships.

Best for: Businesses with delayed receivables.

Microloans

Microloans are short-term funding options designed specifically for startups and small businesses. They range from around $500 to $50,000 and are usually repayable within five years or less.

They are flexible in terms of what you can use them for and come with attractive interest rates. 

Many lenders target these loans at underserved groups such as minority-owned businesses in low-income communities.

The risk with this loan type is accumulating too much debt, especially if you take out multiple microloans. This can strain your finances and hurt your chances of qualifying for traditional funding.

Best for: New businesses and entrepreneurs with limited credit history.

Online Lenders & Alternative Financing

Finally, we have online lending options that feature a streamlined application process. The advantage here is that you can get access to cash fast, often within 48 hours of applying.

You may also find that the eligibility criteria is not so restrictive. Online lenders focus on current financial data such as sales and cash flow rather than credit scores or collateral.

Loan terms are customizable and allow you to pick repayment terms and amounts to suit your needs.

This is a good option if you want to build up your business credit score before applying for a more traditional loan.

The downside is that these loans often have high interest rates and include additional fees for maintenance and transactions. Amounts are lower, too, making it an unsuitable option for large-scale funding.

Best for: Businesses that are unlikely to qualify for other funding methods and want to build up their credit history.

How to Choose the Best Loan for Your Small Business

With so many options, it’s easy to feel lost. But you already know how much you want to borrow and the reasons why. Now, let’s dig into the fine print to help you determine which loans are viable for your circumstances.

Repayment Terms and Interest Rates

Interest rates and repayment terms vary wildly between lenders. 

While a short-term loan with lower interest is an attractive proposition, are you prepared for the higher monthly payments? Cash flow can be tight during the early stages, so this is a big consideration.

Perhaps a longer term with slightly higher interest could work out better because the monthly payments will be much lower.

And don’t forget the extras, such as origination costs or early repayment penalties. Know the full cost before you commit. 

Credit Score and Eligibility Criteria

Your credit score is a significant factor, and both your business and personal credit scores will be analyzed to determine your eligibility.

Traditional banks want top-tier scores. Online and microloan lenders are more flexible, but you’ll pay for it in higher interest. 

Before you apply, know what each lender expects. The last thing you want is to waste time on a loan you can’t get.

Read the fine print. Ask questions. Clarity now saves headaches later. 

Compare and Contrast

Once you’ve shortlisted the loan types that fit your needs, compare them side by side.

If it helps, create a spreadsheet that outlines features such as terms, interest rates and fees. Seeing things laid out can make it easier to identify the right loan for you.

It’s also wise to read customer reviews and check the lender’s reputation for transparency and customer service.

Finally, consider how each loan aligns with your long-term goals. For instance, a short-term solution with high costs might solve an immediate problem, but it may create a lot of strain down the line.

Common Pitfalls

If you’ve never obtained a business loan before, it’s important to watch out for these common pitfalls:

• Don’t apply for multiple loans: Although it’s tempting to cast your net wide, firing off multiple applications can hurt your credit score. Be selective.
• Don’t end up with more funding than you actually need: Splashing the cash may feel good at the time, until the repayments hit. Take only what your business can handle.
• Don’t rush: Yes, the process takes time, but skimming the fine print can cost you. Know the terms. Spot the fees. Ask the hard questions. There’s nothing worse than being hit with a massive early repayment fee because you missed it in the terms and conditions.
• Don’t settle on the first lender you approach: You wouldn’t settle when buying a house or a car, so why would you do it for a business loan? Shop around, ask questions and compare options. You’re not just looking for the cheapest or best deal. You’re also looking for the right long-term fit for your business.

Alternative Funding Options (If Loans Aren’t a Good Fit)

While loans are the main way to help fund a company, they aren’t necessarily the best option for every new business. Why not consider some of the other funding methods that are available to you?

• Crowdfunding: Platforms like Kickstarter and Indiegogo allow you to raise small sums of money from a large number of backers. The advantage is that you get to build an early customer base and they don’t require repayments. However, it’s highly competitive, and you have to have a solid marketing strategy.
• Venture capital: Securing investment from firms in exchange for equity is a great option for rapid-growth startups and large-scale funding. But you will have to give up some ownership and control, which is a downside for many business owners.
• Angel investors: High-net-worth individuals often invest in early-stage ventures in exchange for equity. It’s usually more flexible than venture capital and typically comes with mentorship, but you’re still giving up a slice of ownership.
• Grants: Governments, foundations and nonprofits can issue grants with no repayment required. Competition is hugely fierce, and they come with very strict eligibility criteria and usage terms.
• Bootstrapping: Using personal savings or reinvesting profits to fund your business gives you full control, and you won’t take on debt. However, your growth will likely be a lot slower, and your cash flow may be tight.

Final Thoughts

Obtaining a loan is not a decision to be made lightly. It involves in-depth research and plenty of consideration. But no matter how much funding you need or what you need it for, there’s a solution for you. 

That’s where a financial expert comes in. An experienced accountant can decode the fine print, weigh your choices, and guide you to the smartest path for your startup.

Ready to launch your business with the right funding? Let Finvisor help you move forward. Get in touch today and see how we can help you with funding, accounting and more.