What Are the Different Types of Loans and Financing Available?

January 12, 2012

Signs show small businesses loans from banks are slowly increasing. According to data from Thomson Reuters/PayNet lending index, small business loans have climbed to a three-year high of 18%. Yet, a study from Pepperdine University found that 60% of small businesses failed to get loans.

In fact, one bank is trying to close some of its small business loans. The Bank of America has been contacting small businesses to request they pay off their loans sooner, or switch to a more expensive option with higher interest rates. Read the Bank of America story at Los Angeles Times.

Working capital is available from sources other than banks. However, not all of them fit every business and these are some of the possibilities.

Angel investors are affluent individuals who invest their own funds in exchange for ownership equity or convertible debt. Also known as informal investor or business angel, some know the business or industry and investing in a business keeps them involved. They may request little or no control as they're more interested in the opportunity and the company's value potential.

Crowd funding involves a group of people who pool their money and resources. This network may know and trust each other. The downside of this funding is that the person with the idea will have to share the product or service early in the game. This puts the company's success at risk because another competitor with more resources could gain advantage.

Financial services companies offer financing options and rates that vary from company to company. This could include invoice financing, purchase order financing, factoring asset-based lending and commercial equipment financing. They usually have different qualification requirements and more flexibility than banks.

Microfinancing funds low-income or unemployed individuals with no means to get traditional financing. It's been getting a lot of coverage in the news, so I had to include it even though it's not meant for small businesses.

Peer-to-peer (P2P) loans come from individuals who may be strangers, friends or family. They have lower overhead than a bank allowing you to borrow money at lower interest rates. While these remove lending institutions from the equation, they can require more time and risk than traditional loans. Despite the low overhead, some P2P loans have higher interest rates than standard bank loans because of the risks involved.

SBA loan programs from U.S. Small Business Administration help small businesses owners finance or grow their business. The organization isn't a lender. Instead, it acts like a facilitator by setting guidelines for its partners to use in giving out loans. SBA's loan programs include 7(a) loans, Certified Development Company (CDC)/504 Loan Program and the Microloan Program. Here's a post with details about SBA's loan programs.

Venture capitals (VC) provide funding to companies with high potential during the early stages. In exchange, venture capitalists can significantly own equity and gain control over a company's decisions.

As you consider funding your business, think about whether you want a loan, funding in exchange for equity, selling your accounts receivables or bootstrapping. You can find the right funding solution for your business by doing your research, being thorough and asking questions.

What has your experience been with funding? What stories have you heard about others using any of these options?