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Every company can benefit from a cash infusion, especially if it is a startup or in the midst of a growth phase. From crowdfunding to personal investments, there are a variety of ways that business owners can access this capital, with financing being one of the most popular.
Small business financing can help you manage payroll, pay for equipment, and expand your operations. There are two main types of financing you can apply for: short-term and long-term financing.
It’s a good idea to understand the difference before applying so you don’t end up with too much or too little capital. In addition, the term of the loan will affect how much you are able to borrow and how much interest you pay over the life of the loan, which makes understanding the intricacies of each option all the more important.
short term capital vs. Long term capital
Short-term financing is a loan that you take out and repay over a shorter period of time – generally 1 to 2 years. These loans are usually used to cover immediate needs, such as stock fluctuations or cash flow.
In contrast, long-term financing usually comes with multi-year repayment terms. For example, if you get a 7(a) loan from the Small Business Administration, your maximum repayment terms will be Between 10 and 25 years old. Long-term financing is used to cover large purchases, such as new equipment or facilities.
A closer look at short-term financing
One of the big advantages of short-term financing is that it is often available to small businesses. There are usually no collateral requirements, and companies with poor credit are more likely to qualify.
These loans tend to be easier to apply for and faster to finalize. Once the loan is approved, you may receive the money within a day or two, especially if you apply with a non-bank lender.
A short-term loan does not come with higher monthly payments because you are paying off the loan over a smaller period of time.
A closer look at long-term financing
One of the big advantages of long-term capital is that it comes with higher financing amounts than short-term loans. Because you’re paying off the loan over a longer period of time, your monthly payments are spread out and more manageable.
However, they are often accompanied by more stringent financial requirements. You’ll usually need excellent credit to qualify, and you may have to put up collateral or put up a personal guarantee.
Contrary to what many assume, long-term borrowers end up paying more interest than short-term borrowers, even though the interest rate is technically lower. An extended schedule means you make more payments, which translates to more interest paid at the end of your term.
What to consider when choosing a lender
Once you understand the different types of business financing, you will need to decide what type of lender you want to work with. You can apply for financing through a bank, credit union, or non-bank lender.
Banks and credit unions tend to have the lowest rates, although they usually have strict eligibility requirements, and the approval and financing process is slower.
If you’re having trouble qualifying for a loan through a bank or credit union, you might consider non-bank lenders, such as online lenders, lending marketplaces, and peer-to-peer lenders. These loans tend to come with more flexible eligibility requirements and faster financing, though at generally higher rates.
It’s a good idea to compare quotes from several lenders to see which one offers the best deal. When you’re weighing your options, you can consider things like:
• The loan amount offered by the lender.
• Which lender offers the lowest APR rate.
• Whether you will receive a fixed or variable interest rate.
• Whether the lender charges any set-up fees.
• If there are any warranty requirements.
Which is better for your business?
Your “best” financing option will depend on your specific needs and business goals. Short-term loans are useful for short-term revenue opportunities or facing an immediate financial challenge.
But if you have a more significant purchase – such as if you want to take up another business or invest in real estate – long-term financing would be a better option. Long-term financing is better suited for higher-end investments that will not generate an immediate return on investment.
Whatever loan you choose, it is important that you find a lender that is experienced in working with small businesses. Working with a lender who understands your business needs and challenges will help you determine the type of financing you need.
The information presented here is not investment, tax, or financial advice. You should consult a licensed professional for advice regarding your specific situation.