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9 Types of business loans for SMEs and how to choose the right one

There are several types of small business loans available for those wanting to start or grow a business. Let’s take a look at the different loan types available in Australia, and how to apply for them.

Types of business loans

1. Friends and family loan

Believe it or not, one of the most common types of business loans comes from close to home, rather than banks or lenders. Asking friends or family for a loan is a great option if they can afford it, however, it’s always smart to put the loan conditions and details in writing to avoid any unpleasantness in the future.

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Advantages: Low or no interest, and potentially more flexible repayment terms. Also, with friends and family being financially invested in your business, they’re likely to also find other ways to help you succeed.

Disadvantages: If things go wrong, it can have a detrimental effect on your relationships. The person lending the money may also feel they have a say in how to run your business.

How to get approved: Unlike traditional lenders, there’s no formal process here. However, when asking anybody for financial assistance or investment, you should prepare a sound business plan to show them you’ve thought of everything and take the business venture seriously.

How repayments work: This is something you can work out with the lender, but as we mentioned before, it’s good practice to have repayment details in writing.

2. Business line of credit

A business line of credit is similar to a credit card in the sense that you can draw and repay funds as you need them (up to the credit limit). It means that you only pay interest on the amount you use, rather than the full credit amount.

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Advantages: The main advantage is flexibility. You have access to money when you need it, and you can better manage your cash flow. The line of credit is usually unsecured too, so you don’t need to put up collateral.

Disadvantages: Like credit cards, it’s easy to see your line of credit as ‘available money’, and can lead to non-essential expenditure.

How to get approved: You usually need information such as tax returns, a business bank account and business financial statements. Some online lenders may have fewer criteria, but be careful because interest rates can be higher.

How repayments work: Repayments work much like a credit card. You pay a minimum monthly amount towards the amount you’ve borrowed, and you have the flexibility to pay more as you’re able.

3. Business credit cards

A business credit card is much like a line of credit in how they work, however, there are certain pros and cons when comparing the two.

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Advantages: It’s easy to qualify, and you might even have rewards programs attached to a credit card. Also, you have flexibility in how you use the funds.

Disadvantages: Interest rates are higher, and again, you need to be very careful with how you use a business credit card.

How to get approved: For most banks and lenders, applications can usually be started online, however, there’s always the need to verify your ID with the bank if you haven’t already done so. All lenders ask for different documentation, but some of the common items you’ll need to prepare are your balance sheet, income statement, cash flow statement, and also your business tax documents. This will include tax returns, BAS and possibly a printout of your activity from your ATO portal.

How repayments work: Best practice is to repay the amount in full each month as interest rates can be high and outstanding balances can increase quickly.

4. Square Small Business Loans vs Bank Small Business Loans

A Square small business loan is a great option for businesses that derive income mainly through credit and debit card sales. You can access funds quickly, and repay them at a percentage of your daily takings, additionally, Square Loans don’t charge any interest as there’s a single fixed fee.

Advantages: Funds are usually transferred quickly, and because you pay it off directly from your sales, you barely notice the payments. Also, the approval process is generally fast.

Disadvantages: Because you pay the loan back in line with your income, you may end up repaying faster than you expected if sales are up. Or, comparatively, if the business is slow, the loan will be with you for a bit longer than you’d planned.

How to get approved: Square Loans are unsecured, so you don’t need collateral. Usually, there are no credit checks, you just need to fill out a form and approval is quick. Note however that the amount you can borrow is determined by your historical sales, which determine how much you can reasonably pay back in a designated time frame.

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How repayments work: Payment is taken directly from your credit and debit card sales, and you can also make direct payments.

5. Business overdraft

A business overdraft lets you run a negative balance on your normal business bank account up to an approved amount.

Advantages: You don’t need to panic as much about cash flow, and you have a safety net in case of unexpected expenses.

Disadvantages: You’re charged fees when you go into overdraft, as well as interest on the overdrawn amount. There are also establishment and account management fees.

How to get approved: Each lender has different requirements, but you can access a business overdraft in secured or unsecured form. Your financial position generally informs the amount of overdraft you’re approved for.

How repayments work: Monthly payments may apply, depending on the lender. Even with no minimum monthly payment, it’s advised to pay the overdraft back quickly to avoid costly interest.

6. Working capital loans

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A working capital loan is a short-term business loan that you can use for marketing activities, equipment, unexpected expenses, or everyday expenses.

Advantages: You can get a cash injection into your business to help with cash flow, and also the interest rates are lower than credit cards or overdrafts.

Disadvantages: The approval process is quite involved and, in some cases, it can take weeks to be approved and receive the funds. Collateral may also be required.

How to get approved: You’ll need to provide a lot of information about your business finances, personal finances, bank statements, and of course you’ll need a strong credit history.

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How repayments work: Monthly repayments like most loans.

7. Business term loans

A business term loan is much like a personal loan, mortgage or other types of loans you’ll be familiar with. You borrow a lump sum and pay it back monthly, at a fixed interest rate, over a specified term.

Advantages: You get the ability to make significant purchases for your business, such as equipment or vehicles. It’s great for expanding your business, and you also have clarity over loan repayments with a fixed monthly amount.

Disadvantages: Like all loans, you pay a significant amount of interest over the term, which is usually five years. You may also need to provide collateral to the lender.

How to get approved: Again, you’ll need a good business and personal credit history. You’ll also need to provide a lot of documentation such as business and personal tax returns, bank statements, credit checks, balance sheets, audited financial statements and profit and loss statements.

How repayments work: Your loan has a fixed interest rate, meaning your monthly repayment stays the same for the life of the loan. Always check if you have the option to pay early and save interest.

8. Unsecured business loans

Unsecured loans require no collateral, so you’re at much less risk of losing your property. However, interest rates are often higher.

Advantages: There’s no risk of losing your property, and also the application process is generally quite fast.

Disadvantages: High-interest rates and the amount you can borrow is usually lower.

How to get approved: Each bank or lender will vary. You’ll usually need a good credit rating, and the lender will carefully examine your business financials.

How repayments work: Monthly payments like regular loans, with relatively high-interest rates.

9. Revenue-based financing

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This type of financing is extremely popular for entrepreneurs and small start-ups. Revenue-based financing is basically the same as seeking investors. An investor provides capital, and in return, they are promised a percentage of future revenue up to an agreed amount which is usually more than the initial loan (similar to interest).

Advantages: A great way to raise large sums of money to launch a business idea. You also don’t have to deal with banks or lenders.

Disadvantages: You usually need to generate high revenue for investors to be interested. It can also take a lot of time and effort pitching to investors, when compared to the time it takes preparing documentation for a bank loan.

How to get approved: You need to find investors or revenue-based financing companies who are willing to invest in your business. This usually involves having solid business plans, clear financial documents and an idea people are enthusiastic about.

How repayments work: Payments are taken as a percentage of annual revenue, and any interest is agreed upon by the parties in advance.

How to choose the right loan

So, which loan is right for your business? You need to consider your circumstances very carefully, and also the reasons for needing the loan. Do you need fast cash, or are you prepared to wait so that you can access better interest rates and loan terms? Here are the top three things to consider when comparing loans.

1. Understand the total cost of the loan

Loan costs can include interest and fees, or just fees (in the case of Square Loans it’s one fixed fee). The interest rate of your loan can save or cost you thousands over the life of a loan. With some loan types, you have no choice but to accept the interest rates on offer, but if you have plenty of options available to you, always choose the best interest rate. Note that for shorter loan terms (under 5 years), a small difference in interest rate won’t make too much difference. But over the course of a longer loan, it can add thousands to your repayments. A great way to compare capital offers is to look at the total you will repay over the life of a loan.

2. Consider the affordability of repayments

One thing you should always be wary of is the conditions on how you repay the loan. With Square Loans, you make repayments based on your sales. So, on a slow day, you won’t pay as much as you will on a busy day.

3. Are there application fees?

Finally, always check for application fees. Depending on the size of your loan, an application fee may not be a huge issue for you. But if there are significant fees on smaller loans, you could be adding an extra expense that you don’t need.

Always check the terms and conditions of a loan, including all the fees and applicable charges. Choose the loan that best suits your circumstances, and takes control of your business finances.

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