About Different Types of Business Loans
- Financial institutions and other lenders will give businesses two different types of loans: secured and unsecured. With a secured loan, the business secures or backs the money borrowed by collateral, such as cash, inventory, receivables or securities. If the business cannot repay the borrowed money in the time and terms prescribed, the lender can take legal action in order to reclaim and sell the collateral. With an unsecured loan, the money borrowed is not backed up with any collateral. The business requires a high credit rating for this to transpire.
- The most typical business loan is called a term loan, which is normally borrowed for large amounts of money needed for acquisitions, or acquiring other business entities, working capital, company expansion and loan refinancing. These are paid monthly over a designated amount of time, or term, which is based on the expected lifespan of the assets being purchased.
Short-term loans are usually only borrowed for a year at most for seasonal inventory or small investments, and are repaid in one payment when the term is over, not monthly. This is usually for smaller borrowing amounts, such as $100,000 or less. - Lines of credit are more general business loans that are often established to protect against cash-flow difficulties. Rather than having a check made out for the total amount of the loan, the lender will let the business owner borrow a maximum amount annually. The funds are withdrawn only as required. If the money is not repaid rather quickly, it can accrue considerable interest. For this reason, lines of credit should not be used for long-term needs but rather short-term cash flow.
- When a business gets an equipment loan, the equipment being purchased acts as the collateral. If the borrowed money is not paid back as the terms of the loan dictate, then the equipment must be given back. Due to the sometimes high cost of equipment, especially for larger companies, a business may have to borrow several million dollars for the financial institution.
- Seasonal or working capital loans are different from other business money borrowed, because they are paid back at the end of the borrowing cycle from the conversion of inventory and accounts receivable into cash. Although these are normally unsecured loans, at times they can be secured by accounts receivable and/or inventory. Companies in the manufacturing, distribution, retail and service-oriented fields often have need for short-term working capital loans.
