Small business owners, especially those looking to start or expand their operations, often rely on outside financing to get the funding they need. Two of the most common financial vehicles they use are grants and loans.
The primary difference between a grant and a loan is the repayment requirement. Simply put, a business owner does not have to repay a grant, while they eventually do have to pay back a loan.
Grants and loans come from various sources: financial institutions, private corporations, trusts, governmental entities, and even family or friends. Just about any small business owner can use grants or loans to fund operations, but there are a few factors that you’ll need to take into consideration before deciding what kind of financing to apply for.
In this guide, we'll break down the difference between a grant and a loan: who they're for, what they cover, and how to find them.
A business loan is most commonly issued by a financial institution like a bank or a credit union. It can also come from a private lender.
The business has to repay the loan, plus interest, within a certain time frame. Oftentimes, the loan is issued against collateral, some sort of physical business asset the lender will take over if the borrower fails to repay the debt.
Almost any small business can take out a loan, but most banks and credit unions require that a business be incorporated to apply.
What Loans Are Used For
The only real requirement for most business loans is that funds are used for business purposes. This can include startup or expansion costs, employee compensation, buying equipment, getting office space, marketing efforts, or expenses related to operations.
Pros and Cons of Business Loans
The biggest advantage of a business loan is its liquidity. As long as you meet the criteria the lender requires, it’s not complicated to get a loan. Business owners can get as much financing as their credit line or repayment ability will allow.
The downside is the burden of repayment. Most financial institutions have inflexible payment schedules. If the borrower fails to pay on time and goes into default, they risk substantial penalties, including seizure of collateral.
A business grant is like a cash infusion that doesn’t have to be repaid. Grants are most commonly issued by governmental agencies at the federal, state, and local levels, as well as some private organizations, trusts, and corporations.
A small business that gets a grant doesn’t have to pay it back. However, the grantor may require that the business meet certain demographic or locational standards to be eligible.
For example, there may be a grant reserved for minority business owners or small businesses in a certain neighborhood or community that's going through redevelopment.
The grantor has the ultimate say in how the business spends the grant. Some grantors require that the business spend the funds for specific purposes.
In the case of government grants, these purposes are usually related to some kind of public benefit. A corporate or private grant may come with a requirement that the funds be spent on activities like research and development that benefit the industry or society.
Pros and Cons of Business Grants
The glaring advantage of a business grant is that it’s yours to keep. You never have to pay it back. As long as you use the funds for the intended purpose, a grant entails no financial risk.
A grant seeker usually has to do extensive research on available grants, spend time grant-writing, file paperwork, and sometimes wait a long time to get a response from the issuing organizations. Competition for grants can be tough.
Many grants are only for specific purposes or business types. Government grants also come with certain stipulations — for example, federal grants can’t be used for repaying debts or covering operational expenses.
Major Differences Between a Grant and a Loan
The main difference between grants and loans is the intent of the lending or granting party. Grantors are more concerned about how the money will be spent, while lenders are concerned about the financial stability of the borrower.
Grants are often reserved for certain types of business owners or those in certain areas or industries. Loans are issued after consideration of a company’s credit score, financial profile, and ability of the borrower to make good on repayment.
Accessibility is another big difference between a grant and a loan. Grant money is limited — the grantor has a set limit or budget on how much they can give, so competition for grants is often fierce. Loans, while riskier, are sometimes more accessible and are often used to start or expand businesses.
Types of Business Loans
Business loans can be structured in many ways, depending on the borrower’s financial status and needs.
Line of Credit
This type of business loan works like a credit card — the borrower gets a certain amount and repays it with interest over a given time.
Some businesses take out loans for a certain amount upfront and repay them with interest over a designated period of time.
A business owner can get a loan for buying or leasing specific assets like equipment, vehicles, or real estate.
Business owners can borrow funds against outstanding accounts receivable items on their ledgers. This structure entails higher risk.
Merchant Cash Advance
Mainly suitable for credit-strapped businesses with heavy credit card transaction volume, this loan is funded according to expected credit transactions over a certain time.
Small Business Administration Loans
These are government-guaranteed loans that go through banks and lenders. The process of getting an SBA is more like that of a grant: it takes longer and is more competitive.
Secured and Unsecured Loans
A secured loan is backed by business collateral, like equipment, land, or cash reserves. An unsecured loan is issued solely on the lender’s faith of repayment.
Types of Business Grants
Business grants essentially come in two forms: governmentally and privately funded.
Government grants are issued at the federal, state, and local levels. A business applying for government grants must meet certain requirements as set forth by grant administrators. Local government grants are often slightly easier to get than those issued by federal or state authorities.
For example, in the aftermath of COVID, the government began issuing small business relief grants for companies that were hit hardest by the economic slowdown of the pandemic.
Private and corporate grants can take several forms and serve various purposes. Most are issued after some form of competition between businesses. Other grants are set forth for specific purposes, like scientific research or product innovation.
Specialty grants, whether they come from private and government, may be earmarked for certain populations of business owners, such as women or minorities.
Deciding Between Grants and Loans
Which financial instrument is right for a small business? The answer depends on a few factors.
A business owner who only needs a small amount of financing may be better served to pursue a loan, especially a short-term one or a micro-loan. A business that needs a large flush of capital may find it worthwhile to apply for a grant.
The grant application process takes a long time, and it may be a while before the grantor issues their approval. A loan may be the right choice for a business with immediate needs.
Grants come with some restrictions and exclusions on who gets them and how they can be spent. Loans are issued based solely on the company’s financial status and ability to repay. A business can be eligible for both or neither.
Grant vs. Loan: The Final Word
Small business financing through grants or loans boils down to the matter of accessibility and risk. A business willing to take on the terms and occasional stress of a loan will find it easier to get. But a company with patience and a clearly defined vision may enjoy the benefits of a public or private grant.