Small businesses are the backbone of the U.S. economy. According to the Chamber of Commerce:
While these statistics remain impressive, running a small business isn't for the faint-hearted -- even when balanced by the many rewards of this process. There are tons of things to do and tough decisions to make. If challenging times arrive, you might need a cash infusion.
When small businesses need more funds, they generally have two choices: a business loan or a line of credit. Choosing between the two can be the difference between growing your business fast and slowing it down. We want to help you grow quickly. In this guide, we take a closer look at both types of financing, their differences, pros, and cons to help you make an informed decision.
Related Reading: A Business Owner's Guide to Business Loans
Business loans or term loans offer small business owners a lump sum of money to repay over time (with interest, of course). Depending on the purpose, business loans can either be long-term or short-term.
Long-term loans are meant to finance long-term goals like remodeling or buying a building. They are usually more significant amounts with 3 years or more repayment period.
On the other hand, short-term loans are designed to help small business owners with immediate needs like paying employees, paying rent during a slow season, or buying inventory. These loan types generally have a shorter repayment period of about six months.
A business line of credit is similar to a credit card. It allows you to borrow up to a specific limit, and you only pay interest on what you've borrowed. Once you repay, you can continue drawing on the funds again.
While a business loan and a line of credit can be useful funding sources for small businesses, they have some key differences. Mainly in the requirements needed to qualify and apply and their main use cases.
Many lenders prefer businesses with good credit ratings (600 and above) to qualify for a small business loan and want to see that this business has been operating for more than a year. You can still get the loan if you don't meet these requirements; however, terms like interest rates may be unfavorable.
The approval process for a business line of credit is similar to business loans. But it's easier to qualify for a line of credit. Many lenders provide lines of credit to businesses with a relatively lower credit score (560 and above).
Related Reading: Is my Business Lendable? Common Requirements Lenders Look For.
Business loans are typically used to finance long-term or one-time projects like purchasing major equipment, building renovations, growth investments, debt consolidation or refinance, and lease improvements. Just be sure to do your due diligence and review lender requirements to learn about any restrictions on using the business loan before applying for one.
On the other hand, business lines of credit are often used to finance emergency expenses. They can also be used as short-term working capital when funds are tight (like during slow seasons), paying employees, covering rent, and buying inventory.
Choosing between a business loan and a line of credit can be an uphill task if you don't know the specific details of both. The right choice depends on how much you need, how you intend to use it if you want flexible or predictable payments, and your business and personal credit score.
Take your time in weighing your options against each other to make an informed decision that works best for you and your small business! Ready to start searching? Find your next lender through our Capital Marketplace today!