How to choose the right business financing option

A business financing option is "right" when it aligns with your timing, intended use, and need for access to funds. Loans, lines of credit, credit cards, and other financing options each have unique benefits. Some types of financing are better for large expenses that may take years to repay, while others make sense for daily expenditures or unexpected financial needs.

Understanding business financing options can help you choose the best one for your company.

Term loans

Term loans provide a lump sum that you repay on a fixed schedule, often over several years. They can provide access to larger sums of money than shorter-term financing options, and typically have longer repayment periods. For these reasons, term loans are best suited for funding one-time investments that will generate additional revenue or long-term cost-savings - for example, equipment, vehicles, or a facility.

The interest rates on term loans are either fixed - stay the same throughout the life of the loan - or variable, meaning they may fluctuate. The interest rate your business can secure for a term loan may be based in part on your business credit score. Consistently making on-time payments for a small business loan could be a good way to build a business credit history. On-time loan payments can boost your business credit rating, which could help secure future financing with positive terms.

Businesses that don't have an established credit history or don't meet conventional lending guidelines may qualify for a Small Business Administration (SBA) loan, a portion of which is guaranteed by the government. While SBA loans may offer advantages such as longer repayment terms and lower down-payment requirements, the application process is typically lengthier.

Lines of credit

A business line of credit lets you access funds as you need them. You pay interest only on what you withdraw. As you repay the funds, they become available again. Unlike term loans, which are typically used for long-term investments, lines of credit are a business financing option often used to handle short-term needs.

Lines of credit can provide a safety net for unplanned expenses, like cash when customers are slow to pay or flexible financing to help you seize growth opportunities.

Lines of credit typically have variable interest rates and must be renewed every year. Lenders will check your business credit score and may review other financial documents, as they do with a loan, before deciding whether you qualify for renewal. Like a term loan, a line of credit can help a business owner to establish a good credit history. It can also help a business build a relationship with a lender and demonstrate an ability to handle credit responsibly.

Business credit cards

Business credit cards, like lines of credit, offer a set amount of revolving credit. You may spend up to the credit limit, and funds become available again as you repay them. Business credit cards often carry higher interest rates than other business financing options and are best used for day-to-day expenses, such as office supplies, travel, and business services.

A unique benefit of credit cards is that if you can pay off your next statement in full, the "float" (grace period you're given to pay off your balance) on the credit card allows for short-term borrowing at no interest. The bonus potential of cards is that many offer points or cash rewards that you can accrue and use for business expenses, travel, or workplace perks.

A business credit card is also a powerful tool to separate professional and personal expenses. The reporting capabilities with some business credit cards can simplify task tracking and managing business expenses. If you choose to give cards to employees, have a policy in place to set limits on the size and nature of transactions.

Equipment financing

Equipment can be a considerable investment for a business, and equipment financing lets businesses spread the payments out over time, freeing up cash for other business expenses. A fixed monthly loan payment in this business financing option helps businesses to manage cash flow, without the stress of fluctuating payments.

As you pay off the loan, your business' equity in the equipment increases. Depending on where your business is located, you may be able to deduct payments on the financed equipment on your tax return. Talk to your tax advisor about any potential deductions before making a purchase or securing financing.

Small business grants

A small business grant is a monetary award gifted to a business owner or entrepreneur for a specific purpose, and it usually does not need to be repaid. Grants can be an appealing route for companies that either do not qualify for lines of credit, bank loans, or a business credit card, or don't have the resources to pay back a loan in a timely fashion.

However, don't assume that grants are a route to quick cash. The process of researching, applying for, and obtaining grants can be time-consuming and competitive. Grants are typically very specific about eligibility - for example, a grant may be specifically for Latina women opening new businesses. In addition to requiring an application, some grantors may ask for an interview to review a business plan or other requirements.

Grants can come from a wide variety of sources, including federal, state, or local governments, nonprofit organizations, corporations, or private groups, such as trade associations. Online resources such as Grants.gov can help identify potential grant opportunities for your business. If you do receive a grant, talk to your financial advisor, as grants may be considered taxable income.

Crowdfunding platforms

Crowdfunding has become a popular option for startups that want to avoid taking on debt or potentially giving up equity. It allows businesses to raise funds through small contributions from a large pool of investors, and it is often promoted via social media.

Campaigns are usually based on crowdfunding-specific websites, like Kickstarter, Fundable, Indiegogo, and GoFundMe, which typically earn revenue by collecting a percentage of the money raised or a monthly fee. In addition to raising capital, crowdfunding gives businesses the opportunity to gauge interest in their offerings. A successful campaign can serve as proof of concept for other stakeholders.

To be successful, businesses need to mount a strong promotion effort that builds trust and excitement with potential investors while clearly explaining the proposition of the venture. In exchange for support, businesses typically offer some type of incentive, such as products or services once the business is established, or occasionally an ownership stake in the company. In most cases, if the funding goal is not reached, funds are returned to the investors.

Financing platforms

Companies that provide business financing, often for specific types of purchases such as inventory or technology, are called financing platforms. Financing platforms let businesses obtain financing and pay for funded purchases directly through the platform.

For example, a business that is purchasing software and hardware from multiple vendors could use a financing platform to secure financing and make payments to a variety of vendors through the platform. Financing platforms typically charge higher interest rates than traditional lenders.

Peer-to-peer lending

Peer-to-peer (P2P) lending is an alternative form of financing that enables individuals to obtain loans directly from other individuals, without a financial institution. P2P platforms each have their own terms and rates and connect potential borrowers and lenders. P2P lenders are often individual investors looking for a better return than they could get from putting funds into a bank.

Interest rates are determined based on a borrower's credit rating, and rates and fees can be higher than at banks. The process can be automated, or borrowers and lenders can negotiate terms.

Ready to finance your business growth?

Citizens is here to help with all of your business financing needs. Learn more about our simple, hassle-free business loans and lines of credit.

Learn more