At some point, most successful small businesses require additional capital to sustain growth and will need to consider loan options. Short-term loans generally last for less than three years. This is might be convenient for a small business but it's often difficult to find lenders. Most banks prefer loans that will last for more than three years because they make more money over time.
Besides the time factor and associated costs, a small business also needs to understand the differences between these two types of loans. With loans continuing to be difficult to secure through traditional banks and lenders, many owners find that short-term funding through alternative financing options may be their best option.
What Is A Short-Term Loan?
Through a traditional bank, there are several types of short-term financing: an overdraft, a letter of credit, a short-term loan, and a bill of exchange. An overdraft is an extended credit granted by a financial institution. A letter of credit is a guarantee of payment to a seller. A short-term loan is for a period of less than a year, and it has to be repaid with interest over a fixed period of time. A bill of exchange is a binding document, where one party agrees to pay another party a specified amount by a certain date.
Alternative financing options depend on the size of loan and business need. Crowdfunding works well for new initiatives that typically don't require a lot of capital, private equity funding typically offers a greater loan amount with a strong base of experienced investors, or account factoring which helps company maximize invoices and cash flow.
Advantages and Disadvantages
A short-term debt has more advantages than disadvantages. It is a quick way to get liquidity, can help overcome small economic setbacks, allows owners to capitalize on an opportunity, and provides a much greater pool of lenders. Disadvantages are minor: often interest rates are higher and it does not help long-term capital investment needs.
What Is A Long-Term Loan?
This type of loan is useful for a company that has a long-term growth plan—for instance, buying machinery that will improve profitability in the future. It generally covers a span of five years or more. There are two types of long-term financing: term loan and leasing.
Term loans have a repayment schedule that extends longer than a year. An example is a mortgage. Leasing, meanwhile, is the use of an asset that does not require immediate payment in full. Repayment is periodic. An example is a rental agreement for use of machinery until the lessee can own the equipment or buy it at a discounted rate when the agreement comes to an end.
Advantages and Disadvantages
With long-term loans, advantages and disadvantages generally balance each other out. While there is more financial stability, the cost of interest repaid over a longer time, is higher. While it promotes a company’s capacity for growth, the borrower needs to present a clear plan on how this will occur to the lender. And while this type of loan requires less maintenance, it is harder for a new company, which has yet to establish a track record and build up assets, to get this type of financing.
For most small businesses, short-term loans and alternative financing offer the greatest flexibility. Quicker access to cash, when they need it most. Long-term loans are more suitable for mid- to large-businesses whose focus is on future growth.
Are you consider a growth opportunity or looking to expand your business? Contact us today to discuss your short-term loan options, we'll help you find the best loan choice for your company.