How Do Small Business Loans Work?

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How Do Small Business Loans Work?

Jun 02, 2022

Small businesses employ about half of the private sector workforce in the United States, and they account for two per every three new employment created. Obtaining a business loan can help you get started or build your firm, acquire critical equipment, or fund working capital requirements if you're a small business owner. Knowing how business loans work will assist you in locating the appropriate loan for your company, which could be a lifesaver when utilized wisely.

Many types of business loans are accessible depending on your demands and requirements. However, when it comes to elements like the type of loan, the loan's terms and rates, and the methodology and duration of repayment, business loans can vary substantially.

In this post, we'll go over the fundamentals of how a small business loan works and how to choose a suitable and appropriate loan for you.

What is a Business Loan?

A small business loan is a source of funds obtained through a direct lender's contract and repaid with interest and/or fees. Some lenders charge costs including initiation, servicing, and application fees.

Installment loans are usually repaid over a period of months or years. In most cases, payments are made once a month. Withdrawal fees are charged on business lines of credit (a type of business loan). A line of credit, unlike an installment loan, can be used repeatedly as prior withdrawals are paid off.

Types Of Business Loans

There are numerous ways to finance your business, but let's take a look at some of the most prevalent options.

Small Business Long Term Loan

A long-term loan is likely what comes to mind when you think of a small company loan. It's a standard loan in which you and your lender agree on the amount of money your company requires and your company receives that amount, which is then paid back in monthly installments. These business loans are generally for a longer period of time, ranging from one to five years, so you can acquire the funds you need to start your firm while still having enough time to repay the loan.  

Small Business Short-Term Loans

Short-term loans are similar to standard term loans in that you receive an agreed-upon amount of money from your lender that must be repaid with a set fee. Short-term loans, on the other hand, are available in lesser amounts and for shorter periods. Payments for short-term loans are often made on a daily or weekly basis. However, a short-term loan has the significant advantage of having a quick application process and the opportunity to receive funds quickly. Furthermore, most funders who provide these short-term loans consider the company's overall health when deciding whether or not to approve it.

Small Business Line of Credit

A small business line of credit is equivalent to a credit card in that it allows you to borrow money for your business. You may borrow up to a particular amount and pay the interest on that amount. You can borrow cash and repay the loan as often as you want with a small company line of credit as far as you don't go over your credit limit.

Equipment Loan

When a company takes out a loan to pay for a machine or equipment required, it is known as an equipment loan. Equipment loans are a sort of self-secured loan in which the equipment you purchase with the loan funds serves as collateral. Because the equipment loan is centered on the equipment, the loan terms will also be based on the equipment. You can get a loan of up to 100% of the cost of the piece of equipment your company requires with equipment loans.

Invoice Financing

Unpaid invoices frequently cause cash flow problems. Invoice financing is the practice of obtaining a loan or line of credit by utilizing unpaid customer invoices as collateral – in other words; you're borrowing money that you've previously earned. When consumers settle their invoice in full, the lender costs are taken from the payment. A comparable arrangement is factoring in invoices. Unpaid bills are often sold to a lender for a cash advance, and the lender is then responsible for recovering payment from the consumer. When a consumer pays an invoice, the lender deducts a fee before handing you the remainder of the balance owed.

SBA Loans

The Small Business Administration (SBA) offers many loan programs to help small business owners navigate the financing processes. The agency doesn't usually give money directly; instead, it collaborates with lenders and other groups to help firms get loans that they wouldn't otherwise be able to get. It establishes loan rules, decreases lender risk, and makes it easier for the lenders it works with to obtain financing, allowing small firms to receive more funding.

SBA-guaranteed loans come in many sizes and can be utilized for various purposes. However, businesses must usually meet its size requirements and other fundamental conditions to take full advantage of the SBA's loan programs.

Overview of the Small Business Loan Process

The loan application process varies based on the type of business lender you're working with. On the other hand, most lenders demand that you complete specific processes, such as reviewing your credit record and filling out an application. The following are the typical stages in approving a small business loan:

  • Write a Business Plan: Small business owners will almost certainly be requested to write a business plan outlining how their company operates. They might also meet with a business lender to discuss their funding requirements.

  • Send in your application: The owner is responsible for filling out and submitting the lender's loan application.

  • The lender completes the application and credit review: The lender will examine the application, run a credit check on the company, and authorize the loan. If your personal or business credit score falls below the lender's minimum standards, you may be denied.

  • Lender Prepares Loan Offer: The loan provider will prepare the loan documentation.

  • Loan Offer Finalized: The loan will be closed whenever all of the terms and conditions of the loan authorization are met.

  • The Borrower receives a loan: The loan proceeds will be disbursed according to the terms and conditions that have been agreed upon.

  • The Borrower Repays the Loan: The borrower will pay all agreed-upon installments during the loan's term.

  • The loan process is over after the balance is paid off: When the debt is fully paid off, the collateral liens are discharged, and the document is marked as paid.

These are the stages that often accompany a regular bank or SBA small business loan. You may be required to submit extra documentation depending on the purpose of the loan.


Getting accepted for a small business loan becomes much easier when you've done your investigation and are aware of all of your opportunities. Make it a goal to repay your loan on time, regardless of the type, so that it benefits rather than hinders your business.

The opinions expressed in our published works are those of the author(s) and do not necessarily reflect the opinions of the National Association for the Self-Employed or its members.

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