Small businesses often have a challenging time obtaining financing to support or expand their business. Uncertain cash flows, a lack of earning history, and unreliable credit history are all causes of the difficulty of getting credit. Lenders tend to have both different types of emergency business loans available to small business lenders with unique characteristics that differ from loans for bigger corporations. This article will discuss both to show the unique flavor of small business loan.
Many big companies will borrow directly from the public or institutional investors like hedge funds or pension plans through bond offerings. Small companies don’t have the same options but sometimes will enter into arrangements with private equity funds for debt that is convertible to equity interests in the company. Convertible debt is a half debt half equity instrument that gives the lender the protection of a loan and the upside of equity. They are great ways for small businesses to get financing when other options are not available to it but can dilute the interests of the owners of the company and limit their upside in many ways. Some small business owners are adverse to this structure of convertible debt and turn to other borrowing options for their small business.
A popular loan structure for a small business is an asset backed loan. An asset based loan is theoretically any loan that is secured by an asset underlying the loan liability. An example would be a mortgage loan that is secured by the property purchased with the mortgage loan. However, in practice for small businesses this is typically limited to a loan that is secured by either the accounts receivable or the inventory of the business. The lender then has a cap that represents a percentage of the assets that the company has outstanding. While the company can typically use this to grow the business and finance their expansion and sales, if their business were to sour in any way the lender can recover a portion of their loan balance by commandeering the assets that are held by the business and therefore recover a portion of their principal in the process.
Another loan option that is commonly available to a small business is a line of credit or revolving loan. While this represents a wide range of products including lines of credits and even credit cards, in practice a line of credit operates where a lender can access a maximum amount of borrowings as they need the funds and repay the money when they receive money from their customers on the outstanding receivables. The attraction of this type of loan for a small business is the way in which it allows them to meet the needs of the business by being able to smooth out those times when customers are slow to pay and to still cover payroll and other routine expenses.
Just because a business is small does not mean that they have no access to credit. There are many forms of credit available to small businesses that can help to drive the growth and support the operations for a business that should be considered when a company takes out a loan.