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When looking for funding for your small business, there are plenty of types of loans to consider, including term loans. A term loan provides a borrower with a lump sum of cash they repay on a fixed repayment schedule.

Term loans can be helpful for businesses looking to expand, buy more real estate, update equipment, or purchase more inventory in advance.

So, what are term loans exactly? Read on to learn more about small business term loans, their advantages and disadvantages, and the different types of term loans available.

What Is a Business Term Loan?

A business term loan is a type of small business financing that provides a lump sum of money up front you then pay back over a set period of time, called a term. Payments are often monthly but could be weekly, bi-weekly, or even quarterly.

Part of each payment goes toward the principal, lowering the remaining loan balance, and part goes toward interest. Interest rates on business term loans may be fixed or variable. Repayment terms can range anywhere from 12 months to 25 years, depending on the loan amount, lender terms, and the borrower’s creditworthiness.

Term loans aren’t just used for small businesses, though. Mortgage loans, auto loans, and student loans are also all types of term loans.

What Can a Term Loan Be Used For?

Common uses of term loans for businesses include:

•  Buying real estate or upgrading property you already own (the real estate would likely serve as collateral)

•  Buying new equipment or repairing equipment you already own (the equipment could serve as collateral)

•  Restocking inventory

•  Buying vehicles for work

•  Meeting payroll and other expenses

•  Covering employee wages

What Are Different Types of Business Term Loans?

Most small business owners factor in two things when considering term loans — the purpose of the loan and the term length (there are short-, intermediate-, or long-term business loans).

Payments may be higher with short-term loans than long-term loans, though this depends on how much the business borrows. When considering what your business can qualify for and pay back with its available cash flow, remember to factor in how the length of your loan term affects the payment amount.

Short-Term Loans

Short-term loans typically have a length of less than one year but can extend up to 18 months. Businesses that don’t qualify for a line of credit might find short-term loans helpful. Though these loans are typically easier to qualify for, they tend to have higher interest rates.

It’s important to note that short-term loans may come with a balloon payment, meaning the last payment is much larger than the rest. Keep this in mind when deciding whether a short-term loan is right for your business.

Recommended: The Cost of Capital

Intermediate-Term Loans

Intermediate loans typically have terms between one and three years. Because of their slightly longer payoff time, they may be an option if you’re hiring a new salesperson, for instance, and know there might be some lag time before they start bringing in revenue.

Like short-term loans, intermediate business term loans may also have a balloon repayment structure.

Long-Term Loans

Long-term loans typically have terms of five to 10 years, but they may extend up to 25 years. They typically require collateral, such as real estate or equipment, and may come with lower interest rates than short- and intermediate-term loans.

Long-term loans are often more difficult to qualify for, requiring proof of revenue and a solid credit history. However, they can provide helpful capital for business investments, making them a valuable option for established businesses planning for growth.

Recommended: Merchant Cash Advance for Bad Credit

How Do Business Term Loans Work?

Once you’ve determined the amount you need to borrow and the purpose, you can approach financial institutions to explore their available programs, interest rates, and loan terms.

You’ll also want to find out what documentation you’ll need to apply, what collateral might be required, and whether they can supply the funds on your timeline. Be sure to check what small business loan fees may apply.

Once you’ve evaluated the above factors, compare multiple lenders and choose the one that suits your needs. The loan application process typically happens online, but you may be able to apply in person if the loan is through a bank.

Rates and terms offered vary based on the lender, your personal and business credit history, your time in business, and your financial health and history. Pay particular attention to whether the loans you research are secured and how the interest rates are structured:

•  Secured vs. unsecured loans: Secured loans require collateral or a personal guarantee, meaning that your assets will be used as payment if you can’t pay your loan. Unsecured loans do not require this collateral and are therefore riskier for the lender, so they often have higher costs and shorter terms than secured loans.

•  Fixed vs. variable interest rates: A fixed interest rate remains stable over the entirety of the term loan. A variable interest rate fluctuates throughout the life of the loan, depending on the prime rate — the rate that commercial banks charge their most creditworthy borrowers.

If you’re approved for the loan, you are free to use the funds once disbursed. From there, you’d make regular payments based on the loan agreement.

Recommended: How to Check Your Credit Score for Free

Deciding If a Business Term Loan Is Right for You

It can be challenging to decide which kind of loan is the right fit for your business. There’s a lot to consider. Here are a few questions to ask before applying:

•  Why do I need funding?

•  How does this help me reach my business goals?

•  How healthy are my business finances?

And if any of these apply to you, it may not be time to consider term loans just yet:

•  Your business is new

•  You have poor credit

Business Term Loans: Pros and Cons

Like any other loan, business term loans have advantages and disadvantages that are important to consider when deciding whether they’re right for you. Below, we’ve outlined the pros and cons of term borrowing to help you determine whether term loans are a good fit.

Advantages of Business Term Loans

Pros of term loans include:

•  You may be able to borrow a large amount of money.

•  Multiple types of term loan programs may be available when you look at different lenders.

•  Interest rates are typically lower than credit cards, payday loans, and other short-term funding options.

•  As you pay the term loan back on time, you can boost your business credit score.

Note: Check with your accountant or tax professional to see what tax benefits you may realize. Term loan interest may be tax-deductible.

Recommended: What Are the Tax Benefits of a Limited Liability Company (LLC)?

Cons of Term Loans

As with any financial product, there are downsides to consider, as well. Cons of term loans include:

•  You may be able to borrow a large amount of money.

•  Multiple types of term loan programs may be available when you look at different lenders.

•   Interest rates are typically lower than credit cards, payday loans, and other short-term funding options.

•  As you pay the term loan back on time, you can build your business credit score.

Note: Check with your accountant or tax professional to see what tax benefits you may realize. Term loan interest may be tax-deductible.

Recommended: What Are the Tax Benefits of a Limited Liability Company (LLC)?

Disadvantages of Business Term Loans

Cons of term loans include:

•  You may be entering into a long-term debt.

•  The loan application process may take longer than you’d like.

•  Some business term loans come with prepayment penalties, which means you can’t prepay to reduce the amount of interest paid over the loan’s life.

•  If your credit isn’t the best, the interest rates you’re offered may not be, either.

Recommended: Debt-to-Income Ratio

How to Apply for a Business Term Loan

Assess your business goals and lenders’ eligibility requirements as you choose the best option for your company. Here’s how:

1. Compare Small Business Term Loans

Comparing lenders’ terms can help improve your chances of qualifying for a loan. That way, you don’t spend valuable time applying for options for which you’re not eligible. On top of that, it helps keep you from overpaying on rates and fees or endangering your business cash flow with a repayment schedule that’s too aggressive.

2. Look at Each Lender’s Eligibility Requirements

It’s helpful to examine these requirements side by side:

•  Personal and business credit

•  Time in business

•  Annual revenue

•  Collateral

•  Down payment

•  Personal guarantee

3. Scrutinize the Lender’s Fees

Also look at the fees side by side:

•  Interest rate and APR

•  Origination fees

•  Late payment fees

•  Early payoff penalty

4. Review the Repayment Schedule

Important questions to ask:

•  Are payments made daily, weekly, monthly, or quarterly?

•  Are payments automatically deducted from a business bank account?

Many lenders have strict repayment terms for their business term loans, meaning you need to make sure you can meet those standards. That way, you don’t overdraft your accounts, accrue late fees, or damage your credit score.

Recommended: Long-Term Small Business Loans

5. Gather the Required Documents and Apply

When applying for a loan, documents often requested by lenders include:

•  Bank statements (personal and business)

•  Tax returns (personal and business)

•  Business legal documents, including licenses and permits

•  Personal identification

•  Business plan

•  Revenue statements

•  Accounts receivable reports

•  Accounts payable reports

Because the exact documentation required varies by lender and loan type (and whether collateral is involved), you’ll need to clarify what the lender you choose will need.

Also, it can be worthwhile to explore business grants since those do not need to be paid back.

Recommended: What Are Small Business Grants?

The Takeaway

When businesses seek funding, term loans are worth considering. With a business term loan, the company borrows a certain amount of money in a lump sum and then pays it back in regular installments at either a fixed or variable interest rate. Terms can range from short (even under a year) to long (perhaps as long as 25 years), with the funds used for a variety of purposes.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What does “term loan” mean for a business loan?

Like other term loans, a business term loan provides a borrower with a lump sum of cash they repay on a fixed schedule over the set period of time, or term. The interest rate can be either fixed or variable.

What is an example of a term loan?

An example of a term loan is a small business loan of $50,000 from a bank that has to be paid over three years in monthly payments, with fixed interest.

What are the three main types of term loans?

There are short-term, intermediate-term, and long-term loans.

Photo credit: iStock/pikselstock

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOSMB-Q324-020

Working capital for small businesses powers daily operations and fuels growth. It’s the amount of liquid cash a small business has available for expenses like operational costs, payroll, and inventory. By definition, working capital is the difference between a business’s assets and debts (or accounts payable).

When a business has enough cash to cover its operating expenses and invest in future growth, it has positive working capital. When it doesn’t have enough, it has negative working capital.

If a business has negative working capital, it may want to seek out a working capital loan. There are numerous types of small business working capital loans available, including term loans, lines of credit, and invoice financing. Let’s walk through some options that may be a fit for your small business.

What Is a Working Capital Loan?

A working capital loan is a type of small business funding that can work well for a small business with negative working capital or fluctuating cash flow. This type of loan offers short-term financing to cover expenses like:

•  Monthly bills

•  Debt payments

•  Payroll

•  Inventory

•  Operational expenses

•  Emergency expenses

Unlike commercial real estate loans or large business loans, working capital loans aren’t intended for long-term investments or big purchases.

Since working capital loans are typically smaller loans, many types of lenders offer this type of business financing. Banks, credit unions, online lenders, peer-to-peer (P2P) lenders, and alternative lenders are all potential sources for working capital loans. Each has varying eligibility requirements and business loan terms, so it’s a good idea to do some research to determine which option suits your needs best.

What Can a Working Capital Loan Be Used For?

Many small businesses don’t have predictable cash flow or sufficient assets, resulting in negative working capital. Seasonality, sales cycles, holidays, or economic fluctuations can all contribute to negative working capital. It is common for startups, restaurants, manufacturers, or less-established small businesses to have negative working capital. Without reliable revenue, these businesses may turn to working capital loans.

Depending on your business needs, you can use working capital loans to:

•  Manage cash flow: Working capital loans can help maintain smooth operations during periods of uneven cash flow, ensuring bills and expenses are paid on time.

•  Manage seasonal business expenses: Businesses with seasonal fluctuations can use these loans to cover costs during off-peak periods.

•  Cover emergency expenses: In the event of unexpected expenses, a working capital loan provides quick access to funds.

•  Grow your business: These loans can also be used for short-term investments, such as marketing campaigns or purchasing additional inventory, to support business growth.

How to Calculate Working Capital

To calculate your business’s working capital, start by identifying your current assets and current liabilities.

Current assets are things that currently belong to your business and could easily be converted to cash within one year or one business cycle (whichever is shorter). These can include:

•  Cash (checking and savings accounts)

•  Accounts receivable

•  Inventory

•  Assets soon to be paid off or liquidated

•  Stocks, bonds, and mutual funds

Current liabilities are expenses that must be paid within the next year or business cycle. These can include:

•  Rent

•  Utilities

•  Supplies

•  Principal and interest payments on any debt

•  Accounts payable

•  Accrued taxes

•  Long-term debt that will be due in the short-term

After adding up your current assets and liabilities, calculate working capital using the following formula:

CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL

For example, if your business has $200,000 in current assets (property, cash, inventory, etc.) and $75,000 in current liabilities (rent, debt payments, taxes, payroll), your positive working capital is $125,000.

$200,000 – $75,000 = $125,000

Conversely, if your business has $100,000 in current assets but $150,000 in current liabilities, you would have $50,000 in negative working capital.

$100,000 – $150,000 = -$50,000

Positive working capital is a sign of good business health. It’s usually an indicator that you’re in a good place to expand. Negative working capital can indicate financial troubles, which could ultimately lead to defaulting on debt payments or entering bankruptcy. For this reason, determining your working capital is an important step in planning for your business’s growth.

Types of Working Capital Loans

Working capital loans can help if your business needs extra cash. Several loan products offer short-term solutions. Keep in mind that not all will be suitable for every business, so be sure you understand each loan option before making a decision.

SBA 7(a) and 7(a) Express Loans

SBA loans are offered through approved Small Business Administration (SBA) lenders and provide flexibility for various working capital expenses. The SBA Express program offers a faster review time of around 36 hours, with a maximum loan amount of $500,000. The standard SBA 7(a) loan can provide up to $5 million but may take longer to process.

SBA-backed loans offer low interest rates and are suitable for short- and long-term expenses. Loans of $25,000 or less do not require collateral. However, eligibility requirements vary, and qualifying can be challenging. Good credit, proof of revenue, and a business plan are essential for application.

Short-Term Loans

Short-term business loans are used to secure working capital, providing a sum of money up front that is typically repaid with interest over 18 months or less. These loans are ideal for businesses needing quick cash that can repay the loan in a short time frame.

They are often easier to obtain for borrowers with poor credit or less-established businesses, as they pose less risk to lenders. However, short-term loans typically have higher interest rates and lower borrowing amounts than other term loan products.

Lines of Credit

A business line of credit is a small business working capital loan that can help manage cash flow and cover small expenses. Like a credit card, it provides a set credit limit to borrow from, with interest charged only on the money withdrawn. These lines of credit are often revolving but can also end when the balance is paid off.

This option is useful for businesses with seasonal fluctuations, sales cycles, or emergency expenses. It’s typically easier to qualify for business lines of credit because the funding amounts are smaller and the debt is short term. However, consider the additional fees and lower borrowing limits before opening a business line of credit.

Invoice Factoring

Invoice factoring is when a business sells its unpaid invoices to a factoring company at a discount in exchange for immediate cash to cover working capital expenses. The factoring company then owns the invoices and collects payments directly from the business’s customers.

This option can be ideal for businesses with irregular billing cycles, allowing them to cover operating expenses without waiting for customer payments. The factoring company provides a percentage of the invoice value up front, which can be used to reinvest in the business or pay expenses.

Costs can be high due to fees and high APRs, and the business loses control over collections, so choosing a reputable factoring company is essential.

Inventory Financing

Inventory financing is a short-term working capital loan that provides funds to purchase inventory, using the inventory itself as collateral.

This financing is helpful for retailers managing cash flow fluctuations due to seasonality or revolving inventory, allowing them to pay for products up front in anticipation of high sales periods. The amount of financing and interest rates can vary, and since inventory depreciates over time, the loan amount may not reflect the inventory’s original purchase price.

Merchant Cash Advances

A merchant cash advance offers businesses cash upfront in exchange for a percentage of future credit card sales, with automatic withdrawals made daily or weekly from the borrower’s bank account.

Merchant cash advances are helpful for businesses needing quick access to cash, especially those with bad credit or newly established operations without other loan options. They can be expensive due to higher costs associated with the increased risk to the lender, meaning borrowers pay more for the convenience of fast cash.

Bank Overdraft Facility

A bank overdraft facility provides a business with access to cash even if its account is empty or overdrawn. The bank continues processing payments for a set period so the business can meet its financial obligations.

This option is useful for small businesses with inconsistent cash flow or negative working capital. It acts as a backup plan until additional funds are available. Keep in mind that interest is charged on the loan, and there may be additional fees when an overdraft occurs.

Pros and Cons of Working Capital Loans

Working capital loans can be a valuable resource for small businesses needing immediate funds to cover operational expenses. Like any type of business loan, they have their own set of advantages and disadvantages.

The pros of working capital loans may include:

•  May not require collateral (unsecured loans)

•  Can help improve cash flow

•  Let you maintain ownership of your business

•  May involve a faster loan process than other products

•  Come in numerous types of loan products

A few potential cons may include:

•  Certain loans may require a higher credit rating

•  Interest rates may be high on certain loan products

•  May affect both your personal and business credit

Recommended: Business Expansion Loans

How to Get a Working Capital Loan

The process for getting a working capital loan for your small business will depend on the type of loan product and the lender. Generally, the following steps will help you find, apply for, and obtain a loan for your small business.

•  Determine the loan purpose and amount: Consider how much money you need, how often you’ll be able to make payments, your budget for making payments, and whether you have any other sources of funding.

•  Choose a loan type: Research the different types of loans available and choose the best fit for your business needs.

•  Assess your qualifications: Check that your qualifications match the loan product you want to apply for. Some things to consider are personal/business credit ratings, collateral, and your working capital.

•  Choose a lender: Compare small business lenders that align with your needs and qualifications (and their associated terms, conditions, and fees) before choosing the best fit.

•  Submit your application: Prepare necessary documentation, such as financial records, business plans, and cash flow projections. Then, submit your application to the lender.

•  Partner with your lender: After you’ve submitted your application, continue working with your lender to ensure that the process goes smoothly and you can receive funds promptly.

Recommended: How to Read Financial Statements: The Basics

Alternatives to Working Capital Loans

If you’re looking for additional financing for working capital or have long-term financing needs, the following types of loans may be helpful:

•  Restaurant loans: Offered by several types of lenders, restaurant loans help with costs when you’re starting or expanding a restaurant business.

•  Franchise financing: A franchise loan can help with the expenses of opening a franchise. There are franchise companies that specialize in offering loans specifically for franchise owners.

•  Equipment financing: Equipment loans are useful for purchasing business equipment. The loan term is typically equal to the equipment’s expected lifespan, and the equipment acts as collateral for the loan.

•  Personal loans: If you don’t qualify for working capital loans, you may want to consider a personal business loan. This type of loan can give you more flexibility than a business loan.

•  Trade financing: Trade financing helps international businesses manage working capital by transferring payment or goods risks to third parties through options like bank guarantees and letters of credit.

•  Customer advances: Consider charging customers in advance instead of at delivery to receive cash up front, which frees up working capital.

•  Vendor credit: If you regularly purchase from the same vendors, ask if you can open a credit account. This allows you to pay your invoices in 30, 60, or 90 days.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is a working capital loan?

A working capital loan is a type of business loan used to help pay for everyday operations and expenses. Types of working capital loans include short-term business loans, business lines of credit, merchant cash advances, and invoice financing.

How do you qualify for a working capital loan?

To qualify for a working capital loan, a lender assesses your credit, revenue, and business history. While there are working capital loans for startups and those with poor credit, the best loans and rates will be reserved for those with solid credit scores, a business history of at least one year, and positive revenues.

What is an example of a working capital loan?

An example of a working capital loan is a short-term business loan. These loans are typically 18 months or less and are given to the borrower in one lump sum. Payments are made monthly, and the interest rate is determined by the market and the business’s financial profile, including credit score and annual revenue.

Photo credit: iStock/shapecharge

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOSMB-Q324-026

Starting a new business requires a good idea, customers who want your product or service, and money to get you off the ground. A personal loan to start a business can be one option for funding your business, especially if you don’t yet qualify for a small business loan.

Let’s walk through the difference between personal loans and business loans, the advantages and disadvantages of using a personal loan for business, and some alternative options to explore.

What Is a Personal Business Loan?

Personal loans for business are offered by some banks, credit unions, and online lenders. While many loans will specify what you can spend the money on — a mortgage must be used to buy a house, for example — the sum you receive from a personal loan can be used in several ways. That said, it’s important to confirm with your lender whether its personal loans can be used for business expenses, as some lenders do not allow this.

Your personal loan interest rate is based on various financial factors, including your financial history, income, and credit score. Generally, the higher a person’s credit score, the more likely they are to receive a personal loan with favorable terms and interest rates. Applicants with lower credit scores may have more difficulty qualifying for low interest rates. Lenders tend to see them as at greater risk of defaulting on their payments. To offset that risk, they might charge a higher interest rate.

Personal Business Loans vs. Small Business Loans

Borrowing money to pay for business expenses is a decision that takes some consideration. There are different reasons you might want or need a business loan, many lenders to choose from, and different lending options to compare. Some things to think about if choosing between a personal loan for business or a small business loan include:

Recommended: Business Loan vs. Personal Loan: Which Is Right for You?

Benefits of a Personal Loan for Business

Taking out personal loans for business purposes can offer several advantages over other financing options.

Ease of Qualification

If your business is brand new, it can be tricky to get a business loan and may be easier to qualify for a personal loan. Banks offer personal business loans based on your personal income and credit score. On the other hand, you’ll be asked for a lot of information during the business loan application process, including your personal and business credit score, annual business revenue and monthly profits, and your length of time in business. The longer your business has existed, the more likely you are to have a record of revenue and profit — and the more likely you are to qualify.

Faster Funding

The length of time it takes to get approved for a personal loan and receive funding will vary by lender. Online lenders are typically faster than traditional banks and credit unions. You are likely to receive funding within seven business days.

By contrast, the process for a business loan can be much slower. For example, it can take 30 to 90 days to receive funding from a Small Business Administration (SBA) loan.

Potential for Low Interest Rates

If you have strong credit, personal loans can have lower annual percentage rates (APRs) than other financing products — such as credit cards. While it can be useful to have a business credit card, you’ll pay a relatively high rate If you carry a balance from month to month. Credit cards may also have penalties and fees that personal loans may not have, such as penalty APRs that go into effect if you make a late payment, over-limit fees if you spend more than your credit limit, annual fees, and more.

Flexibility and Versatility

Personal loans have few restrictions on how you’re allowed to use the money you borrow. You can use them for anything from debt consolidation to home repairs to a veterinary bill.

Recommended: 11 Types of Personal Loans & Their Differences

Disadvantages of a Personal Loan for Business

Despite the potential advantages of using a personal loan to help you start your business, there are drawbacks.

Some Lenders Don’t Allow Personal Loans for Business

Some lenders place restrictions on how personal loans can be used. It’s wise to be transparent about your intention to use the personal loan for business expenses and confirm if the lender permits it.

In some cases, it may not be. However, it’s far better to be honest about how you plan to use a loan than risk breaching the loan agreement. If you end up using a loan in a prohibited way, your lender could force you to immediately repay the full amount of the loan with interest.

Lower Loan Amount Limits

Personal loans generally offer borrowing limits as low as $1,000. They can go as high as $100,000 for larger personal loans. For small businesses, this might be plenty. But if you own a larger business that needs more money, you might benefit more from a loan specifically designed to meet business financial needs. Small business loans generally have lower interest than personal loans.

Shorter Repayment Terms

Lending periods for personal loans vary. Typically, you can find loans with term lengths of 12 months to five years. Compared to some small business loans, this is a relatively short period. Consider that for SBA loans, maximum terms can be as much as 25 years for real estate, 10 years for equipment, and 10 years for working capital or inventory.

Potential to Affect Personal Credit Score and Assets

If you take out a personal loan and can’t make monthly payments, you are putting your personal credit at risk. Missed payments may harm your credit score, which can make it more difficult for you to access funding in the future.

Recommended: What Is Considered a Bad Credit Score?

Fewer Tax Deduction Opportunities

Generally, the interest you pay on a personal loan is not tax deductible, unlike the interest paid on business loans. However, there’s an exception if you use the proceeds of a personal loan for business purposes.

However, this can get a bit tricky, as you may only deduct interest on the portion of the loan used for business expenses. So if you use any of that money to remodel the primary bathroom in your home, for example, interest on that portion can’t be deducted.

How to Get a Personal Loan for Business

Securing a personal loan for business purposes involves several key steps. The process looks like this:

1.   Assess your finances: Begin by looking at your personal credit score, income, and overall financial health. This will give you insight into the likelihood of qualifying for a personal loan and the interest rates you might get.

2.   Choose a lender: Look for banks, credit unions, and online lenders that offer personal loans suitable for business purposes. Make sure they allow you to use personal loan funds for business expenses. Compare interest rates, loan terms, and fees to find the best lender for your needs.

3.   Prepare your documents: Gather documents like proof of income, tax returns, identification, and any business-related information required for your application.

4.   Submit your application: Complete the loan application process with your chosen lender. Be honest about your intention to use the loan for business expenses. This transparency helps avoid potential issues in the future.

5.    Review loan terms: Once your application is approved, carefully review the loan terms, including the interest rate, repayment schedule, and any associated fees. If everything looks good to you, accept the loan terms to move forward with the funding process.

Alternatives to Personal Business Loans

Personal loans might not be ideal for everyone and aren’t the only funding option for your small business. It may be worth considering small business loans or other types of business loans as alternatives.

Small Business Loans

Small business loans are offered through online lenders, banks, and credit unions. There are various options available, each designed for specific purposes. For example, a working capital loan is designed to help you finance the day-to-day operations of your business. An equipment loan can help you replace aging technology and buy new equipment.

SBA loans are guaranteed by the Small Business Administration, whose aim is to help small businesses start and grow. If you aren’t able to make your payments, the SBA will step in and cover up to 85% of the default loss. By reducing risk in this way, the organization helps businesses get easier access to capital.

Shopping around for the best small business loans rates is a good way to compare lenders and find the one that works best for your unique financial needs.

Business Lines of Credit

A business line of credit is revolving credit, similar to a credit card. You have a set credit limit and only pay interest on the amount you’re currently borrowing, making it a more economical option than a term loan for some business owners. As you repay the funds, they are available to borrow again.

Another advantage to a line of credit over a term loan is the ability to use a check to pay vendors who do not accept credit cards.

Business Credit Cards

Business credit cards can be useful for separating personal and business expenses. They also usually have higher credit limits than personal credit cards, which gives you more flexibility to make larger business purchases. Plus, they may offer rewards, perks, and bonuses. It’s important to keep in mind, however, that credit cards tend to have higher interest rates than other types of business financing.

Recommended: Can You Get a Business Credit Card Before You Open Your Business?

Merchant Cash Advance

A merchant cash advance (MCA) is an alternative form of financing for businesses that get revenue through credit card sales. With an MCA, a business can borrow a lump sum of money and repay the lender with a percentage of future credit card transactions. The repayment amount is larger than the advance, since the lender charges a fee. In some cases, MCA fees can significantly exceed interest rates on other types of business loans.

The Takeaway

Can you use a personal loan to start a business? Perhaps. Taking out a personal loan may be one way to fund your small business needs. However, some lenders do not allow a personal loan to be used for business purposes. It’s a good idea to explore alternatives, such as a small business loan or line of credit.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Can a personal loan be used for business?

Yes, you can use personal loans for business if the lender allows it. It’s important to check with the lender to ensure there are no restrictions on using the loan for business expenses.

Can I write off a personal loan if used for my business?

You can typically write off the interest on a personal loan used for business purposes, but only the portion directly related to business expenses. Personal loan principal repayments are not tax-deductible.

Does the SBA offer personal loans?

No, the Small Business Administration (SBA) does not offer personal loans. The SBA provides various loan programs designed specifically to support small businesses, such as SBA 7(a) loans and SBA 504 loans.

Photo credit: iStock/fizkes

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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A factor rate expresses the percentage of a loan amount that you need to pay back. It’s commonly used in commercial financing offers (such as sales- or revenue-based financing) and merchant cash advances. Factor rates are typically expressed as a decimal figure between 1.1 and 1.7.

Below, you’ll learn more about what a factor rate is, how it operates, and how nonbank finance companies typically use factor rates to make money.

Factor Rates Defined

Factor rates are typically used by nonbank finance companies to calculate some or all of your total costs on nontraditional commercial funding.

A factor rate is typically used in the following sales-based financing or revenue-based financing products:

•  Inventory financing

•  Invoice factoring

•  Merchant cash advance (MCA)

•  Purchase order financing

Factor rates on a merchant cash advance typically range from 1.1 to 1.7, and the rate is used to calculate your repayment costs (not including any additional fees).

Factor Rates vs APR

It’s worth noting that MCAs and other sales-based financing products are typically expensive when compared with traditional small business loans. That’s because the total costs of a merchant cash advance can include a factor rate and additional fees that would typically represent a high annual percentage rate (APR) if it were a traditional bank loan.

With a merchant cash advance, reports indicate that you can wind up with an APR of close to or even more than 100%.

The APR on a small business microloan, meanwhile, can have APRs starting at 7% or 8%. Community-based microlenders may offer microloans of up to $50K.

Recommended: What Is Trade Working Capital?

How Do You Calculate a Factor Rate?

To calculate the total cost of the loan with a factor rate, simply multiply the loan amount by the factor rate.

Here’s an example of a factor rate in action: Say a business owner takes out a merchant cash advance (MCA) for $10,000 and the factor rate is 1.2.

$10,000 x 1.2 = $12,000

So $12,000 is the total amount of money owed on the merchant cash advance if the provider doesn’t charge additional fees. Some MCA providers may charge additional fees on top of the factor rate.

An MCA is a common type of sales-based financing that charges a factor rate vs. a short-term business loan that charges interest.

What Lenders Look at To Determine a Factor Rate

As with a lender who issues interest rate loans, a lender who offers sales-based financing with a factor rate generally also wants to know that borrowers will be able to pay the financing back. Even though taking payments directly from a merchant’s sales provides some security to the lender, if a borrower is perceived as more risky, it might be offered a higher factor rate.

Every lender has its own requirements, of course. But across the board, in order to determine your factor rate, a lender may ask to see:

•  Credit card processing statements. The lender will want to see proof that you have credit card sales large enough for it to deduct payments from them.

•  Bank statements. A lender may want a sense of your business’s financial situation and request some of your recent bank statements.

•  Time in business. Typically, lenders prefer to lend to businesses that have been operating for at least a year.

•  Business tax return. This will allow the lender to assess the financial health of your business.

Lenders may consider other factors when determining your factor rate, but these are among the most likely components.

Factor Rate vs Interest Rates

Although it’s similar in some ways, a factor rate is not the same thing as an interest rate. As mentioned earlier, a factor rate is a percentage of a commercial financing offer, and the rate is typically expressed as a decimal figure between 1.1 and 1.7. Sales-based financers, including merchant cash advance providers, can make money by charging a factor rate.

Factor rate example: A $10,000 MCA with a 1.2 factor rate would cost at least $12,000. The factor rate doesn’t necessarily tell you the total cost of the MCA, because MCA providers can charge additional fees on top of the factor rate.

An interest rate is a finance charge typically expressed as an annual percentage of a borrower’s outstanding principal. State usury laws can limit the maximum interest rate that lenders charge on traditional loan products. You can typically minimize your total interest charges by paying a loan off early.

Interest rate example: A $10,000 microloan with a 7% interest rate, five-year repayment plan, and no additional fees would cost about $11,880 after 60 months. The total borrowing costs would be lower if there’s no prepayment penalty and you pay the loan off early.

Here are some points to keep in mind:

•  The interest rate doesn’t necessarily tell you the total cost of a loan, because lenders can charge additional fees on top of the interest rate charges.

•  A merchant cash advance is a sales-based financing solution that typically charges a factor rate, whereas traditional loans typically charge interest.

•  APR takes the interest rate and upfront fees into account, so APR can give you a better idea of a loan’s total cost than the interest rate alone.

Recommended: Guide to Variable Costing Income Statements

Pros and Cons of Factor Rates

Here are some pros and cons of factor rates:

Pros of Factor Rates

•  Relatively easy to calculate costs upfront

•  Factor rate products, such as merchant cash advances, typically have fast funding times

•  Factor rate products may have less rigorous credit score requirements than other forms of financing

Cons of Factor Rates

•  Factor rate charges cannot be minimized via prepayment

•  Factor rates are a nontraditional commercial financing term

•  Can translate into APRs of 70% or higher

Recommended: What Is the Minimum Credit Score for a Business Loan?

The Takeaway

A factor rate is the percentage of the loan amount that a borrower must pay to pay back a loan, expressed as a decimal. It’s a nontraditional financing term typically used by merchant cash advance providers. Nonbank finance companies may charge a factor rate along with additional fees.

Typically, loans that come with factor rates end up being more expensive than traditional small business loans.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is a factor rate?

A factor rate is a fee structure used in merchant cash advances and some short-term business loans. It’s expressed as a decimal, such as 1.2 or 1.4, rather than a percentage and determines the total repayment amount.

How is a factor rate calculated?

To calculate the total repayment, multiply the loan amount by the factor rate. For instance, a $10,000 loan with a factor rate of 1.2 would require repayment of $12,000. Factor rates do not accrue over time, and the total repayment amount is fixed from the start, making it easier to understand the full cost of borrowing.

How do factor rates work?

Factor rates are fees that lenders charge for certain types of business loans, mainly merchant cash advances. They are expressed as a decimal rather than a percentage, and are multiplied by the total loan amount. If you have a loan for $10,000, for example, and a factor rate of 1.3, you would multiply those two numbers together for a total of $13,000. The factor rate calculates a flat fee and it does not grow over time.

Photo credit: iStock/FG Trade Latin

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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A business plan is a must-have for any company, no matter how long it has existed.

A three-year business plan gives you a healthy timeframe to work with. It’s long enough to let you develop robust strategies and revenue estimates, but it’s not so far out that your projections aren’t based on quality data.

Learn how to create a business plan structure that is easy to craft while also able to serve as a compelling resource for anyone interested in your company’s overall strategy — especially lenders and investors.

Why Should You Write a Business Plan?

Taking the time to write a thoughtful business plan can help you get a firm understanding of where you’re taking the company and how you’re going to get there. Without a plan, it can be easy to be pulled in many directions, especially if you’re a new small business. Use your business plan as a reference for how to prioritize in order to best meet your goals.

Measure Progress and Goals

A business plan serves as a roadmap that outlines your business’s objectives, strategies, and timelines, providing clear benchmarks to measure progress and goals. By setting specific, measurable targets, such as revenue milestones, customer acquisition numbers, or market expansion timelines, you can track your progress regularly.

Recommended: Getting a Million Dollar Business Loan

What to Include in a 3-Year Business Plan

Here are the key things to make sure you do in your three-year business plan.

Describe Your Business

This section is often called an executive summary. It should outline the goods or services you plan to provide.

This is also where you should state where and how you plan to sell your product, and whether it’s an online or a brick-and-mortar store.

Another important component of this section is your differentiator. Are you marketing to a specific audience? Are you selling a product that’s new to market? Investors and lenders want to know how you plan to outperform your competition.

This is also where you can talk about where your company is today and where you plan to be in the next few years.

Define Your Goals

Once you outline the structure of your business, it’s time to set goals for the next three years.

Revenue is a frequently used metric here. Provide a year-by-year estimate of expected revenue growth based on your specific company and the broader industry.

Gross margin is another important goal to consider, especially since your expenses may grow as your revenue increases.

All of this information helps you figure out how to calculate cash flow and prepare for any upcoming financing needs to meet these goals.

Depending on your business structure, here are some other goals that might make sense to include in your three-year business plan:

•  Number of new and repeat customers

•  Net profit

•  Net income

•  EBITDA

•  Locations

•  Product line revenue

•  Sales closing ratios

•  Market share

Analyze Your Potential Market

In order for your new small business to be competitive, you need to understand the market you’re entering. If you have a more established business, a market analysis helps you figure out where you currently stand.

In this section, you can explain the size of your industry, as well as growth projections and current trends.

Also, research your target audience to determine its size and buying habits. You should also perform an in-depth analysis of your competition to identify their strengths and weaknesses.

Explain Your Marketing Plan

Your three-year business plan outline should include a clear strategy for your marketing efforts.

Describe any advertising or promotions you plan to do, whether it’s through online, print, TV, or radio media. Also include the costs involved and the reach you expect to gain with your target audience.

A key part of your marketing strategy should be a calendar outlining your campaign schedule. Creating that calendar gives you the chance to think about the upcoming seasonal flow of your business. It’s also helpful for lenders to see that you’re thinking ahead, in case you need to get a business loan in the future.

Recommended: What You Should Know About Short-Term Business Loans

Estimate Costs and Revenues

As you nail down the details of your business operations and marketing strategy, it’s also important to estimate your costs and revenues.

Figure out your business’s current amount of capital, whether from a business loan, investor capital, early earnings, or your own personal money.

Then, calculate the costs of business activities you outlined in the sections above. Find a conservative balance between inventory and customer demand.

Or, if you’re a service-based business, figure out how quickly you can scale your workforce size to meet your customers’ needs.

Lenders and investors also want to see your customer acquisition cost, which accounts for the expenses involved in your marketing strategy.

Example of a 3-Year Business Plan

Start your business plan by covering each of the previous sections under its own heading. Then you can write your strategy in narrative form and input graphs and tables, as appropriate.

You can also create a timeline using this three-year business plan template example:

Year 1 Plan

Describe Your Business: Launch a new e-commerce platform specializing in eco-friendly home products. The business will cater to environmentally conscious consumers looking for sustainable alternatives.

Define Your Goals: Establish a solid online presence, acquire the first 1,000 customers, and achieve break-even by the end of the year.

Analyze Your Potential Market: Target market includes individuals aged 25-45 who prioritize sustainability. Market research indicates growing demand for eco-friendly products, with a potential market size of $50 million in the initial region.

Explain Your Marketing Plan: Utilize digital marketing strategies, including social media campaigns, influencer partnerships, and content marketing focused on sustainability. Launch a blog and social media platforms to educate and attract eco-conscious customers.

Estimate Costs and Revenues: Initial setup costs estimated at $100,000, including website development, inventory, and marketing. Projected Year 1 revenue is $200,000 with a break-even point expected by month 10.

Year 2 Plan

Describe Your Business: Expand the product line to include eco-friendly personal care items. Begin exploring international shipping options to reach a broader audience.

Define Your Goals: Double customer base to 2,000, increase revenue by 150%, and enter at least one new international market.

Analyze Your Potential Market: The expanded market includes a broader demographic, with a potential size of $100 million in targeted regions. Market research supports growing international interest in sustainable living products.

Explain Your Marketing Plan: Enhance digital marketing efforts, introduce targeted ads for international customers, and collaborate with international influencers. Launch email campaigns promoting the expanded product line.

Estimate Costs and Revenues: Estimated costs for expansion and marketing: $150,000. Projected Year 2 revenue is $500,000, with a significant increase in profit margins due to economies of scale.

Year 3 Plan

Describe Your Business: Solidify market position as a leading provider of eco-friendly products with a diverse product range and global customer base.

Define Your Goals: Achieve market leadership in the niche, triple the customer base to 6,000, and reach $1 million in revenue.

Analyze Your Potential Market: The global market for eco-friendly products is rapidly growing, with an estimated market size of $500 million. The business will focus on maintaining a competitive edge through innovation and customer loyalty.

Explain Your Marketing Plan: Expand marketing to include global campaigns, partnerships with major eco-friendly brands, and participation in international trade shows. Continue to invest in content marketing and customer engagement.

Estimate Costs and Revenues: Estimated costs: $200,000 for global marketing and operational scaling. Projected Year 3 revenue is $1 million, with substantial profitability and strong financial stability for future growth.

The Takeaway

A three-year business plan will require some effort, but thinking it through can give you some clarity on what you want from your small business and how you can best achieve it. And it can help your company in several ways, from giving you clear objectives to attracting external funding.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Why write a business plan?

A business plan keeps you organized and focused when you’re growing your company. The process allows you to set goals and milestones, along with providing plans for actually reaching them. It’s also an essential part of any type of small business financing application, which can help build your business credit.

What should you include in a 3-year business plan?

There are five core components to include in your 3-year business plan: business description, goals, market analysis, marketing strategy, and cost and revenue estimate.

How do I describe my business?

Start by defining what your business plans to sell, whether it’s a product or a service. Then directly state what makes your business stand out from the competition.

How do I write an executive summary?

An executive summary is the description of your company and your products and services. It also includes high-level information on your target audience and financials. Positioned at the beginning of your three-year business plan, your executive summary is meant to encourage the reader to learn more and keep reading about your business.

Photo credit: iStock/cagkansayin

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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