SoFi

Grants can give your business an injection of working capital when you need it the most. And, unlike loans, the money does not need to be repaid. However, in most cases, grants are taxable income for a business. It’s important to understand the terms and conditions of any grant program you apply for so that your company is financially prepared come tax season.

Read on for a closer look at how business grants work, how to find and apply for one, plus tips for doing your taxes if you receive one.

What Are Business Grants?

A business grant is a lump sum of money given to a small business for either a specific purpose or to help cover general operating expenses in order to help that business succeed. Business grants are offered by government agencies, nonprofit organizations, and private businesses. Depending on the program, you could receive anywhere from a few hundred dollars to hundreds of thousands of dollars.

Small business grants can be helpful for all types of small businesses, particularly those that are just getting off the ground and may not qualify for traditional types of financing, such as small business loans.

How Business Grants Work

Business grants often become available when a government agency, nonprofit organization, or corporation decides to set aside money for a particular area of interest or concern. Their focus might be helping minority- or women-owned businesses, promoting research and development in a specific industry, or bringing more businesses into an underserved community. Whatever their concern, the organization, agency, or business will then start a grant program by putting money aside and establishing qualifications and an application process.

Grants differ from small business loans in that they typically don’t have to be repaid. However, that doesn’t mean there are absolutely no strings attached. Often, the grantor will have strict reporting requirements to make sure you adhere to the terms of the funding. For example, if you received a grant to develop a specific product or achieve a specific goal, you will likely need to provide paperwork to show that you are indeed using the money for this purpose.

Types of Business Grants

Just as there are many types of business loans offered by a variety of lenders, there are also different types of small business grants offered by various entities. Here are some of the most common types of business grants.

•  Federal business grants: These are offered by federal government agencies, including the U.S. Small Business Administration (SBA), to businesses that benefit the public or focus on certain areas of research and development.

•  State and local government grants: Many small business grants are offered at the state and local government level. States often provide grants to businesses that can help further their economic goals, such as child care centers or companies that are developing alternative sources of energy.

•  Startup grants: This type of grant is designed to provide the seed funding for a company that is just getting off the ground.

•  Grants for women- and minority-owned businesses: Some organizations offer grants specifically to help underserved groups, such as women and minorities, start or grow their own businesses.

•  Grants for veterans: There are a number of grants available specifically to assist business owners who are currently serving or have served in the U.S. military.

How to Get Business Grants

The first step to getting a small business grant is to do some research to find a grant your business qualifies for.

A good place to start your search is the federal government’s grant directory at Grants.gov. You can also check the SBA’s website at www.sba.gov (which offers a loans and grants search tool), along with your state’s official web page. If you are a woman, you may want to look into the Amber Grant. If you are a veteran, it can be worth looking into grants offered through the military.

Before you apply for a small business grant, you’ll want to make sure you meet all of the qualification requirements. Business grants are competitive and the application process can be labor-intensive. You don’t want to invest a lot of effort into a grant you aren’t likely to get. Also take note of deadlines to make sure the date hasn’t passed and you’ll have enough time to put together your application.

If you find a grant that fits the bill, the next step is to fill out the application and supply any other requested information or financial records. Take note of when the application period closes and when winners will be selected.

If you’re selected to receive a grant, the grantor will notify you about your funding along with the details about the process for reporting your use of the funds. Once you’ve agreed to the terms, you will receive the proceeds of the grant.

Are Grants to Businesses Taxable?

Typically, yes. Unless your company or the grant meets specific exemption requirements, any funds received as a grant counts as income. This applies to federal taxes and typically state taxes, as well. You will need to report any grant funds you’ve received as part of your business income for that tax year. Depending on your deductions, you may need to pay taxes on the funds.

Recommended: Is Business Loan Interest Tax Deductible?

Which Business Grants Are Not Taxable?

Business grants are not taxable in all situations. Exceptions include:

•  Nonprofit recipients: Not-for-profit businesses are usually considered tax-exempt under the 501(c)(3) section of the IRS code. Consequently, a grant would typically be considered nontaxable income if the purposes are relevant to the nonprofit’s mission.

•  COVID-19 relief grants: Two government grant programs related to pandemic are not taxable — the Shuttered Venues Grant and the COVID-19 EIDL.

•  Grants made by a federally recognized Indian tribe: If a grant is made by the government of a federally recognized Indian tribe to a member to expand an Indian-owned business on or near reservations, the grant is generally not taxable.

Business Grant Tax Tips

If you’re trying to determine whether or not small business grants are taxable, here are some tips that can help ensure you’re not caught with an unexpected tax bill.

•  Ask questions before (and after) receiving the grant. Read the terms and conditions of your grant agreement carefully (it may outline your tax obligations) and ask any questions you have. Understanding your tax liability can help you determine how much of the funding is available to use.

•  Set aside some grant money for taxes. Before you spend all of the proceeds from a business grant, it’s wise to set aside the amount you will likely owe in taxes. Typically, grant funds will be taxed at the same rate as any other business income.

•  Include grants in estimated taxes. If you pay quarterly estimated taxes, you’ll want to include any grant funds you received during that quarter when estimating how much you owe in taxes for that quarter.

•  Keep good records. If you received a government grant that is not considered taxable income, it’s important to keep records showing how the funds were spent in the event of an audit by the Internal Revenue Service (IRS).

•  Consult a tax professional. It can be a good idea to use a small business tax consultant to help with your taxes and review grant paperwork.

State and Local Tax Laws

While state tax laws vary, you may also have to report grant funds as income on your state tax returns. To help businesses understand their state tax obligations, some states have economic development corporations or agencies whose websites include tax guidelines for small businesses. You may also want to check your state’s Department of Revenue website.

Recommended: Grants for Georgia Small Business

The Takeaway

Grants can be a huge help for small businesses in any growth stage. And, while they are essentially free money, grant funds are still counted as business income in most instances. If you are able to secure grant funding, it can be a good idea to set aside some of that money to cover your federal and state tax obligations. Grants are typically taxed at the same rate as any other business income.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

Are all business grants taxable?

Most are. Exceptions include certain government relief grants, grants by and for federally recognized Indian tribes, and nonprofit recipients of grant funds.

How can you estimate taxes for a business grant?

A business grant is generally taxed at the same rate as any other business income. You can estimate how much tax you’ll owe by applying your usual tax rate.

Are there any downsides to accepting business grants?

While business grants are essentially free money, there are a couple of downsides to accepting a business grant. For starters, you may need to use the money for a specific purpose. You also may need to adhere to specific reporting requirements to prove that you are using the grant for its intended purpose. Also keep in mind that, unless you run a nonprofit business, you will typically need to pay taxes on any grant proceeds you receive.

Photo credit: iStock/Weekend Images Inc.

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.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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.

SOSB-Q224-1863252-V1

Both the U.S. prime rate and LIBOR are benchmark interest rates that play a role in what banks charge their customers for loans. However, there are some key differences between these two indexes.

The prime rate is set by each bank and is tied to the U.S. Federal Funds Rate. While the prime rate is variable, it may remain fixed for long periods of time. LIBOR (London Interbank Offered Rate), on the other hand, is an interest rate average based on what leading banks in London say they would charge for a short-term interbank loan. LIBOR changes daily and reacts to current market events.

Another key difference: Prime rate isn’t going anywhere, but LIBOR is now being phased out and will eventually be replaced by SOFR (Secured Overnight Financing Rate) in the U.S.

In the meantime, here’s what you need to know about LIBOR vs. prime rate, how these rates are set, and how they affect the cost of borrowing for consumers and small businesses.

What Is LIBOR?

LIBOR has long been a key benchmark for setting the interest rates charged on adjustable rate loans, mortgages, and corporate debt. One reason for its popularity is that LIBOR makes it easy to calculate rates for upcoming dates. You can get a LIBOR rate for an overnight short-term loan, or you can get a rate for 365 days from now.

However, due to numerous scandals and questions around its validity as a benchmark rate, the U.S. has largely shifted away from using LIBOR. Therefore, within the U.S. market, it’s no longer a case of LIBOR vs. prime rate, since there are very few scenarios where U.S. banks are allowed to use LIBOR. By September 2024, LIBOR will be fully phased out and replaced by SOFR.

Recommended: GAAS vs GAAP

How LIBOR Is Calculated

Every day, the Intercontinental Exchange (ICE) asks roughly 18 global banks at what rate they would charge for a loan in a specific currency and a specific maturity. Those currencies include:

•  Euro

•  Japanese yen

•  Pound sterling

•  Swiss franc

•  U.S. Dollar

For each currency, the top 25% and the bottom 25% are removed. The remaining rates are averaged. This is done for each maturity, which includes:

•  Overnight

•  One week

•  One month

•  Two months

•  Three months

•  Six months

•  One year

In total, there are 35 LIBOR rates published everyday. This is one of the biggest differences between prime rate vs. LIBOR. LIBOR is calculated daily and for multiple currencies, while prime rate is not.

Recommended: What Is Funds From Operation?

What LIBOR Is Used For

Lenders, including banks and other financial institutions, have used LIBOR as the benchmark reference for determining interest rates for various debt instruments, including mortgages, corporate loans, government bonds, credit cards, and student loans.

Apart from debt instruments, LIBOR has also been used for other financial products like derivatives, including interest rate swaps or currency swaps.

Though LIBOR will no longer be used for loans in the U.S., it hasn’t fully disappeared yet and will continue to be published until September 2024. Some loans may hang on to it as their benchmark until that time.

What Is Prime Rate?

Prime rate is the rate banks give to their best, most creditworthy corporate customers. However, it’s not the rate most businesses will pay. The rate a bank would quote you for most types of small business loans will simply be based on the prime rate. The prime rate is also used to set rates for credit cards, mortgages, and personal loans.

When comparing business loan rates, you might come across lenders that express the terms of a loan as “prime plus” a certain percentage. The percentage that gets added to prime will depend on the borrower’s credit rating and other factors.

How Prime Rate Is Calculated

The prime rate is tied to the Effective Federal Funds Rate, which is the target for the interest rate banks charge each other for short-term loans. The federal funds rate is established by the Federal Reserve and is based on the economy’s current conditions. Banks generally add 3% to whatever the federal funds rate is. Therefore, if the federal funds rate is 2%, then the prime rate would likely be 5%.

However, there isn’t any single prime rate. Each bank sets its own prime rate that it charges its best customers. But because banks want to remain competitive with one another, many will actually adopt the same or very similar prime rate.

You may have also heard of the WSJ Prime Rate. In a similar fashion to LIBOR, each day the Wall Street Journal asks the largest banks within the U.S. what rate they would charge for a short-term loan to their most qualified customers. When 70% of the banks change, WSJ Prime Rate changes too.

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

What Prime Rate Is Used For

Prime rate is used as a benchmark when establishing rates for many loan products. These loan products may include:

•  Credit cards

•  Small business loans

•  Auto loans

•  Mortgages

•  Personal loans

•  Student loans

The prime rate is the starting point for establishing what rate a customer will receive when taking out a loan. However, many things affect what rate a borrower will get. Credit scores, income, debt-to-income ratio, collateral, fixed interest vs. variable interest, and maturity also play key roles in determining how much a person or business will ultimately pay for a loan.

Recommended: Refinancing Your Student Loans While Starting a Business

Differences and Similarities Between LIBOR and Prime Rate

There are some similarities between prime rate and LIBOR, as well as some key differences.

Similarities

•  Both rates are used as reference points for lending transactions.

•  Both are based on surveys given to large banks asking them at what rate they would lend.

•  Both tend to move in the same direction as the federal funds rate.

Differences

•  Prime rate is a reactive rate. It only moves after the federal funds rate has changed.

•  LIBOR is an anticipatory rate. It moves in anticipation of economic conditions.

•  LIBOR is used by 5 different currencies, with 7 different maturities.

•  In the U.S., commercial banks may each have their own “prime rate” that they issue to their most qualified and best borrowers.

•  LIBOR is published by the ICE.

The most quoted prime rate is published by the Wall Street Journal (WSJ).

Pros and Cons of LIBOR

Pros and Cons of Prime Rate

Recommended: Business Cash Management, Explained

The Takeaway

Both prime rate and LIBOR act as benchmark interest rates. However, LIBOR can be used to calculate future loans because it’s the rate that banks expect they’ll lend at in the coming weeks and months. Prime rate, on the other hand, only represents the going rate.

Prime vs. LIBOR was once a talking point among lenders, but since the end of 2021, LIBOR has been steadily phasing out. While still used in some situations, the U.S. has switched to SOFR.

As a borrower, a benchmark rate, like prime or LIBOR, is only one of many factors that go into determining the interest rate you’ll pay for a loan. If you’re applying for a small business loan, lenders will also look at your credit scores, time in business, annual revenue, and collateral when determining your rate.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

How is prime rate and interest rate different?

A bank’s prime rate is the rate it charges its most qualified corporate customers, who are highly unlikely to ever default on a loan. An interest rate is the rate a bank will charge other businesses and consumers for loans.

What does LIBOR stand for?

LIBOR stands for the London Interbank Offered Rate.

Why do U.S. banks use LIBOR?

U.S. banks used LIBOR (London Interbank Offered Rate) as a benchmark because of its global popularity and adaptability in setting the rates for future loans. However, due to its role in numerous scandals, LIBOR has since been replaced with SOFR (Secured Overnight Financing Rate) in the U.S.

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.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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.

SOSB-Q224-1860176-V1

Starting or expanding a hotel or motel can be an expensive proposition. You may be looking to purchase property, renovate or remodel an existing structure, add a restaurant, hire staff, market your business, and more.

Fortunately, there are a number of different types of small business loans designed specifically for aspiring hoteliers, including conventions loans, acquisition loans, bridge loans, and low-interest SBA loans. Read on to learn how to find the right type of financing for your hospitality business.

What Are Motel and Hotel Loans?

A motel or hotel business loan refers to a type of commercial financing product designed to help businesses in the hospitality industry. These loans can be used for the purposes of building, acquiring, refinancing, or gaining working capital for a hotel, motel, resort, bed & breakfast, or RV park.

How Do Hotel Loans Work?

Many types of lenders offer hotel and motel loans, including banks, credit unions, private lenders, and alternative lenders. Bank and government-backed hotel loans typically have stricter lending criteria but charge lower interest rates, while private and alternative lenders tend to offer quick and easy approval, but come with higher financing rates.

The precise terms of a hotel loan will depend on the lender and type of loan. Hospitality financing often requires a downpayment of at least 10% to 15% of the loan amount and/or collateral in order to secure the loan. In some cases, the hotel property itself serves as collateral for the loan. There are also financing options that involve giving a company shares in the hotel in exchange for capital.

Times When a Hotel Loan Can Be a Good Idea

A hotel loan can be a good idea in a variety of situations, including:

•  The purchase of an existing hotel property

•  New construction

•  Refinancing an existing hotel loan

•  Funding operational expenses

•  Relocating

•  Remodeling

•  Hiring additional staff

•  Purchasing new hospitality equipment

•  Getting hotel bridge financing until permanent financing becomes available

•  Positioning the property for profitability

•  Stabilizing a distressed property

Common Types of Loans for Hotels

There are a variety of hotel and motel loans available. Here are some options you may want to consider.

Hotel Construction Loans

If your dream is to build a new hotel or motel, then a hotel construction loan can help get the wheels moving. Loan terms vary lender to lender, but it’s often possible for a construction loan to transition to a hotel commercial loan once the building is complete.

Hard Money Loans for Hotels

Hard money loans for hotels and motels are not offered by traditional lenders, but instead by individuals or private companies that accept property or an asset as collateral. Hard money loans typically involve minimal paperwork and fast funding, making them ideal if you need to make a hotel purchase happen fairly quickly. However, these loans generally come with higher interest rates than conventional hotel loans and shorter loan terms (often just a few years).

Hotel Bridge Loans

Hotel bridge loans fill in cash gaps between getting a new mortgage and obtaining a new asset or selling an older asset or piece of real estate. Bridge loans are particularly useful when building or acquiring a hotel. They can also be useful as a financial safety net during periods of slow cash flow or while waiting on another lender to close on their financing.

Conventional Loans

Also known as a classic loan, this type of financing is offered by conventional lenders like banks, savings institutions, and credit unions. Conventional loans typically come with a fixed interest rate and set repayment term. They can be used for hotel improvement projects, like buying hospitality equipment, hiring more employees, and hotel renovations.

Unlike loans backed by the Small Business Administration (SBA), conventional loans are not insured by the federal government. Consequently, they can be more difficult to qualify for. However, if you have a strong credit score, a conventional loan often comes with low rates and attractive loan terms for borrowers.

Recommended: Business Loans for Cafes

Permanent Loans

This type of financing is designed for entrepreneurs who want to build a hotel from the ground up. Permanent loans typically start out as hotel construction financing, then once the building is complete, get converted into a mortgage. Permanent loans save you from applying and qualifying for two separate loans and working with more than one lender.

Preferred Equity

With preferred equity financing, a private company extends credit to the hotel owner in exchange for preferred shares in the hotel. This puts the financing company in a priority position for repayment from any cash flow or profit earned from the hotel. Preferred equity financing is often used for securing the last mile of funding a bank didn’t offer for purchasing commercial real estate.

Mezzanine

Mezzanine financing is a hybrid of debt and equity financing that gives the lender the right to convert the debt to an equity interest in the hotel in case of default. Mezzanine financing can allow you to achieve goals that require capital beyond what a lender will extend. However, this type of financing typically comes with a higher interest rate than other types of hotel loans.

Fully Amortized

Amortization refers to the amount of principal and interest you pay each month over the life of the loan. Near the beginning of a loan, most of your payment goes toward interest. Over the course of your loan term, the ratio gradually tips the other way until nearly almost your entire payment goes toward paying off the principal. A fully amortized loan is a loan that, if you make every payment on time according to your loan schedule, the loan will be completely paid off by a specific date.

Acquisition Loans

An acquisition loan is a loan for purchasing a hotel asset or an existing hotel. This type of financing often comes with favorable rates and terms because the asset/business being purchased has tangible value and can be used as collateral for the loan. Acquisition loans must be used within the allotted time period and only for the purpose specified at the time of application.

SBA Loans for Hotels

SBA hotel loans are loans backed by the U.S. Small Business Administration (SBA). The SBA itself does not provide the financing but, rather, works in partnership with approved lending partners — including local and national banks as well as non-bank lenders and nonprofits — to guarantee a large portion of the loan’s proceeds in the event that the borrower defaults.

Because this reduces the risk to the lender, SBA loans offer borrowers low rates and attractive terms. However, the application process is extensive and borrowers must meet fairly strict qualifications in order to get approved.

SBA 7(a)

The most common type of SBA loan, the SBA 7(a) loan, can be an excellent choice for hotel financing because it comes with low interest rates, long repayment terms, and loan amounts up to $5 million. An SBA 7(a) loan can be used for a variety of hotel financing needs, including purchasing real estate, working capital, buying hotel equipment, renovation, construction, and more.

SBA 504/CDC

The SBA 504/CDC loan combines a loan from a non-profit Community Development Corporation (CDC) with a loan from a bank lender to create a long-term, low-interest loan. Because this type of loan is connected with community development, it can be more easily accessible to hotel borrowers who may otherwise struggle to obtain an SBA hotel loan.

Pros and Cons of SBA Loans

Pros and Cons of Hotel Loans

Getting a Hotel Loan

Whatever type of hotel or motel financing you’re looking to get, there are several steps involved in applying for and getting a small business loan. Here’s what you need to know.

Finding Out How Much of a Loan and What Kind You Need

The first step in finding a loan is to determine exactly how much financing you need. If you’re purchasing property or an existing hotel, you’ll need to first determine its value. Private lenders may offer 60% to 75% of that value, while SBA lenders will often provide 90% of the value. Consider how much of a downpayment you will be able to come up with, as well as what size loan payments you will be able to make each month.

You also need to consider the type of loan you may be able to qualify for. For an SBA loan, you’ll need a strong business or personal credit profile. For a hotel acquisition or new construction, where you don’t have an existing business with credit and revenue history to share, your personal credit history will be a major factor in the SBA’s decision. If you have less-than-excellent credit, you may want to consider a hotel loan from a private or alternative lender.

Recommended: Liquor Store Loans Explained

Gathering Important Documents

The documents needed to apply for a hotel loan will depend on the lender and type of loan, but may include the following.

Borrower information:

•  Driver’s license

•  Three years of tax returns

•  Most recent mortgage statement for any real estate owned

•  Bank statements

•  Life insurance if there is a cash surrender value

•  IRA/401(k) information

Hotel information:

•  Hotel specifications

•  Number of rooms

•  Amount of floors

•  Number of buildings on property

•  Year built

•  Square footage

•  Building acreage

•  Last mortgage statement

•  Profit and loss balance sheet

•  Three years of tax returns

•  Most recent quality inspection report

•  Latest property improvement plan

•  Copy of all business contracts

•  Capital expenditure

•  Survey report

•  Most recent appraisal

•  Customer occupancy rate

Comparing Lenders and Rates

When comparing lenders and rates, make sure to pay attention to not only a company’s interest rates, but also its fees. The easiest way to compare loans is to look at the loans’ annual percentage rate (APR), which includes the loan interest rate, plus all fees associated with your loan, including origination fees and interest.

Recommended: Business Loan Uses

Applying

Before you jump in and make your dream of owning your own hotel a reality, make sure you have everything in place before you begin. Selecting a business structure, for example, should be done well in advance of applying for any business loan, particularly if your goal is to keep your personal assets protected.

In addition to gathering all the necessary documents, you will also likely need to create a business plan. You may also need to provide a hotel loan request letter in which you specify the loan amount you’re asking for and describe how you’ll use the funds. When filling out a loan application, be sure to follow the loan application directions to the letter to avoid delays.

The Takeaway

If you’re looking to buy or expand a hotel or other type of hospitality business, lack of funding shouldn’t stand in your way. Finding the right hotel or motel loan at the right price, however, can take a fair amount of time and legwork.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

Can you get a loan to open a hotel?

Yes, there are many loan options to help new business owners open a hotel, including acquisition loans and loans backed by the Small Business Association (SBA).

What is the down payment required for a hotel?

If you’re purchasing a hotel, you will typically need to put down at least 20% in order to secure financing.

What is a hospitality loan?

Hospitality loans are the same as hotel or motel loans, which means they are loans designed for businesses that can be described as either an inn, bed and breakfast, hostel, motel, or hotel.

Photo credit: iStock/Chadchai Krisadapong

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.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

SOSB-Q224-1871636-V1

Organic growth occurs when a firm expands its operations using existing resources, rather than by merging with or acquiring another company. Achieving organic business growth generally means that a company has successfully been able to boost its size, output, or revenue by growing the business or developing a new one. This is in contrast to inorganic growth, which occurs through the acquisition of other companies.

There are pros and cons to both growth strategies. Here’s a closer look at organic growth, including how it works, how it compares to inorganic growth, plus strategies that can help you expand your small business through organic growth.

What Is Organic Growth in Business?

By definition, organic growth is growth that a firm achieves from within by harnessing internal resources. To attain this type of growth, a business typically needs to have a well-thought-out business plan and strong leadership.

Strategies business owners often use to foster business expansion through organic growth include optimizing processes to reduce costs, improving their existing product/service mix, enhancing their sales and marketing strategies, expanding into new markets, and developing new products and services.

Recommended: What Is a Silent Partner Agreement?

How Does Organic Growth Work?

Organic growth works by making the most of a firm’s existing assets and resources, including skills, knowledge, experience, relationships, and other tools. Often, it comes down to thinking creatively about how best to leverage what you own and how you do business. Some business owners prefer to grow their businesses via organic rather than inorganic growth because it allows them to maintain control of their company (which might not be the case with a merger or acquisition).

It can sometimes be challenging, however, to achieve rapid growth through internal growth strategies alone. For example, if your company needs to pivot quickly due to a sudden change in consumer preferences, it might take more time and money to launch a new product line yourself rather than acquire a company that already has that product.

Inorganic vs Organic Growth

Here are some of the key ways that organic growth differs from inorganic:

Organic growth happens when a firm uses inside opportunities to grow. Inorganic growth, on the other hand, involves using resources outside of the company, such as taking on debt and engaging in mergers and acquisitions.

While inorganic growth typically involves taking out small business loans, it can allow for faster expansion than organic growth. Organic growth, by contrast, tends to occur slowly and naturally. It relies on internal skills and resources, and may not require taking on any debt.

Investment Analysis

When investors and lenders analyze a company’s financial health, they generally like to see growth of any kind. However, how a company achieves growth may also come into play. If a business grows inorganically through a merger or acquisition, for example, analysts may want to make sure that the company they acquired made sense and is related to their core business and that they aren’t stretching themselves too thin.

Generally, analysts like to see a mix of organic and inorganic growth strategies. A company that is generating growth by maximizing their core business, while also boosting revenue through strategic acquisitions, may find it easier to attract investors or get approved for different types of financing.

Pros and Cons of Organic Growth

Here’s a closer look at the advantages and disadvantages of organic growth:

Pros and Cons of Inorganic Growth

Next, consider the upsides and downsides of inorganic growth:

Measuring Organic Growth

You can measure organic growth by looking at your company’s key financial statements — the income statement, balance sheet, and cash flow statement.

The income statement shows your company’s profit (or loss) for a specific time period. The balance sheet provides a snapshot of your business’s financial health, measuring how much you owe and own at a specific point in time. And, the cash flow statement sums up the amount of cash that enters and leaves your business.

Generally, if your profits are growing year over year, that’s a sign that you are experiencing organic growth.

Organic Growth Strategies

There are numerous strategies a small business can use to foster organic growth. Here are some to consider.

•  Investing into existing products or services

•  Developing new products or services through research and development (R&D)

•  Enhancing your sales and marketing strategies

•  Targeting customer profiles and pricing structure

•  Launching a rebranding initiative

•  Restructuring the organization and its processes

•  Cutting costs

Recommended: How Much Does It Cost to Start a Business

Inorganic Growth Examples

Here’s a look at some common ways that businesses can achieve inorganic growth.

•  Combining with a similar company to increase market share

•  Acquiring a company that has products, services, and/or a customer base that your company wants to have

•  Merging with a dissimilar company to create a conglomerate

•  Opening in a new location to bring in customers in a geographical area where you’re not currently represented

The Takeaway

Organic growth refers to the growth of a business through internal processes, utilizing its own resources. Businesses often grow organically by optimizing processes, reallocating resources, and adding new products or services. It contrasts from inorganic growth, which is often accomplished through dealmaking to acquire other companies and products. Either approach may involve outside financing. However, inorganic growth generally requires significantly more capital than organic growth.

If you’re looking to finance business growth, you likely have an array of options.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

What are some examples of organic growth?

Examples of organic growth strategies include investing into existing products and services, developing new products and services, reallocating resources, making improvements to your business model, and adjusting pricing.

Is getting organic growth harder than inorganic?

It can be. Organic growth in business requires thinking about existing assets and resources in new ways, and it may be some time before you reap any rewards. Growing inorganically through a merger or acquisition, however, also comes with challenges. It requires a large amount of capital, can be time-consuming, and, by merging workforces, can lead to friction.

Is organic growth better than inorganic growth?

There’s no one answer since each growth strategy has pros and cons. Organic growth offers a steady and predictable path towards growth, and allows you to retain control of your business. However, it requires a lot of time and effort, and has the potential to stagnate. Also, it may not be the right choice if you need to pivot quickly to keep up with changing market demands.

Photo credit: iStock/oatawa

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.

SOSB-Q224-1880426-V1

A merchant cash advance (MCA) is an option for small businesses to consider when seeking funding. While they are legal, they have their benefits and disadvantages, as do most forms of financing. As with all financial decisions, choosing whether to use one should involve considering both pros and cons.

How Do Merchant Cash Advances Work?

At a high level, here’s how merchant cash advances work. An MCA is a type of financing for small businesses (also known as “merchants”) that accept credit card/debit card payments from their customers. When a small business applies for and is approved for this type of financing arrangement, it can get funds advanced from merchant cash advance companies.

The small business then usually repays the advance in one of two ways.

•  The cash advance company could take an agreed-upon percent of the small business’s credit card and debit card sales revenue each day.

•  Alternatively, it could directly withdraw funds from the merchant’s bank account on an agreed-upon schedule through an ACH transfer.

MCA providers may also accept other repayment arrangements stemming from your credit card and debit card sales revenue.

Rather than charging an interest rate, this type of funding has a factor rate — often ranging from 1.1 to 1.5. Unlike interest rates, which are given as percentages, a factor rate is expressed as a decimal figure. The factor rate is then used to calculate the cost of financing for the small business borrowing the funds.

The rate a company is charged can depend upon how much of a risk it poses to the lender. Factors considered when setting a rate can include the industry the company is in, the company’s financial history, its credit and debit card sales, and its years in business. To calculate the amount owed, you multiply the advance by the rate. For example, consider a $10,000 advance at a 1.4 factor rate. That’s $10,000 x 1.4 = $14,000. This would not include any fees charged.

Next, consider the regulations that affect MCAs.

Merchant Cash Advance Regulation Overview

MCA regulation is generally not as stringent as small business loan regulation, but regulations do exist.

The Federal Trade Commission (FTC), for example, has the authority to sue merchant cash advance providers that engage in deceptive or predatory lending practices.

Here are some of the federal laws that merchant cash advance providers are expected to abide by:

•  Federal Trade Commission Act (FTCA)

•  Gramm-Leach-Bliley Act (GLBA)

•  Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act

The FTCA has provisions that prohibit unfair and deceptive trade practices. The GLBA, meanwhile, has provisions that prohibit creditors from making false statements to obtain a customer’s bank account information. These laws apply to MCA providers.

Section 1071 of the Dodd-Frank Act requires covered financial institutions — including merchant cash advance providers — to collect and report to the Consumer Financial Protection Bureau (CFPB) data on small business applications for credit.

State usury laws may not apply against merchant cash advance providers, but some states as of 2023 have implemented regulations affecting nonbank financial companies. New York and California, for example, have state laws requiring MCA providers and other nonbank lenders to provide disclosures similar to those required under the Truth in Lending Act.

Any merchant cash advance provider that engages in unfair or deceptive trade practices can be subjected to compensatory damages, civil penalties, and a permanent injunction from marketing, selling, or collecting merchant cash advances.

UCC Regulations

Companies offering merchant cash advances typically conduct business under the Uniform Commercial Code (UCC).

The UCC isn’t a federal law. Rather, it’s a collection of proposed model laws covering the conduct of business and commercial contracts. All 50 U.S. states have adopted the entire UCC, with the exception of Louisiana, which only adopted parts of it, according to the Louisiana Department of State.

When you sign your merchant cash advance funding agreement, the MCA provider may file a UCC lien in your state. This lien becomes a public record documenting how the MCA provider has a security interest in your business assets as collateral on the debt.

If you default, the MCA provider may take action to seize the assets. Alternatively, if you pay off your MCA and the provider does not remove the lien, you generally have the right to get it removed under UCC regulations.

Recommended: Merchant Cash Advance Consolidation

Self-Regulation

Some merchant cash advance companies may agree to abide by the Small Business Borrowers’ Bill of Rights. The Responsible Business Lending Coalition pioneered the creation of the Small Business Borrowers’ Bill of Rights, and elements of it include:

•  The right to transparent pricing and terms

•  The right to nonabusive products

•  The right to responsible underwriting

•  The right to fair treatment from brokers

•  The right to inclusive credit access

•  The right to fair collection practices

If you decide to obtain funding through an MCA, it may make sense to find out whether the MCA company you’re considering will honor these rights.

What Are Merchant Cash Advance Brokers?

The fourth bullet in the bill of rights described above focuses on brokers. A merchant cash advance broker is someone who connects companies that need financing with funding companies that can provide them with the money they need.

These brokers typically get paid on a commission basis. These commissions and the ways in which MCA brokers treat customers can vary, as implied by the bullet point in the bill of rights. If you decide to use a broker, you may want to choose one recommended by a trusted friend or colleague.

Using Merchant Cash Advance Companies

There are a number of reasons why a small business might want to use an MCA. Small businesses may decide to use an MCA to fill in gaps in cash flow and to cover unexpected expenses. Some might use one to tide over seasonal fluctuations or to buy inventory.

This type of funding may be right for you if you aren’t able to get more traditional forms of funding and need to get a merchant cash advance with bad credit.

In general, merchant cash advance requirements are not complicated. But it’s important to talk to specific MCA providers to find out what’s needed for your small business to begin to receive advances. Not all merchant cash advance companies are alike. Some offer higher limits than others; some are more open to companies with bad credit than others; and so forth.

Private merchant cash advance companies generally have less regulatory requirements than SBA loan lenders. It’s typically a good idea to check out an MCA company you’re considering with your local Better Business Bureau® to see how it rates and whether there are any complaints against it.

Recommended: Personal Business Loans: Risks, Appeals, and Alternatives

Pros and Cons of Merchant Cash Advances

As with just about any kind of small business funding, there are pros and cons to this option. Here are some of the most significant:

Pros of MCAs

•  Advantages of this kind of funding may include:

•  Speedy process from approval to the receipt of funds

•  Uncomplicated paperwork (perhaps just a basic application and a record of recent credit card/debit card transactions)

•  Payment amounts may drop if the amount of sales transactions dips

•  Lack of credit history isn’t typically an obstacle

•  Freedom to use the funds as desired

Cons of MCAs

Disadvantages of this type of funding can include:

•  High cost, with factor rates typically translating into 20% to 50% of the cash advance amount

•  Fees, which can be significant

•  No early repayment benefits

•  Could create debt cycles that can be difficult to escape

•  Automatic payments can complicate cash flow

The Takeaway

A merchant cash advance is a form of business financing for businesses that accept credit cards. Instead of being charged an interest rate, this type of financing involves a factor rate. Some regulations govern this type of cash advance.

Merchant cash advances aren’t the right solution (or even possible) for every business in every given situation. When your small business needs funding, it may help to prepare by knowing how to apply for a small business loan.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

Photo credit: iStock/Natee Meepian

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.

This article is not intended to be legal advice. Please consult an attorney for advice.

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.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

SOSB-Q224-1863299-V1