SoFi

When you start your own business, you may have trouble getting approved for traditional financing because you haven’t been in business very long or haven’t established business credit. Yet you still need capital to launch your business, renovate space, or hire employees.

An unsecured business line of credit for startups may be one option worth considering. Be aware that they usually have higher interest rates because lenders consider them riskier.

Keep reading to learn what an unsecured business line of credit is, pros and cons, and how your startup may be able to qualify for one.

What Is an Unsecured Line of Credit?

An unsecured business line of credit is a flexible form of financing that allows businesses to borrow funds as they need them. Similar to a credit card, you spend what you need (up to your credit limit), pay it back with interest, and are free to use the funds again. Unsecured lines of credit do not require collateral, such as property or equipment.

The credit limit on an unsecured line of credit is determined by the business’s creditworthiness and financial history, with interest charged only on the amount borrowed. Because startups lack an established financial history, lenders typically require strong personal credit scores, a solid business plan, and sometimes a personal guarantee to offset the risk.

Pros and Cons

An unsecured business line of credit may make it easier for startups to access funds for operational needs or growth opportunities. However, like any form of business financing, they come with pros and cons.

Pros of unsecured business lines of credit for startups include:

•  Quick access to cash

•  Interest charged only on the amount borrowed

•  No collateral required

Cons of unsecured business lines of credit for startups include:

•  May need a strong personal credit score

•  Interest rates may be higher due to lack of collateral

•  Credit line may be low

Unsecured vs Secured Business Line of Credit

The difference between secured and unsecured lines of credit is that secured business lines of credit require collateral, whereas unsecured lines do not. Collateral includes property, equipment, or inventory, which backs the loan and reduces the lender’s risk. This often results in lower interest rates, higher credit limits, and more favorable terms.

In contrast, an unsecured business line of credit doesn’t require collateral, making it more accessible for businesses without significant assets.

Recommended: Unsecured Business Loans

Requirements to Qualify

For established businesses, lenders look at credit scores, time in business, and annual revenue to qualify for an unsecured line of credit. However, startups typically do not have established revenue or a lengthy business history.

Because of that, lenders typically require a strong personal credit score since there is no collateral involved. Startups may also need to provide a solid business plan and financial projections to demonstrate the viability of the business.

Some lenders may also require a personal guarantee, meaning the business owner is personally liable for repayment. Additionally, the startup should be legally registered and in good standing, with a clear use for the credit line, such as managing operational costs.

Alternatives to Unsecured Business Line of Credit for Startups

Some startups may find it difficult to qualify for an unsecured line of credit. Here are a few other small business financing options that may be available to startups.

Business Credit Cards

Business credit cards can provide new business owners with needed access to cash. They can also be an important tool to help business owners separate their personal finances from their business finances. Credit card issuers will generally review things like your personal credit score and income. Some options may require collateral or a personal guarantee.

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

SBA Microloans

The U.S. Small Business Administration (SBA) has a microloan program that offers loans up to $50,000 to certain eligible small businesses. These small business microloans can be used to finance things like working capital, inventory, furniture, and machinery or equipment. Other SBA loans may also provide eligible small businesses with funding to meet their needs.

Crowdfunding

There are a variety of crowdfunding platforms online that allow business owners to raise money to support their business. This process allows business owners to raise money for their business without taking on additional debt.

Equipment Financing

Equipment financing helps businesses that are in need of new or used equipment. With this type of loan, the equipment becomes the loan collateral, which means that lending requirements may be less strict than for unsecured loans.

Recommended: Bad Credit Business Loans

An Unsecured Business Line of Credit Can Give You the Boost You Need

Having access to cash when you need it can be tremendously helpful to a startup. It can be used for business growth, managing cash flow, purchasing inventory, covering operational expenses, financing short-term projects, or addressing unexpected costs.

Keep in mind, though, that some lenders will charge more than others — whether that’s in fees, interest, or both — so it’s important to choose a lender that will offer you the best rates and terms for your situation.

Recommended: Business Loan vs. Personal Loan

The Takeaway

An unsecured business line of credit can help you fund and build your venture. The growth of many new businesses depends on their ability to access adequate capital. However, unsecured business lines of credit have higher interest rates and you may have to sign a personal guarantee, meaning you will be responsible for paying if the business fails.

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 an unsecured line of credit for business?

An unsecured line of credit for business is a revolving credit account that a company can access and draw funds from up to a set limit. It’s a commercial lending product that does not require businesses to pledge any assets as collateral.

How do I get a $250,000 unsecured line of credit for my business?

Each lender has a different cap for lines of credit, so look around to find one that offers $250,000 or more, then review the requirements to see if you might qualify.

How do I qualify for an unsecured line of credit for small business?

Requirements vary from one lender to another, but you will likely need to meet eligibility standards like a minimum time in business. Your business may also need to generate strong annual revenues and meet a minimum level of creditworthiness to qualify for an unsecured line of credit.

What banks give out unsecured lines of credit?

Many major banks offer unsecured lines of credit, including Wells Fargo, Bank of America, U.S. Bank, and Citibank. Credit unions and online lenders also offer unsecured lines of credit. It’s always best to shop around to determine who can offer you the best rate and terms for your situation.

Photo credit: iStock/Erdark

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.

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 .

SOSMB-Q324-037

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 has been phased out and 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. In the U.S., LIBOR is currently no longer used to issue new loans.

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.

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: Average Business Loan Interest Rates for 2024

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

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 five different currencies, with seven 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 (Intercontinental Exchange).

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

Secured Overnight Financing Rate (SOFR)

The Secured Overnight Financing Rate (SOFR) was introduced in 2017 to replace LIBOR as a key benchmark for loans, derivatives, and other financial products. It reflects the cost of borrowing cash overnight and is collateralized by U.S. Treasury securities. Unlike LIBOR, which relied on estimates, SOFR is seen as more accurate and less susceptible to manipulation, promoting stability in the financial system.

The transition from LIBOR to SOFR was effective as of July 1, 2023 in certain financial contracts.

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 and the U.S. dollar LIBOR setting has permanently ceased.

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

FAQ

How are 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.

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.

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 .

SOSMB-Q324-036

Once your small business starts earning a profit, you have to decide if you should distribute those profits to yourself (and any other owners) or reinvest them back into the business.

While it can be tempting to pocket your company’s profits, funneling at least some of that money back into the business is worth considering.

For one, reinvesting can help improve the company or expand operations, leading to even higher profits down the line. For another, reinvested money is generally considered a business expense, which means you likely won’t have to pay income taxes on it.

Read on for a closer look at why you may want to reinvest a percentage of your profits back into your business, how this can impact your business taxes, and ways you might use profits to help expedite business growth.

What Constitutes a Business Profit?

Profit is the money a business pulls in after accounting for all expenses. Any profits earned funnel back to business owners, who can choose to either keep it as earnings, distribute it to shareholders as dividends, or reinvest it back into the business.

Whether you own a small dog grooming business or a multinational corporation, the main goal of any business is to earn money. Thus, a business’s performance is based on profitability. For accounting purposes, companies will often report gross profit, operating profit, and net profit (the “bottom line”).

Recommended: How to Read Financial Statements: The Basics

What Are Businesses Taxed On?

Any profits that aren’t reinvested in a business are typically taxed as income. How that tax is paid depends on the structure of the business.

Most small businesses are pass-through entities, which means that the gains or losses are passed through to the owners on their personal income tax returns. Corporations, on the other hand, pay a flat tax on business profits.

Recommended: 10 Steps to Starting a Small Business

Types of Business Taxes

When we refer to “taxes” for a business, we’re actually using an umbrella term for many different types of taxes a business may have to pay. Let’s take a closer look.

Income Taxes

Income taxes are based on the net income of your business for the tax year. Net income is the same thing as profit (income minus expenses). If you share a business with others, the net income is divided among the owners based on your business agreement. Most small businesses pay both federal and state income taxes.

Estimated Taxes

Employees have taxes withheld from their paychecks, but as the owner of your business, no one is withholding taxes from the money you take out of the business.

Instead, you need to file estimated taxes throughout the year based on the income you have earned up to that point in the year. Typically, federal and state estimated tax payments are due on April 15, June 15, September 15, and January 15 for the previous tax year.

Self-Employment Tax

Employees generally have Social Security and Medicare taxes withheld from their paychecks. If you are a self-employed business owner, however, you must calculate and pay your own Medicare and Social Security tax through self-employment taxes.

Excise and Sales Taxes

Depending on which state you operate in and what type of goods or service you sell, you may need to set up a system to collect sales tax from your customers and report and pay that tax to your state.

You may also need to pay federal and local excise taxes. An excise tax is a legislated tax on specific goods or services, such as fuel, tobacco, and alcohol.

Payroll Taxes

If you have employees, you must withhold payroll taxes from their paychecks and pay applicable federal, state, and local taxes. The taxes usually withheld from employee paychecks include FICA (Medicare and Social Security taxes) and federal, state, and local income taxes. Employers and employees each pay half of the FICA tax.

Recommended: 3-Year Business Plan Structure

How to Reduce Taxable Income

As a business owner, there are many strategies you can use to reduce the portion of your business income (or profits) that can be taxed. Here are some you may want to consider.

Reinvesting Business Profits Into the Business

Reinvesting means retaining net profits (the income left over after all operating costs and overhead are paid) and investing them in activities or expenses that can help increase the value of the business. As a business expense, reinvested income generally isn’t taxable.

You may, however, want to reinvest only a portion of your profits and look for other ways to infuse capital into the business, such as applying for a small business loan. Interest paid on business loans is typically tax deductible as a business expense.

Finding Deductions

There are numerous business tax deductions you may qualify for and, when you add them all up, they can amount to a significant reduction in your taxable business income. Here are some of the most common small business deductions:

•  Inventory

•  Business property rent

•  Startup costs

•  Utilities

•  Company vehicle expenses

•  Insurance

•  Rent and depreciation on equipment and machinery

•  Office supplies

•  Furniture

•  Advertising and marketing

•  Business entertainment

•  Travel expenses

•  Interest paid on all types of small business loans

Tax Audits

As a small business owner, it makes financial sense to explore all your options for reducing your tax bill. However, when it comes to deductions, you need to be careful. It’s particularly important, for example, to keep your business and personal expenses separate. If your deductions look suspicious to the IRS, the agency could potentially audit your business.

Investing in Employees

One great way to reduce your company’s taxable income is to invest in your employees. Generally speaking, any wages, bonuses, or other compensation you pay your workers in a given year are tax deductible as a business expense. That includes any fringe benefits you offer — such as gifts, health plans, and employee discounts — as well.

Rewarding your workforce can do more than lower your tax liability, however. It can also help boost their morale, increase productivity, attract the top talent, and grow your business.

Choosing Purchases and Investments Wisely

While it’s clearly important to invest in your business, the question remains: Where should you focus your funds? Here are a few purchases and investments you may want to consider.

•  Equipment: It can be smart to reinvest profits into new machinery and equipment as your current assets age and become expensive to maintain. Upgrading equipment can increase efficiency and help you stay on the cutting edge of your industry.

•  Software: Investing in software, such as payroll and accounting software, can help streamline tedious tasks and free you up to focus on more important matters, such as growing your business.

•  Inventory: In some cases, using business profits to buy more inventory can be a smart business move. If you often sell out of popular products, for example, beefing up inventory can help you capture sales you’ve been missing out on.

•  More marketing: You might consider hiring a marketing professional or agency to help create buzz about your business, improve search rankings, and expand your customer base.

Recommended: Business Cash Management, Explained

Tax Planning Strategies

One of the best ways to make your business tax efficient is to pay attention to tax credits and not just deductions.

Tax credits are particularly valuable because, unlike deductions, which reduce your taxable income, credits reduce your tax bill on a dollar-for-dollar basis. For example, if your small business owes $25,000 in taxes, a $5,000 tax credit means you can subtract $5,000 from your tax bill and only owe $20,000.

There are a number of tax credits your business might qualify for, including:

•  Credit for Small-Business Health Insurance Premiums

•  Employer Credit for Paid Family and Medical Leave

•  Work Opportunity Credit

•  Credit for Increasing Research Activities

•  Disabled Access Credit

•  Credit for Employer-Provided Childcare Facilities and Services

•  New markets credit

The Takeaway

It takes hard work to establish and grow your business. Once you’re able to cover all your expenses, pay yourself a salary, and still have money left on the table, it may be time to consider putting that extra money into your business.

Reinvestment means pouring a percentage of your company’s profits back into your business. It can be a great way to increase the value of your company and to help your company grow. What’s more, reinvesting can reduce your business tax liability at the end of the year, for the ultimate win-win.

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

How much is a small business able to make before paying taxes?

A small business generally must pay taxes on any profit it earns, but the specific amount before paying taxes depends on deductions, credits, and the business structure. For self-employed individuals, income over $400 is subject to self-employment tax, while other tax obligations vary by income and state laws.

What does the 20% business tax deduction do?

The 20% business tax deduction, part of the Qualified Business Income (QBI) deduction, allows eligible small businesses to deduct up to 20% of their qualified business income from their taxable income. This reduces their overall tax liability, promoting business growth and investment.

What is a business write-off?

A business write-off is a tax deduction that allows businesses to subtract certain eligible expenses from their taxable income. Common write-offs include operating costs, rent, supplies, meals, startup expenses, employee salaries, and more. These deductions reduce the overall tax liability by lowering the business’s reported income.

Can you invest business profits to avoid taxes?

Yes, you can reinvest business profits into the company to reduce taxable income, but you cannot avoid taxes as a small business owner. While reinvesting can lower taxes, it doesn’t fully eliminate tax obligations, as profits are still subject to applicable tax laws and limits.

Photo credit: iStock/Andrii Yalanskyi

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.

SOSMB-Q324-032

For the 33.2 million small business owners in America, a good night’s rest may be hard to come by.

Many entrepreneurs struggle with cash flow, but today’s higher prices and interest rates can make keeping the business on track, not to mention securing a business loan, pretty challenging. Those worries hit hard at night, with 85% of small business owners saying they are losing sleep over financing, according to a recent survey of owners conducted for SoFi.

“Almost every day there is a constant worry about funding,” said Amy Wampler, CEO at Spartan Mechanical in Bedford, Indiana. “I find it hard to sleep at night because of the issue of managing cash flow. It is so stressful that, during off-seasons, I might not have enough money to cover all our bills.”

America says it loves small business. When asked about their views on U.S. institutions, an overwhelming portion of Americans (86%) have positive views of small businesses, according to the findings of a 2024 PEW Research Center study.

But what the admirers may fail to realize is this is not always an easy path for the owners, especially in recent years. In our survey, 25% of the entrepreneurs say they are dissatisfied with the current financial situation of their small business.

When Small Business Owners Are Searching for Loans: An Interesting Trend

“To put it frankly, small businesses have to do the same things corporations do to stay afloat, but with a fraction of the budget and team,” said Brooke Webber, head of marketing and executive team member at Ninja Patches. “This dilemma is part of what keeps me up at night.”

Our analysis of small-business-owners’ nocturnal stress began with data spotted on Google Trends. We looked at searches for “small business loans” and were struck with the fact that it peaked in the middle of the night. Not only did we see that middle-of-the-night anxiety hits hard, we discovered precisely when it hits hardest.

Based on data gathered from Google Trends for more than 120 days between October 2023 and April 2024, the average peak search interest for “small business loan” was at 4:50 AM Central Time.

This surprising revelation led us to dig deeper into the question: Why are small business owners searching for small business loan information in the wee hours of the morning?

Small Business Owner Concerns

According to the Small Business Administration (SBA) Office of Advocacy, a small business is an independent business having fewer than 500 employees. Over the last ten years, those small businesses have employed an average of 46% of the country’s workforce.

But the stakes are high. The Bureau of Labor Statistics says that approximately 20% of new businesses fail within the first two years of operation.

For our research on small business challenges, we heard from 1,000 adults (18+) in the U.S. who were owners or partners of a business employing 50 people or less.

In the survey, the respondents said these issues keep them up at night (more than one response was possible):

•   41%: Cash flow management

•   40%: Competition in the market

•   38%: Marketing and customer acquisition

•   21%: Employee-related concerns

•   17%: Regulatory compliance*

But more than anything else, it seems that financing questions make people turn on their computers or smartphones at night. Half of small business owners said they search online for information about small business loans at least monthly, according to our survey. And 30% said they search online for this info at least weekly.

* We rounded percentages to the nearest whole number, so some data sets may not add up exactly to 100%.

Concerns for Funding and Capital

New small business owners often need to borrow money to buy equipment and supplies, pay employees, and otherwise finance their operations. In our survey, about three out of four small business owners said they have some level of concern about securing funding for their business, and 18% said they are “very concerned.”

When we asked which was the primary worry about small business funding they dealt with, the answers broke down this way:

•   38%: Insufficient capital for growth

•   30%: High interest rates

•   15%: Fear of rejection

•   11%: Complex loan application process

“As a bootstrapped business, I frequently worry about funding, especially during critical phases of development,” said Axel Lavergne, Founder of Review Flowz. “The most troubling aspect is ensuring we have sufficient cash flow to cover operational expenses, development costs, and marketing efforts without external financial backing.”

Recommended: Mompreneurs in 2024: Generational Wealth and Real-Life Struggles

Sourcing and Applying for Loans

In our survey, 40% of small business owners said they’ve applied for a small business loan.

For some of them, getting a loan was a game changer.

“It was quite the journey—wading through the sea of paperwork and convincing the powers-that-be of our growth potential,” said Eugene Klimaszewski, Founder of Mammoth Security Inc.“ “But in the end, it paid off. We were able to funnel those funds into state-of-the-art security systems, giving our services a serious upgrade.”

For those who said they had difficulty seeking financing, the obstacles ranged from the entrepreneurs saying the lenders didn’t understand their business to the complexity of the loan process. One respondent said, “I applied for an SBA loan, and the process was so cumbersome that I again opted to personally fund.”

Here’s how the challenges break down when we asked respondents what problems they faced during the loan application process (responses given by the 40% who’ve applied for a loan and more than one choice was possible):

•   47%: revenue or asset amount requirements

•   40%: Credit score issues

•   40%: Lengthy approval times

•   39%: Documentation requirements

•   33%: Business maturity (length of time business has been in operation)

•   31%: Lack of transparency in terms and conditions

Recommended: 15 Types of Small Business Loans

Alternative Funding Options

Owners often find alternatives to small business loans to boost their company, whether it’s microloans, family help, or investors.

In our survey, one-third of small business owners (33%) said they have explored alternative funding options like crowdfunding or peer-to-peer lending. Of those, less than half (41%) have found a suitable option. And another one-third (33%) haven’t explored alternative options, but said that they plan to.

When Businesses Suffer

A lack of funding has caused some business owners to cancel or delay certain business initiatives, according to our survey.

When asked which initiatives they had to put a stop to or push back because of lack of funding, the owners said:

•   39%: Business expansion

•   39% Purchasing assets

•   36% Marketing

•   28% Hiring employees

•   18% Research and development

•   13% Acquisitions or partnerships

•   13% Meeting compliance standards

“The real crunch is making sure we’ve got the funds to stay ahead and make waves in the
fast-paced gaming world, said Marin Christian-Ovidiu, CEO of Online Games. “The price tag for creating and releasing a new game is hefty, and any hiccup in financing can throw off our schedules and put us behind in the race.”

Recommended: Unemployment Rates by City

The Takeaway

After seeing that on Google Trends the average peak search interest for “small business loan” was at 4:50 AM Central Time, we surveyed 1,000 small business owners and found that 85% say they are losing sleep over worries about financing.

In the survey on small business challenges, when asked which was the primary worry about small business funding they dealt with, the answers broke down this way: Insufficient capital for growth (38%), high interest rates: (30%), fear of rejection (15%), and complex loan application process (11%).

If you’re seeking financing for your small 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.

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.

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.

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.

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Maintaining cash flow and covering essential expenses can be a challenge for small business owners. When faced with limited options and a pressing need for quick funding, a merchant cash advance (MCA) can be helpful.

Read on to learn what a merchant cash advance is, its advantages and disadvantages, when businesses use them, and how to apply for one. We’ll also explore some alternative loan options if you decide an MCA isn’t right for your business.

What Is a Merchant Cash Advance?

A merchant cash advance is a small business funding option that allows you to receive money in exchange for future sales. MCAs are technically not loans since they offer cash upfront in return for a portion of a business’s future sales. For this reason, they do not have to follow small business lending laws.

Since they aren’t loans, MCAs don’t require collateral, and merchant cash advance companies typically won’t look at your credit scores to determine approval. However, there is little government regulation on MCAs, which can lead to some merchant lenders engaging in practices that are costly to your business.

Merchant Cash Advance Example

Merchant cash advances charge a factor rate instead of a traditional interest rate. A factor rate is a decimal multiplier used to calculate the total amount you’ll repay on a loan or, in this case, an advance. Most factor rates range from 1.1 to 1.5 depending on the lender and your specific business.

Let’s say you want a merchant cash advance for $75,000. Assuming a factor rate of 1.3, you’d pay a total of $97,500 over time to get that $75,000 now ($75,000 x 1.3 = $97,500). This does not include any additional fees the lender may charge.

To pay the MCA back, a portion of your daily or weekly credit card sales will be automatically withdrawn from your account. The lower your credit and debit sales are, the longer it will take you to pay back the MCA. However, the longer it takes, the lower your overall annual percentage rate (APR) will be. Keep in mind that MCAs are one of the most expensive forms of borrowing for small businesses.

How Does a Merchant Cash Advance Work?

A merchant cash advance is not a loan but a financing option that allows small businesses (“merchants”) to get a cash advance for business expenses in return for a portion of their future sales or receivables. Unlike traditional loans, an MCA involves purchasing future sales at a discount. Typically, the process looks like this:

1.   Apply for the MCA: The merchant applies for a cash advance, providing necessary business and financial information. The merchant and MCA provider agree on the terms, including the percentage of future sales or fixed payments.

2.   Application approved: The MCA provider reviews the application and approves the advance based on business performance and future sales projections.

3.   Funds received: Once approved, the merchant receives the cash advance, usually within a few days.

4.   Repayment: There are two repayment options. A percentage of daily debit and credit card sales is automatically deducted until the advance is repaid or fixed amounts are withdrawn directly from the merchant’s bank account on a predetermined schedule. The advance is fully repaid once the agreed-upon amount, plus any fees, has been collected.

This structured process ensures that small businesses can quickly obtain the funds they need while clearly understanding their repayment obligations.

Factor Rate Used for Merchant Cash Advances

So, what goes into the factor rate merchant cash advances use?

As noted earlier, a factor rate is a decimal figure that reflects the total amount to be repaid on the merchant cash advance. They often range from a rate of 1.1 to 1.5, depending on the terms of the advance.

Similar to how traditional lenders calculate interest, merchant cash advance companies calculate factor rates by assessing the potential risk of providing funds to your business. Items that may affect the factor rate you receive include:

•  The type of industry your business operates in

•  Your business’s financial history

•  Credit and debit card sales

•  Your number of years in business

To calculate how much you could owe on an MCA, you’d typically multiply the entire amount of the merchant cash advance by the factor rate. For example, if you’re getting a cash advance of $5,000 and your factor rate is 1.3, then the total amount you’ll owe is $6,500. Here’s the calculation:

$5,000 × 1.3 = $6,500

The factor rate does not include any additional fees that may be associated with the cash advance, so check with your merchant cash advance company to make sure you’re aware of any additional costs. This step is important, as some merchant cash advances have been known to have APRs in the triple digits.

Other Fees in Merchant Cash Advances

It’s important to be aware of the various fees that MCA lenders may charge in addition to the cost of the merchant cash advance itself. These fees can significantly impact the overall cost of the financing. They include:

•  Origination fees: MCA providers charge origination fees for processing the application and setting up the advance. This fee is typically a percentage of the total advance amount and can range from 1% to 5%. It’s a one-time fee deducted from the advance before the funds are sent to you.

•  Underwriting fees: Underwriting fees cover the cost of evaluating the risk associated with providing the advance. This process involves assessing your creditworthiness, sales volume, and business health. The fee compensates the MCA provider for the time and resources spent on this evaluation. Like origination fees, underwriting fees are often a percentage of the advance amount but may also be a flat fee, depending on the provider.

•  Administrative fees: Administrative fees cover the ongoing management of the advance. These fees can cover a range of administrative tasks, such as account maintenance, payment processing, and customer support. While some providers include these costs in the factor rate (the fee structure used to determine the total repayment amount), others may charge them separately. Administrative fees can vary widely and may be a monthly fee or a percentage of the advance.

•  Other potential fees: Merchants might also encounter electronic fund transfer fees, early repayment fees, and fees for insufficient funds if scheduled payments cannot be processed. These additional costs can add up, so review the terms and conditions of the MCA agreement carefully.

Merchant Cash Advance Repayment

Merchant cash advance repayment terms are distinct from traditional loans. Instead of fixed monthly payments, repayment is typically tied directly to sales, providing flexibility and scalability with your business’s cash flow.

Credit Card Sales

This repayment method involves the provider taking a fixed percentage of your daily credit and debit card sales. This percentage, known as the holdback rate, usually ranges between 5% and 20%. Because repayments are based on sales, the amount paid each day fluctuates with your business’s revenue.

For example, suppose your business receives an MCA of $50,000 with a holdback rate of 10%. On a day the business makes $1,000 in credit card sales, $100 (10% of $1,000) would go toward repaying the advance. If sales drop to $500 the next day, only $50 would be deducted. This structure provides a cushion during slower periods, as payments reduce in line with decreased sales.

Fixed Withdrawals

Some MCAs use fixed daily or weekly withdrawals from your bank account. This method provides predictability in repayment amounts but lacks the flexibility tied to sales volume. The fixed amount is determined based on the advance size, the factor rate (the fee structure used to calculate the total repayment amount), and the anticipated repayment term.

For example, say you take out a $30,000 MCA with a total repayment amount of $39,000 over 12 months. If the provider opts for daily fixed withdrawals, the repayment might be calculated as follows: $39,000 divided by 260 business days (assuming a five-day workweek), resulting in a daily repayment of approximately $150.

Alternatively, for weekly repayments, $39,000 divided by 52 weeks equals about $750 per week. While this method provides consistency, it can strain cash flow during slower periods.

What If You Default on an MCA?

Defaulting on a merchant cash advance happens when you can no longer make your daily or weekly payments. If this happens, the MCA lender can file a lawsuit against you, possibly freeze your personal and/or business bank accounts, or even contact your vendors to try and collect payments directly.

If you think you may struggle with making your MCA payments, it’s best to stay one step ahead and apply for a small business loan to pay off the MCA. You can also contact the MCA lender directly to see if you can negotiate new terms.

Small Business Loan vs. Merchant Cash Advance

Merchant cash advance is the most common term used for such financing, but you may also see MCAs referred to as credit card processing loans, business cash advance loans, merchant loans, or merchant advance loans. Just remember, these aren’t loans. That means they come with little federal oversight and require you, the borrower, to do your due diligence when researching your options.

Traditional small business loans are different from MCAs because they provide merchants with a sum of money, typically for a specific purpose, which is then repaid in regular installments. Small business loans tend to have longer repayment terms and stricter approval requirements than MCAs. Whereas a traditional lender like a bank or online loan provider may look at your credit scores and require collateral, merchant cash advance companies usually do not.

Small business loans come with fixed or variable interest rates, which are applied to the principal balance. Interest rates on small business loans can vary depending on the loan type and borrower but may be lower than the factor rates you’d encounter on a merchant cash advance.

While there may be fees associated with a small business loan, APRs are typically lower than those of MCAs. This means that small business loans tend to be more affordable than merchant cash advances. Examples of lending options that could be workable alternatives to MCAs include:

•  Equipment financing

•  Invoice factoring

•  SBA loans

•  Small business loans

•  Working capital loans

•  Online business loans

4 Common Uses for a Merchant Cash Advance

One of the most common reasons a small business owner would choose a merchant cash advance is to access quick funding for short-term business expenses.

Businesses of any size can use merchant cash advances, but they are particularly helpful for startups with little to no business history, businesses with low or no credit that don’t want to apply for a bad credit business loan, small business owners without collateral, and businesses unable to qualify for loans from traditional lenders.

Here are some of the most common reasons businesses use MCAs.

1. Fill Cash Flow Gaps

If a small business has fluctuating cash flow that prevents it from making bill payments or payroll, a merchant cash advance can act as supplementary funding until cash flow returns.

2. Emergency/Unexpected Expenses

If short-term business loans are not accessible to cover unexpected expenses, small business owners can opt for merchant cash advances that could get them cash within a couple of days.

3. Inventory

Small businesses with consistent credit and debit card sales can use MCAs to purchase inventory and then repay the advance with a percentage of the revenue from inventory sales.

4. Seasonal Fluctuations

Some businesses experience significant revenue variation depending on the season. To ensure there’s always cash on hand, small business owners can get a merchant cash advance to cover expected losses during slow times.

Benefits and Risks of Merchant Cash Advances

Like any source of business financing, a merchant cash advance has advantages and disadvantages. Generally, MCAs are a last resort due to their high cost, but there could be times when it’s the right choice for your business. Let’s look at some of the pros and cons so you can make the best decision for your business.

Pros of Using MCAs

•  Quick funding: Unlike a traditional loan, MCAs often provide you with funds in a matter of days.

•  Minimal paperwork: Merchant lenders offering cash advances typically require a simple application and only need to see basic financial information about your business, like a record of recent credit card transactions.

•  Unsecured: Business owners do not need to offer collateral to obtain a merchant cash advance.

•  Payments may change with sales: If the merchant cash advance is based on a percentage of sales, the repayment amount might adjust depending on the success of your business.

•  Don’t need perfect credit: If you have low credit scores, haven’t established business credit, or are struggling to get a short- or long-term business loan, a merchant cash advance can help supplement, as it is one of the few no-credit check business funding options.

Cons of Using MCAs

•  Expensive: Factor rates are typically 1.1 to 1.5, depending on the terms and conditions of the MCA. When you consider additional fees and APRs possibly in the triple digits, a merchant cash advance can be significantly more costly than a traditional loan.

•  No advantage to early repayment: With a merchant cash advance, you typically pay a set amount regardless of how much of the balance you’ve paid off. Merchant cash advances do not amortize like a loan, in which case you could pay less interest when you pay off the balance early.

•  Lack of government oversight: Because MCAs are considered commercial transactions, merchant cash advance companies can offer cash advances to those who otherwise may not qualify for a small business loan. However, the lack of specific government regulation can also lead to questionable financing practices and less protection for your business.

•  Don’t promote good credit: Merchant cash advance companies are not required to report to credit agencies. If you’re trying to build good business credit, using an MCA is unlikely to help the same way a loan would.

•  Hard to get out of debt: If you struggle to get loans, relying on high-APR merchant cash advances has the potential to keep you in a debt cycle that can be hard to get out of.

•  Cash flow restriction: While using an MCA can help secure funding in the short term, it could hurt cash flow in the long term. If you agree to give your merchant lender a high percentage of your daily credit/debit card transactions, for example, cash flow may run leaner during the MCA repayment period, especially if your sales are high.

Applying for a Merchant Cash Advance

Merchant cash advance companies make it fairly simple to apply for financing. The process typically involves the following steps:

•  Fill out an application: A merchant lender may ask for basic identification like your Social Security number, business tax ID (EIN), and contact information.

•  Collect and provide necessary documentation: This can vary depending on the MCA company, but you may need records of credit card transactions, business banking statements, lease agreements, gross revenue, and tax returns.

•  Approval: A decision can take as little as 24 hours or a few days, depending on the company.

•  Set up credit card processing: Your business may be required to set up credit card processing with a specific partner of the MCA provider.

After you’ve been through the application and approval process, you’ll have funds deposited into your small business account. Payments are typically deducted automatically from this account until the entire merchant cash advance is paid off.

Alternatives to Merchant Cash Advances

Because of their lack of regulation and incredibly high APRs, merchant cash advances are usually considered a last resort. Before taking on an MCA, consider these small business lending options:

Invoice Factoring

Invoice factoring uses unpaid invoices as collateral in exchange for a cash advance from a lender. This is different from an MCA, which is based on projected sales. Invoice factoring also typically has a lower APR than MCAs, generally falling between 15% to 35%.

Inventory Financing

Inventory financing is an asset-based loan provided to pay for products that will be sold at some time in the future. The inventory acts as collateral for the loan.

Equipment Financing

Equipment financing is a secured loan to purchase machinery, vehicles, or other business-related equipment.

Recommended: Leasing vs. Purchasing Equipment for Businesses

SBA Loans

SBA loans are backed by the U.S. Small Business Administration (SBA) and offered by banks and other approved lenders. They typically come with competitive rates and terms, but the approval process is lengthier than it is for other small business financing options.

Personal Loans

Personal loans are typically unsecured and based on your personal credit history (not business credit) and income. Personal loans can be used for almost any purpose, including business expenses.

Commercial Real Estate Loans

Commercial real estate loans provide funds to purchase business-related real estate, such as an office space or retail shop.

Business Credit Cards

Like a business line of credit, business credit cards can be used for short-term business needs. Business credit cards use a revolving line of credit, with interest charged only on unpaid balances from previous billing cycles.

Online Small Business Loans

Some online business lenders offer similar loan options as a traditional bank. They typically have a faster approval process and may offer more options (albeit usually at higher interest rates) for people with lower credit scores.

Business Lines of Credit

Business lines of credit are a flexible, revolving form of financing that allows you to use the funds as you need them, pay them back, and use them again. Interest is only charged on the amount you borrow.

Compare Small Business Loan Rates

If you’re considering a small business loan, consider SoFi. With SoFi’s Small Business Loans Marketplace, you can receive a small business loan offer from a top lender with just a single application and no obligation to you. Take the first step toward securing your business’s financial future today with SoFi.

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 merchant cash advance?

A merchant cash advance (MCA) provides a lump sum to a business in exchange for a percentage of future sales or fixed daily or weekly withdrawals.

How much is a merchant cash advance fee?

MCA fees, typically represented by a factor rate, can range from 1.1 to 1.5 times the advance amount, depending on the provider and risk assessment.

What is the difference between an MCA and a loan?

An MCA is repaid through a percentage of daily sales or fixed payments, offering flexibility, whereas a loan requires fixed monthly payments with interest, regardless of business revenue fluctuations.

Photo credit: iStock/mapodile

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.

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.

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