SoFi

If you’ve always dreamed of opening your own business, now may be the time. The entrepreneurial spirit is thriving in the U.S. as historic numbers of Americans start their own companies. In 2023, a record 5.5 million new business applications were filed, according to the U.S. Census Bureau. The trend started in 2020 during the pandemic and has accelerated ever since.

There are many reasons why new business is big business today. For some individuals, the allure of running their own enterprise is a motivation too strong to resist. Others see opportunity created by changing consumer tastes and needs. For yet other people, starting a business may be a way to start over after a job layoff.

Small businesses are the backbone of the U.S. economy, employing 46% of the workforce, according to the Small Business Administration (SBA). But of course, a new business needs to stay in business. And one of the key factors that can help determine its success: Location, location, location.

So then, where is the best place to start a business? In what cities can a new business not only find its footing but go on to flourish?

To discover the answer, SoFi looked at the 50 largest cities across the U.S. with populations of 500,000 or less, and ranked them on eight different criteria, including annual business applications, average cost of office space, unemployment rates, and cost of living. We assessed the criteria for each city on a 10-point scale for a possible total score of 80 points. (See below for the complete details about our methodology.)

What we found was that while businesses are starting nationwide, certain cities across the country seem to be particularly beneficial for new businesses. Read on to learn the 10 best cities to start a business in the U.S.

Key Points

As SoFi analyzed the data about each city, these important findings stood out:

•   The South is a hotspot for new businesses. Three of the top 10 cities on our list are in Florida, and all score high in self employment. Plus, Florida has increasing numbers of businesses owned by underrepresented groups. Atlanta, the Number 3 city overall, has a large population of working age people and ranks high for new business applications.

•   Cold-weather cities are offering new businesses a warm welcome. Minneapolis clinched the Number 2 spot on our list, and St. Paul, Minnesota and Madison, Wisconsin scored in the top 10. All three have large populations of working age people.

•   Texas is poised to become a new-business powerhouse. The Lone Star State has 2 of the top 10 cities on the list — Plano and Irving. Younger people are gravitating to Texas, giving new businesses in these cities plenty of working age adults to employ.

Our Findings

Reviewing the entire list of cities in the SoFi analysis reveals some important, even surprising, information for aspiring business owners. For instance, Miami is the city with the most new business applications and highest level of self employment, while Witchita, Kansas, offers the best prices for office space, and Cleveland has the lowest cost of living.

Check out how other top cities rank when it comes to opening a new business.

The Top 10 Cities to Start Your Own Business

The best cities for new businesses tend to be in the South and Midwest, our research found. But no matter where they are located, each of the cities in our top 10 has attributes that make them great locations for aspiring business owners.

1. Miami, FL

Score: 52.13

This vibrant metropolis combines the perks of big-city life, such as an exciting food and nightlife scene and renowned museums and art galleries, with beautiful beaches and warm, sunny weather. Miami’s population has increased steadily in recent years, making it one of the fastest growing cities in the country. And tourists from around the world flock to this oceanside oasis. In short, there are endless opportunities — and customers — for new business owners in Miami.

In SoFi’s analysis, Miami received top scores for new business applications and the number of self-employed individuals. It also rated highly for walkability and its large working-age population. Not only that, prospective business owners in Miami may be able to take advantage of small business grants in Florida that can help with start-up costs.

2. Minneapolis, MN

Score: 51.13

With its friendly midwestern vibe and cosmopolitan charm, Minneapolis has been experiencing population growth since the pandemic. Despite the cold winters, residents say it offers a good quality of life, access to nature, sporting events, arts and culture, and more. The city is also seeing a surge in new housing and economic development.

In the SoFi study, Minneapolis received a top score for its large working-age population. It also got high marks for the number of self-employed residents and the city’s walkability. Another potential selling point for entrepreneurs: The state of Minnesota works to cultivate small businesses, offering assistance and partnerships through its Office of Small Business and Innovation.

3. Atlanta, GA

Score: 50.30

Atlanta is another one of the fastest-growing metro areas in the country, according to Census Bureau data. The city has seen a boom in businesses opening and relocating there, from major corporations to smaller companies. Atlanta’s lifestyle amenities have flourished as well, making the city a draw for its vibrant entertainment offerings, diverse restaurants, and sporting events.

It’s no wonder then that Atlanta has a robust population of working-age individuals, according to SoFi’s research. It also got a high score in our analysis for new business applications. For entrepreneurs, the city has support networks, incentives, and small business loans that make it an appealing place to set up shop.

4. Plano, TX

Score: 48.89

New businesses are popping up across Plano, making it a welcoming community for those ready to launch their own companies. Located less than 20 miles from Dallas, the city is a family-friendly place to live with easy access to a major metro area. People are drawn to Plano’s parks, cultural events, and restaurant offerings — something new business owners can both enjoy personally and benefit from professionally.

SoFi’s research found that Plano has a large working-age population and a high household income. It also ranks near the top of the list for self-employment. Plus, small business grants in Texas can make Plano a good choice for new business owners.

5. St. Louis, MO

Score: 48.48

Located on the Mississippi River and known for its iconic Arch, St. Louis is actively courting new businesses through incentive programs, tax credits, and enterprise zones. The city has a vibrant start-up scene, with business incubators and accelerators. St. Louis, which boasts a diverse culture, historic neighborhoods, and a fairly affordable cost of living, is a top area for job growth, according to recent data from the Federal Reserve Bank of St. Louis.

Indeed, SoFi’s report found that St. Louis gets high marks for its large working-age population, self-employment score, and household income.

6. St. Paul, MN

Score: 48.06

The state capital of Minnesota, and the other half of the famed “Twin Cities” (along with Minneapolis, the Number 2 city on our list), St. Paul is a mid-sized metropolis with a youthful vibe. There are a number of colleges and universities here, giving the city’s employers access to skilled graduates. In our research, the city ranked high for its large working-age population. In addition, St. Paul offers a number of resources for new businesses, including financial and technical assistance.

7. Orlando, FL

Score: 48.01

Home to Disney World and Universal Studios, among many other theme parks, Orlando is not only a coveted tourist destination but also a cosmopolitan city with a strong arts and cultural scene, good restaurants, and a bustling nightlife.

It also has a variety of employment opportunities to attract workers: Orlando is filled with big companies, such as AAA and Darden Restaurants, and it’s a growing technology hub. As a result, the city has a large working-age population, according to SoFi’s analysis. Orlando is welcoming to new businesses and offers many incentives to entrepreneurs.

8. St. Petersburg, FL

Score: 47.97

This Gulf Coast city is so beloved for its weather that it’s known as Sunshine City. St. Pete is appealing to employees and business owners alike for its working and lifestyle opportunities. Here, you’ll find pristine sand beaches and a walkable city with a dynamic business community. Companies like Raymond James and HSN are located in the city, as are a growing number of new businesses.

St. Petersburg has a booming working-age population and it scores high marks in self employment, the SoFi report found. It also offers tax benefits and incentives to new businesses.

9. Madison, WI

Score: 47.34

This state capital was recently rated the sixth best city in the U.S. to live in by U.S. News & World Report, thanks to its quality of life. Madison has a hot job market and it’s a hub for companies in technology, healthcare, and manufacturing. As a college town — the University of Wisconsin-Madison — it also has a diverse population and a dynamic downtown filled with boutiques, restaurants, bars, and coffee shops.

In SoFi’s report, the city rated highly for its working-age population. The unemployment rate in Madison is fairly low, which also makes it desirable. The city offers programs to help small businesses start and succeed, and there are small business grants in Wisconsin entrepreneurs can explore.

Recommended: Unemployment Rates by City

10. Irving, TX

Score: 46.97

Located near Dallas, Irving combines urban amenities with a suburban feel. It has many perks of city living, such as live music venues, ballet and symphony, art, movie theaters, and restaurants. For nature lovers, Irving has a number of rivers and lakes weaving through it, along with parks and nature trails.

Irving’s economy is strong — major corporations in industries such as technology, finance, and consumer goods are located there. SoFi’s research found that the city has a large working-age population, which can be beneficial to new business owners. Irving also offers incentives and resources for small businesses.

Tips for Small Business Owners

If you’re ready to start a small business, these are some important steps to take to help your venture become a success.

•   Choose the right location for your business.
Do your research to pick an area that best suits your business needs. Consider whether the area has the type of customer you’re targeting, a robust workforce, and real estate and operating costs you can afford.

•   Check out local resources, networks, and programs.
Does the location you’re considering offer incentives and tax credits for new and/or small businesses? The cities on our list do, as do many others. Be sure to check with the chamber of commerce, the city’s SBA office, if there is one, and local economic development centers and business incubators.

•   Find the right financing.
The city or state may offer grants or funding for new businesses — do your homework to find out if they do. Also investigate grants and funding programs from the SBA.

As you’re seeking financing for your small business, you may also want to consider a loan to help get your venture off the ground.

When you’re looking for a loan for your new business, SoFi can help. On SoFi’s marketplace, you can shop top providers to access the capital you need. Find a personalized small business loan option today within 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.

Methodology

To determine the best cities to start a business, SoFi looked at the largest 50 cities across the U.S. with populations of 500,000 or less. (“Population” refers to the city proper and is separate from surrounding urban areas.) SoFi analyzed eight key contributing factors, each assessed on a 10-point scale, in each city for an overall potential score of 80. These factors included:

Walkability

Walkability was determined by reviewing statistics from Walk Score, which were given on a scale of zero to 100. The higher the Walk Score, the higher a city’s walkability score.

Cost of Living

Using Area Vibes, SoFi reviewed the cost of living score — an index score compared to the national average. The lower the cost of living score in a city, the better the score we assigned.

Average Cost of Office Space

Using LoopNet, SoFi assessed all 50 cities using the following filters:

•   Type of space needed: office, retail, or restaurant

•   Number of employees: 10 (which equaled 1250 to 4000 sq. ft. of space)

SoFi averaged the price per square foot per year for the newest 10 results in each city. The higher the average cost, the lower the score.

Median Household Income

Using Data USA, SoFi assessed the median household income for each city. The higher the median income, the higher the score.

Unemployment Rates

Using Area Vibes, SoFi assessed the unemployment rate for each city. The lower the unemployment rate, the better the score.

Annual Business Applications

Using Census Burea data SoFi calculated the percentage of people who applied for a small business loan in the county where each city is located. The higher the percentage of new business applications, the higher the score.

Percentage of Self-Employed People

Using Census Burea data, SoFi calculated the percentage of people in each city who had self-employment income. The higher the percentage, the higher the score.

Working-Age Population

Using Census Burea data, SoFi calculated the percentage of people in each city who were between the ages of 15 and 64. The higher the percentage, the higher the score.

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.

SOSMB-Q324-018

Invoice financing allows businesses to improve their cash flow while waiting for their customers to make outstanding payments. Like any type of financial product, invoice financing has advantages and disadvantages to consider before making a final decision.

We’ll walk you through how invoice financing works, what types of businesses it’s suited for, and alternatives to consider before deciding what type of business loan is best for you.

What Is Invoice Financing?

Invoice financing is a type of small business financing that leverages the outstanding invoices owed to you by your customers. Also known as accounts receivable financing or invoice lending, invoice financing is considered secured funding because your company’s financial invoices serve as collateral for the funds you receive.

In addition to this traditional secured loan structure, there are several other kinds of invoice financing. One of these is invoice factoring, another form of invoice lending in which you sell your unpaid invoices to a factoring company for a percentage of the invoices’ face value. The factoring company then becomes responsible for collecting from your customers, making it an attractive option for businesses that don’t want to chase down unpaid invoices.

Another form of invoice financing is an accounts receivable line of credit. With this type of business loan, you take out a line of credit using a percentage of the value of your unpaid invoices as collateral.

While it’s not suitable for all types of businesses, invoice financing can help many companies with longer billing cycles.

How Does Invoice Financing Work?

Invoice financing is a fairly straightforward process with four key steps. Here’s how it works:

1.   Submit an invoice: The process begins when you submit outstanding invoices to an invoice financing company. These invoices represent the money owed by your clients. At this point, the financing company will assess the validity of your invoices and the creditworthiness of your clients.

2.   Receive funding: Once the invoices are approved, the financing company provides an advance on the invoice amount, typically around 70% to 90% of the total amount. This advance is quickly transferred to your account, providing immediate cash flow to fulfill various business needs.

3.   Assess fees: In exchange for the advance, the financing company charges a fee, which can be a percentage of the invoice amount or a flat fee. This fee covers the service and the risk taken by the financing company. The exact fee structure varies based on the lender and the creditworthiness of the invoiced clients.

4.   Repay the lender: When the client pays the invoice, you direct the payment to the lender. The lender then deducts the advance and the agreed-upon fees before sending the remaining balance to you. This completes the transaction, and the cycle can begin again with new invoices.

Invoice Financing Example

Invoice financing can be tricky because it often uses a factor rate rather than an interest rate to calculate how much you owe. A factor rate may have a short term — such as a week — which means that your obligations will build quickly even if the percentage you see is low. Let’s take a closer look at how it works.

•  Submit an invoice: Let’s say you have a small business with an outstanding invoice for $20,000. You submit it to an invoice financing company.

•  Receive funding: The financing company accepts your invoice and they agree to advance 80% of the invoice value, or $16,000.

•  Assess fees: The financing company charges a 1% factor fee per week until your customer pays the invoice. If it takes four weeks for the customer to pay, the factoring fee would be $640.

•  Repay the lender: You repay the loan amount plus the factoring fee — a total of $16,640.

Invoice Financing vs Invoice Factoring

Invoice financing and invoice factoring are terms that are easy to confuse. While you might even see them used interchangeably, they aren’t the same.

Invoice factoring is a kind of invoice financing, but it’s not a loan. Instead, invoice factoring is a type of cash advance based on your outstanding invoices. You typically give the invoices to a factoring company and receive an advance of up to 90% of the invoices’ amount. Once the customer pays the invoice to the factoring company, you’ll receive the remaining balance minus a factoring fee that is withheld by the factoring company. Instead of being charged an interest rate, you’re charged a factor rate that’s based on the risk of your invoices.

Invoice factoring usually shifts the collection process to the lender. With invoice financing, your business typically keeps control of customer relations and the collection of your invoice funds. If you opt for factoring, your customers will likely know that you’ve outsourced this part of your business. Some businesses may prefer keeping the collection process in-house to maintain customer relationships.

Both invoice financing and invoice factoring involve ongoing fees. Typically, the longer each invoice goes unpaid, the more you’ll pay in fees. An important note: These tiered rates add some uncertainty to how much you’ll owe, so be sure to have some flexibility in your business budget for these fees.

Pros and Cons of Invoice Financing

As with any business loan, invoice financing can help your business in several ways, but it also has disadvantages to consider. Here are some key pros and cons to help you decide if financing invoices is right for your business:

Pros of Invoice Financing

Here’s a look at some of the advantages of using invoice financing.

•  Improves cash flow

•  Provides businesses with a working capital boost during slow periods

•  Allows continuity for businesses with long billing cycles who don’t want to operate order to order

•  Easy application (usually a credit check and invoice documentation)

•  Fast access to funds, sometimes within a day of application

Cons of Invoice Financing

•  Can be expensive, with potentially high rates plus other fees

•  Deprives you of a portion of your revenue

•  Fees are in part based on whether your customers are making payments on time

•  Using a factoring agency may involve them interacting with your clients, potentially affecting your relationship

Is Invoice Financing a Good Idea?

Invoice financing is certainly helpful in some business cases. If your company has seasonal fluctuations, a lengthy billing cycle, or revenues that aren’t distributed throughout the year — and your clients reliably pay their invoices on time — invoice financing may be a good way to keep regular cash flow through the highs and lows.

If your customers are slow to pay, however, the fees you’re charged may increase, and if they default, you may end up having to cover their invoices. If your business has less reliable clients, using funding like this could end up being costly in the long run and may not be a good fit.

How to Apply for Invoice Financing

Invoice financing is a valuable tool for companies looking to improve their cash flow by borrowing against outstanding customer invoices. Understanding the steps involved can help you make the most of this financing option and avoid potential pitfalls.

1.   Determine whether your business is eligible: Invoice financing primarily benefits business-to-business (B2B) companies rather than business-to-consumer (B2C) companies. It’s not meant for businesses that rely on individual customers who buy products through a point-of-sale system. Instead, it’s designed to let companies borrow against outstanding invoices for customer orders.

2.   Research potential lenders: Some lenders allow you to finance 100% of the invoice amount, while others limit you to borrowing up to a certain percentage of your outstanding invoices, typically within the 70% to 90% range. A lender may charge a flat-rate fee or a percentage of the invoice total. Either way, the fee is deducted when the customer pays the invoice. Depending on the lender, you may also encounter other fees, such as a new account fee, a renewal fee, a minimum volume fee, and/or an early termination fee. It’s always a good idea to determine the full cost of financing before you sign a contract.

3.   Submit your application and supporting documentation: When you apply for invoice financing, a lender typically reviews your business credit and the documentation of your unpaid invoices. A lender may also look at your clients’ payment history to gauge how likely they are to pay the invoices. A personal guarantee isn’t usually required, but check the terms of your loan to be sure.

Alternatives to Invoice Financing

Invoice financing is one of many options available to support your business needs. Here are a few other small business loan options to consider before making a final decision.

•  Inventory financing: This type of financing is used to help businesses purchase new inventory in large quantities and can be useful before a busy season or when you experience sudden demand for your product.

You can apply for either a loan or line of credit with inventory financing. The amount you can borrow is based on the value of your business’s inventory, but typically, you can only qualify for between 20% and 65%. Lenders may also use liquidation value as a starting point, as some types of inventory can lose value over time.

Like invoice financing, inventory financing typically comes with higher costs than a regular business loan. You’ll also need to demonstrate a high inventory turnover rate to qualify for higher loan amounts.

•  Merchant cash advance: A merchant cash advance is better suited to businesses with B2C sales. You borrow a lump sum, and the lender automatically deducts a portion of your credit and debit card sales until the loan (plus accrued fees) is repaid.

As with invoice factoring, a factor rate is used with a merchant cash advance instead of an interest rate. Another similarity is that your number of sales, rather than your credit history, is the most important factor in qualifying for a merchant cash advance. Generally, approval also happens quickly, allowing you to get fast access to funding.

•  Long-term business loan: A long-term business loan can last anywhere from several years to 25 years. Rather than bridging cash flow gaps, this type of financing is usually used for larger investments, such as buying real estate, renovating a building, purchasing equipment, or acquiring another business.

Expect eligibility requirements to be stricter with a long-term business loan. Lenders may require you to have been in business for a minimum amount of time and have a strong business and personal credit history. Additionally, you may need to offer some collateral and meet a revenue threshold.

Recommended: 6 Step Guide to Getting a Small Business Loan

The Takeaway

Maintaining steady cash flow can be tricky for many small businesses. Whether you’re looking for a short- or long-term financing solution, finding the best type of loan for your business can take time and consideration. You’ll want to carefully weigh the pros, cons, and costs of each option to find a suitable option.

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

Is invoice financing easy to obtain?

Yes, invoice financing is relatively easy to obtain, especially for businesses with creditworthy clients and strong accounts receivable.

How expensive is invoice financing?

Invoice financing can be expensive, with fees typically ranging from 1% to 5% of the invoice value per week. Actual costs will depend on the creditworthiness of your clients and the terms of the agreement.

Is invoice financing risky?

Invoice financing carries some risk, mostly related to the creditworthiness of your clients. If clients fail to pay their invoices, you might still be liable for the advance received.

Photo credit: iStock/pixdeluxe

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

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

SOSMB-Q324-024

When it comes time to finance your small business or its growth, many options are available — everything from a business line of credit to a small business loan.

Many small businesses turn to SBA loans in such scenarios. These bank loans are backed by the U.S. Small Business Administration (SBA). With an SBA loan, borrowers can work toward their goals, whether that’s getting a startup off the ground or expanding an established small business.

Let’s take a closer look at what an SBA loan is and how it works.

What Is an SBA Loan?

An SBA loan is a type of small business financing that is partially guaranteed by the U.S. Small Business Administration and offered by approved lenders such as banks, micro-lending institutions, and private lending companies. The SBA itself does not lend money directly but helps reduce risk to lending partners. Small business owners usually enjoy competitive rates and SBA loan terms, counseling, and education opportunities with these types of loans.

To apply for an SBA loan, you’ll need to find an SBA-approved lender. Lenders will differ depending on which type of SBA loan you’re applying for. The lender will then assess your eligibility according to SBA requirements. If approved, you’ll receive a loan with a percentage of the amount guaranteed by the SBA. This means that if you default on the loan, the SBA guarantees repayment to the lender, making SBA loans relatively low risk — and appealing — for lenders and borrowers alike.

SBA loan eligibility requirements vary depending on the lender and the type of loan program. A few things lenders consider when assessing a potential borrower are:

•  How does the business receive income?

•  What is the character of its ownership?

•  Where does the business operate?

•  Does the business meet size standards?

•  Has the business received funds from another financial lender?

Additionally, lenders will look at a potential borrower’s creditworthiness. They assess personal credit and business credit (if established) to ensure that the potential borrower can responsibly repay the loan.

It may be possible for those with less-than-optimal credit to qualify for startup funding with certain SBA loan programs and lenders. “Bad credit” business loans are offered by many lenders outside the SBA program but typically carry higher interest rates because there is higher risk involved.

How Do SBA Loans Work?

SBA Loan Terms

Specific business loan terms under the SBA will depend on the lender and eligibility, but they generally fall between five and 25 years.

•  Working capital: 10 years

•  Equipment: 10 years (as long as it does not exceed the life of the equipment)

•  Inventory: 10 years

•  Real estate: 25 years

Certain SBA loans have special terms that may not follow the above criteria. They include:

•  504 loans: Loan terms can be 10, 20, or 25 years.

•  Microloans: Maximum maturity is six years.

•  All CAPLine loans except the Builders CAPLine: Maximum maturity is 10 years.

•  Builders CAPLine loans: Maximum maturity is five years.

•  International Trade loans: Maximum maturity is 25 years.

•  Export Working Capital loans: Maximum maturity is typically 1 year, but can be up to 3.

Finally, the SBA offers longer maximum repayment periods on disaster loans:

•  Economic Injury Disaster Loan (EIDL): Maximum maturity is 30 years.

•  Business Physical Disaster Loan: Maximum maturity is 30 years.

•  Military Reservists Economic Injury Loan: Maximum maturity is 30 years.

SBA Loan Amounts

SBA financing programs offer a variety of loan amounts for small business owners. The exact amount each borrower is approved for depends on the lender and eligibility. You can get an estimate of the amount your business may qualify for by using a SBA loan calculator. Below are the maximum loan amounts for different types of SBA loan programs:

•  Standard 7(a): $5 million

•  7(a) Small loan: $350,000

•  SBA Express: $350,000

•  Export Express: $500,000

•  Export Working Capital: $5 million

•  International Trade: $5 million

•  504 loan: Generally $5 million (qualified energy-efficient or manufacturing projects may receive multiple loans up to $5.5 million)

•  Microloan: $50,000

•  CAPLine loan: $5 million

•  All disaster loans: $2 million

SBA Interest Rates

Ultimately, interest rates on SBA loans are negotiated between the borrower and lender. The SBA provides some guidelines and rules around interest rates, which vary depending on the type of loan:

•  All 7(a) loans: Interest rates vary depending on the type of loan and what the daily peg rate is. As of December 2023, the interest rate for loans with a maturity of less than 7 years is 12.75%. The interest rate for loans with a maturity of more than 7 years is 13.25%.

•  504 loan: Interest rates are below-market and fixed for the life of the loan. In December 2023, the rate averaged at 6.21%.

•  Microloan: Interest rates are typically between 8% and 13%.

•  Disaster loans: Interest rates are determined by law and each type of disaster loan has its own criteria:

◦  Economic Injury Disaster Loan (EIDL): Maximum interest rate for businesses is 3.75% fixed.

◦  Business Physical Disaster Loan: Maximum interest rate is 4% if you aren’t able to obtain credit elsewhere; otherwise, 8% maximum.

◦  Military Reservists Economic Injury Disaster Loan (MREIDL): Maximum interest rate is 4%.

Common Types of SBA Loans

There are multiple SBA loan types available for small businesses. Depending on the type of business you have and its goals, certain SBA financing options may be better suited for your needs over others. The most common types of SBA loans include 7(a) loan programs, 504 loan programs, microloans, and SBA disaster loans.

SBA 7(a) Loans

If you own a small business and need manageable financing, SBA 7(a) loans generally offer more favorable terms and rates than credit cards or business lines of credit. There are standard and small versions of this loan, allowing for flexibility based on your specific funding requirements.

Loan purpose: Can be used for working capital, purchasing equipment or inventory, refinancing existing debt, buying real estate, or funding business expansion.

Max loan amount: $5 million.

Repayment terms: Depends on the purpose of the loan. For working capital, for example, the term can be up to 10 years, while for real estate, it can be up to 25 years.

SBA 504 Loans

SBA 504 loans are for small businesses looking to make significant investments in their infrastructure. They have favorable terms and conditions to support long-term business growth.

Loan purpose: Purchasing fixed assets like real estate, buildings, and machinery. They can also be used to construct, renovate, or improve facilities.

Max loan amount: $5 million ($5.5 million for certain energy-efficient or manufacturing projects).

Repayment terms: Range from 10 to 25 years, which helps keep monthly payments manageable.

Recommended: Leasing vs Purchasing Equipment for Businesses

SBA Express Loans

SBA Express loans are ideal for small businesses that need quick access to capital. Their simplified application process makes them practical for addressing immediate financial needs.

Loan purpose: Provide small businesses with quick and flexible access to capital to meet various business needs.

Max loan amount: $500,000.

Repayment terms: Range from seven to 25 years depending on the loan’s purpose.

SBA Microloans

SBA microloans are small, short-term loans to help small businesses start up and expand.

Loan purpose: Can be used for working capital, inventory or supplies, furniture or fixtures, and machinery or equipment. They cannot be used to pay existing debts or to purchase real estate.

Max loan amount: $50,000.

Repayment terms: Maximum repayment term is six years, with terms varying based on the loan amount, the planned use of funds, and the needs of the small business borrower.

SBA Disaster Loans

SBA disaster loans are low-interest loans meant to help businesses, homeowners, renters, and nonprofit organizations recover from declared disasters. These loans can be used to repair or replace damaged property, cover operating expenses, and prevent future disaster risks.

Loan purpose: Help repair or replace damaged property, cover operating expenses, and prevent future disaster risks.

Max loan amount: $2 million for businesses, $200,000 for homeowners to repair real estate, and $40,000 to replace personal property.

Repayment terms: Up to 30 years, with generally low interest rates. Collateral may be required for loans over $25,000.

SBA CAPLines

SBA CAPLines are designed to help small businesses meet their short-term and cyclical working capital needs.

Loan purpose: Provide small businesses with short-term and cyclical working capital, financing for accounts receivable and inventory, and funding for contract-specific needs.

Max loan amount: $5 million.

Repayment terms: Up to 10 years, with specific terms depending on the type of CAPLine and the borrower’s needs.

SBA Export Working Capital Loans

SBA Export Working Capital loans are designed to help small businesses obtain the necessary working capital to support export sales.

Loan purpose: Provide working capital to small businesses to support export transactions, including financing for production, inventory, and accounts receivable, and cover standby letters of credit used as bid or performance bonds.

Max loan amount: $5 million.

Repayment terms: Up to 12 months, but can be renewed annually.

International Trade Loans

SBA International Trade loans help small businesses engaged in international trade or those adversely affected by competition from imports.

Loan purpose: Provide financing to small businesses for expanding export activities, developing new export markets, or improving operations in response to import competition. This includes funding for working capital, equipment purchases, and real estate acquisition.

Max loan amount: $5 million.

Repayment terms: Up to 25 years for real estate, up to 10 years for equipment, and up to seven years for working capital.

Pros and Cons of SBA Loans

As with any business term loan, SBA loans have advantages and disadvantages. As they’re designed specifically for small businesses, they offer attractive rates and terms. Yet, they can be more difficult to qualify for, especially if your business is fairly new.

Advantages of SBA Loans

•  Competitive rates: Interest rates may be lower than other types of small business loans

•  Low fees: Minimal associated costs and charges

•  Longer terms: Extended repayment periods make managing cash flow easier

•  Large loan amounts: Access significant funding to support business growth

•  Flexible use of funds: Support a variety of business needs

•  Support available: Access resources and guidance from the SBA

•  Lower down payments: Reduce the initial capital required to secure the loan

Disadvantages of SBA Loans

•  Hard to qualify: Strict eligibility criteria can make approval challenging

•  Slow to fund: Approval and funding process can be lengthy

•  May require collateral: Assets are often needed to secure the loan

•  Requires extensive documentation: Application process requires a significant amount of paperwork

•  Personal guarantee: Borrowers must personally back the loan

•  Prepayment penalties: Fees may apply for paying off the loan early

SBA Loan Requirements

To qualify for an SBA loan, businesses must meet specific criteria and provide comprehensive documentation to show their creditworthiness and ability to repay the loan. The requirements are:

•  Business size: The business must meet the SBA’s size standards, which vary by industry and are typically defined by the number of employees or average annual receipts. The SBA generally considers a small business to be independently owned and operated and not dominant in its field.

•  For-profit business: The business must be a for-profit entity. Nonprofit organizations are generally not eligible for SBA loans.

•  Location: The business must be physically located and operate in the United States or its territories.

•  Owner’s equity investment: The business owners must have invested their own time or money into the business. This demonstrates the owners’ commitment and reduces the risk for lenders.

•  Good credit history: Both the business and its owners must have a good credit history. Lenders typically look for a strong personal credit score and a business credit profile.

•  Ability to repay: The business must demonstrate the ability to repay the loan. This is usually assessed through financial statements, cash flow projections, and other documentation that shows the business’s profitability and financial stability.

•  Collateral: While not always required for smaller loans, collateral is often required for larger SBA loans. This can include business assets, personal assets, or real estate.

•  No delinquent debt to U.S. government: The business must not have any delinquent debt obligations to the U.S. government, such as unpaid taxes or federal loans in default.

How to Apply for an SBA Loan

There are some application differences between conventional loans vs. SBA loans. Use this checklist to get a successful start on applying for your SBA loan.

1. Check Your Eligibility

To qualify for an SBA loan, businesses must meet several requirements. They must adhere to the SBA’s size standards, which vary by industry. Only for-profit entities are eligible, and the business must operate within the United States or its territories. In addition, owners need to demonstrate their commitment by investing their own time or money into the business.

Further, both the business and its owners must have a good credit history. Their ability to repay the loan must be evident through financial statements and projections. While collateral is often required for larger loans, it may not be necessary for smaller ones.

Lastly, the business must not have any delinquent debt obligations to the U.S. government.

2. Choose a Lender

When selecting a lender for your SBA loan, it’s important to understand the difference between standard and preferred lenders. Standard lenders must submit the entire loan application and supporting documents to the SBA for approval, which can result in a longer approval process.

Preferred lenders, on the other hand, are part of the SBA’s Preferred Lender Program (PLP) and have the authority to approve loans on behalf of the SBA, typically leading to a faster approval process.

Some questions to ask prospective lenders:

•  What types of SBA loans do you offer?

•  Are you a standard or preferred SBA lender?

•  How long does your loan approval process typically take?

•  What are the interest rates and fees associated with your SBA loans?

•  What documentation will I need to provide for the loan application?

•  How do you handle ongoing support and communication after the loan is approved?

3. Gather Documents

Once you’re ready to apply, you’ll generally need to gather the following documents (the exact documentation you need might vary by the loan program and lender):

•  Business financial statements: Profit and loss statements, balance sheets, and cash flow statements for the last three years.

•  Personal financial statements: Financial statements of all owners with a 20% or greater ownership stake.

•  Business plan: A detailed business plan that includes market analysis, business model, and financial projections.

•  Personal and business tax returns: Tax returns for the last three years.

•  Loan application history: Information on any previous loan applications.

•  Résumé of principals: Background and experience of key business owners and managers.

•  Business license and certificates: Proof of business ownership and any necessary permits.

•  Lease agreements: If applicable, a copy of your business’s lease agreement.

•  Collateral documentation: Description of collateral being used to secure the loan, including appraisals if available.

•  Articles of incorporation or organization: Legal documents that establish the business entity.

4. Submit Your Application and Wait for Approval

The time it takes for an SBA loan application to be reviewed can vary. For standard lenders, the review process may take several weeks to a few months due to the need for SBA approval. Preferred lenders can often process and approve loans more quickly, sometimes within a few weeks, due to their delegated authority.

Explore Small Business Financing Options

Running a business can be rewarding, but it also comes with challenges. When you need financing, it can be overwhelming trying to find a small business loan that meets your company’s needs, budget, and qualifications.

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.

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.

SOSMB-Q324-021

In the world of business, the right location can make all the difference. ​​When business owners need to purchase, refinance, or renovate commercial properties, a commercial real estate loan (CRE) can be an excellent option. The term “commercial” refers to property that is used for business, such as offices, retail storefronts, warehouses, apartment complexes, and more.

CRE loans are typically available through banks and independent lenders, but you can also get capital from private investors and other sources, including lenders that partner with the U.S. Small Business Administration (SBA).

Whether you’re looking for a small commercial real estate loan or more substantial funding, it’s important to understand each option and how they differ. That way, you choose a loan that aligns best with your business needs.

Why Use a Commercial Real Estate Loan?

A commercial real estate loan is a powerful tool for businesses looking to buy, develop, or renovate properties. Commercial real estate loans offer substantial capital at competitive rates and flexible repayment terms, helping you undertake large projects without draining your reserves. By using this type of small business financing, you can expand your business’s operations, increase revenue, and strengthen your market presence.

Commercial Real Estate Loans Pros and Cons

Commercial vs. Residential Real Estate Loans

There are some similarities between loans for commercial real estate and residential mortgages. But there are also key differences to be aware of before you commit to a loan for commercial property.

Commercial loans are used to purchase, develop, or renovate properties intended for business use, such as offices, retail centers, and industrial buildings. Compared to residential mortgages, CRE loans typically have shorter terms, higher interest rates, and larger down payment requirements. The approval process for commercial loans also tends to be more intensive, often requiring detailed business plans, financial statements, and proof of income from the property.

Residential loans are used to finance personal homes and usually come with longer terms, lower interest rates, and smaller down payments. Residential loans primarily focus on the borrower’s credit score and personal income.

How Do Commercial Real Estate Loans Work?

Loans for commercial real estate are among the many types of loans available to small businesses and are specifically meant to help business owners buy or renovate property. A commercial real estate loan is offered only to a business entity — an individual or group of individuals who form an organization to conduct a certain type of business and related activities. These entities can include:

•   S- and C-Corporations

•   Funds

•   Trusts

•   Limited partnership

•   Limited liability companies (LLCs)

Typically, the property itself acts as collateral for the loan (which may then be called a non-recourse loan). However, if a business doesn’t have strong credit, a commercial real estate lender may require the owners or principals in the business to guarantee the loan. This provides the lender with an extra layer of security if the business entity itself can’t repay the loan.

Eligibility Requirements

A few eligibility requirements that lenders typically look for are:

•  Credit score: Lenders often require a strong personal and business credit history to assess the borrower’s creditworthiness and ability to repay the loan. A higher credit score can lead to better terms and lower interest rates on CRE loans.

•  Business finances: Detailed financial statements, including profit and loss (P&L) reports, balance sheets, and cash flow statements, help lenders evaluate the business’s financial health and stability.

•  Collateral: Similar to a residential mortgage, a commercial mortgage is secured by the property itself. This reduces the lender’s risk and can influence the loan terms and interest rates offered.

•  Business plan: A comprehensive plan detailing how the property will be used to generate income is often required. This helps lenders understand the potential for success and the borrower’s vision for the property.

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

Loan Amounts

Loan amounts can vary depending on a few key factors:

•  Type of commercial real estate loan

•  Type of lender

•  Credit rating

•  Loan-to-value (LTV) ratio

•  Down payment amount

•  If the property is owner-occupied

The LTV ratio is particularly important because it assesses the value of the loan against the value of the property. To calculate LTV, lenders generally divide the loan amount by the property’s appraisal value. The average LTV range for commercial real estate loans is between 65% and 80%.

Interest Rates and Fees

It’s common for commercial real estate loans to have higher interest rates than a home mortgage, but they typically remain lower than other business financing options.

Additional fees may include:

•  Origination fees

•  Application fees

•  Closing costs

•  Appraisal fees

•  Prepayment penalties, if applicable

Loan Terms

Commercial properties can be a significant investment, and financing terms vary widely, ranging from a year for a short-term loan to 25 years with an SBA loan.

A key factor in loan terms is amortization, which typically exceeds the loan’s length, leading to a large final payment, or balloon payment, at the end.

For example, a five-year loan with a 30-year amortization period requires smaller installment payments but ends with a substantial balloon payment. If you’re unable to make this payment, securing additional financing may be necessary.

Common Types of Commercial Real Estate Loans

The type of commercial real estate financing you might seek depends on your business needs and eligibility. The different types may have different rates, terms, conditions, and purposes, depending on the lender. Here’s a look at some of the most common types of commercial real estate loans.

Commercial Mortgage

Commercial real estate mortgages are used to invest in properties for business purposes, such as retail, warehouse, office space, or storage. These mortgages are offered by traditional banks, government-backed lenders, life insurance companies, and hard money lenders.

A commercial mortgage can be beneficial for businesses needing a dedicated space for operations or inventory storage, and it can also build equity for future use. Something to keep in mind: These loans often have longer terms and involve larger amounts, making them riskier for lenders. As a result, the approval process can be time-consuming.

SBA 7(a) Loans

SBA 7(a) loans, offered by private commercial lenders who partner with the SBA, provide small business owners with flexible funds (up to $5 million) for various purposes, including non-real estate needs.

Qualifying for an SBA 7(a) loan can be challenging, requiring good personal credit, solid business revenues, and at least two years in business. Down payments typically start around 10% but can be higher depending on the lender’s specific requirements.

SBA 504 Loans

SBA 504 loans provide long-term, fixed-rate financing for renovating commercial real estate or purchasing equipment to help smaller, less-established businesses grow. They’re partially funded by certified development companies (CDCs), which are community-based nonprofits that help economic growth.

Businesses might choose 504 loans for their lower interest rates, longer terms, and lower down payments (around 10%). But these loans are meant for specific purchases, and businesses may be required to show proof of how funding was used. They cannot be used for working capital, inventory, or debt consolidation.

Recommended: Starting a Small Business

Bridge Loans

Bridge business loans are short-term commercial real estate loans with repayment terms ranging from six months to three years. They are used when a business cannot obtain a long-term loan, needs to refinance, or is waiting for other long-term financing.

Commercial bridge loans are ideal for covering small renovation costs or filling financing gaps while waiting for approval from another loan. The application process is typically faster than traditional loans. Note that bridge loans can be more expensive, so borrowers must ensure they can manage the higher costs before committing.

Construction Loans

Construction loans are used for building new structures or renovating existing commercial properties. They can be short- or long-term and are typically offered by banks, credit unions, or private investors through hard money loans.

These loans give borrowers flexibility with repayment and terms, covering costs for materials, labor, and other construction-related expenses. Because they are higher risk, lenders often require a down payment ranging from 10% to 30%, depending on the overall loan amount.

Land Development Loans

Land loans are commercial real estate loans used to purchase undeveloped land for future development, construction, or sale.

Business owners might choose a land loan if they need funding specifically for raw land, including making infrastructure improvements or creating subdivisions. Lenders often have requirements related to zoning, surveying, and land-use restrictions, and borrowing costs for less developed land may be higher than for improved land.

Mini-Perm Loans

Mini-perm loans are short term (three to five years) loans to help pay off income-producing construction or commercial properties or acquire investment properties until longer-term financing is available.

These loans are ideal for higher-risk projects when traditional financing isn’t initially an option. Mini-perm loans help establish payment history, which may also help to secure long-term business loans in the future. Because it’s riskier to lend to less-established businesses, lenders may charge higher interest rates. These loans assume the property will be profitable by maturity, so if projects exceed budgets or timelines, repayment can become challenging.

Hard Money Loans

Hard money loans are short-term commercial real estate loans based on property value rather than the borrower’s credit rating. The property acts as collateral, making these loans quicker and easier to acquire, which can be helpful for those with lower credit ratings or urgent funding needs.

These loans are usually offered by private lenders and have higher down payments and interest rates than traditional loans, with APRs typically ranging from 10% to 18%. Designed as short-term solutions, the high interest rates act as an incentive to pay back the loans as quickly as possible.

How to Apply for a Commercial Real Estate Loan

Applying for a commercial real estate loan requires careful preparation. You’ll want to look at various factors ranging from what the loan will be used for to how your eligibility will be assessed. Follow these steps to ensure you meet commercial property loan requirements:

1. Determine What the Loan Is for

You’ve decided to get a commercial loan, but what exactly is your commercial real estate loan best for? This is an important question since the answer may change the type of loan and lender you seek. Here are a few factors to consider:

•   Is the loan for renovations?

•   Are you planning to build a new structure?

•   If you’re making a purchase, what type of property are you purchasing: land for development, retail space, offices, storage?

•   Do you need to pay for labor and materials?

•   What is your budget?

•   Do you have other sources of funding?

2. Choose the Type of Commercial Real Estate Loan

After you determine what you’ll use the commercial loan for, you’ll be better prepared to research and choose a commercial real estate loan type. Some lenders offer specific types of commercial loans, which may limit how you can use the funds. A few examples of commercial loans are:

•   Construction loans

•   Commercial mortgage loans

•   Land development loans

•   Refinance loans

•   Hard money loans

•   SBA loans

3. Assess your qualifications

Each lender will have different eligibility requirements that may include:

•   Strong personal and business credit scores

•   A debt-service coverage ratio (DSCR) of 1 or higher

•   Down payment

•   A LTV of 65% to 80%

•   Healthy business revenue

•   Approved property type for the type of loan you’re applying for

4. Find a Lender

Use the information you’ve gathered about what you need the commercial loan for, what type of loan best aligns with your needs, and what commercial loan you may qualify for to search for lenders. Potential lenders can include banks, credit unions, and online lenders.

5. Prepare Your Loan Application

Commercial real estate loans typically require significant documentation to show lenders you’re a good candidate for the loan. While hard money loans may be faster to get and require less documentation, in general, it will help to have the following ready when you apply:

•   Up to five years of tax returns

•   Business financial records for up to five years or since your business was established

•   Credit reports for business and all owners/partners

•   Cash flow projections

•   Business plan (to show the property’s intended use)

•   Identifying information (which may include citizenship)

•   Third-party property appraisal

•   Historical income and expenses for the property

Depending on the lender and loan type, the application and approval process can take some time, so it’s important to be patient.

Alternatives to Commercial Real Estate Loans

If a commercial real estate loan doesn’t seem like it’s the right fit for your business, here are some other types of financing you may want to consider.

•  Restaurant loans: These loans help cover costs associated with starting or expanding a restaurant business.

•  Franchise financing: A franchising loan can help with costs involved with opening a franchise location. There are franchise companies that specialize in these types of loans.

•  Merchant cash advance (MCA): A merchant cash advance gives borrowers cash up front with an agreement that the lender will take repayment as a percentage of the borrower’s future credit card sales.

•  Invoice factoring: Invoice factoring gives borrowers cash up front in exchange for unpaid customer invoices. The factoring company (lender) is then responsible for collecting on unpaid invoices.

•  Business line of credit: A business line of credit is a common short-term loan option where borrowers receive a set credit limit and can borrow up to that maximum, paying interest only on the money withdrawn.

•  Personal business loans: In some cases, you may be able to use a personal loan to buy or renovate commercial real estate or make other business-related purchases.

The Takeaway

A commercial real estate loan can help finance the acquisition, development, and construction of a commercial property. This type of loan is available through several sources, including traditional banks, online lenders, and private investors, offering diverse options to meet your business needs.

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.

Photo credit: iStock/ljubaphoto

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

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

SOSMB-Q324-025

If you own a small business that frequently issues invoices to customers and vendors, you may have encountered times when an invoice is late or goes unpaid. It can be frustrating and worrisome when expected income is unavailable, leaving your business short on cash flow for necessary expenses.

There are options like business lines of credit or short-term business loans to provide cash flow. But in this case, you might also consider invoice factoring to quickly access cash for your immediate needs. This type of financing allows you to leverage your unpaid invoices without applying for an actual loan.

Let’s walk through what invoice factoring is, how it works, and what business cases are a good fit for this type of funding.

What Is Invoice Factoring?

Invoice factoring, also known as accounts receivable factoring, is a form of small business financing in which you sell your unpaid invoices to a factoring company. The factoring company gives you a percentage of the invoice up front and pays you the rest of the invoice once it’s paid by the customer (minus fees charged by the factoring company).

With this type of financing, you no longer own the invoices — the factoring company does. As a result, it’s important to choose a reputable company that you can trust to treat your customers with respect.

What Is a Factoring Company?

A factoring company is a financial institution that purchases a business’s outstanding invoices at a discount to provide immediate cash flow. The factoring company then takes on the responsibility of collecting payments from the business’s customers.

Factoring companies can be independent firms or divisions within larger financial institutions such as banks or credit unions. They specialize in providing working capital to businesses with long receivables cycles or that need quick cash for operational expenses. By selling your invoices to a factoring company, you can receive up to 90% of the invoice value up front. The company pays you the remaining balance, minus a factoring fee, once the customer settles the invoice.

Factoring companies typically cater to industries with extended payment terms, such as manufacturing, trucking, and staffing agencies. These lenders evaluate the creditworthiness of the business’s customers rather than the business itself, making this an accessible funding option for businesses that have poor or limited credit.

How Does Invoice Factoring Work?

Invoice factoring involves selling your unpaid invoices to a factoring company, which then takes ownership of the invoices. Invoice factoring is technically not a business loan, as you are selling your invoices to the lender.

Factoring companies will pay you a percentage of the invoice amount up front, which reflects the advance rate. Advance rates are typically based on how risky the invoice factoring is for the factoring company.

Some industries, such as the medical industry, may be seen as higher risk, thus offering lower advance rates — often ranging from 60% to 80%. Other types of businesses, such as staffing agencies, may receive advance rates from 80% to 90%.

Once the factoring company receives full payment from your customers, they provide you with the remaining invoice amount minus a factoring fee.

Here’s a quick look at the steps involved in factoring invoices:

1.   Choose a factoring company: It’s a good idea to shop around and pick a reputable company to work with.

2.   Submit invoices: To apply for factoring, you’ll need to provide invoices for approval.

3.   Receive advance: If approved, you’ll get an upfront payment (typically 60%–90% of invoice value).

4.   Company collects payments: The factoring company collects payments from your customers.

5.   Receive balance: After full payment is collected, you receive the remaining amount minus fees.

Recommended: Getting a Cash Flow Loan for Your Small Business

Recourse vs. Non-Recourse Factoring

You might be wondering: What happens if customers don’t pay their invoices?

With recourse factoring, the business is liable for paying the factoring company for any invoices that are left unpaid. This type of invoice factoring is most common because it’s less risky for the factoring companies.

With non-recourse factoring, the factoring company takes on most of the risk associated with unpaid invoices. Since the invoice factoring company is assuming more risk with non-recourse factoring, they may tack on a higher factoring rate. Carefully consider whether the higher rate is worth the cash advance amount and compare factoring companies to see what terms they offer.

Example of Invoice Factoring

To give you a better understanding of how invoice factoring works, let’s imagine you own a clothing store that sells large quantities of T-shirts to other companies.

1.   Complete sale and issue invoice: You sell $100,000 worth of t-shirts and invoice your customer with a due date in 60 days. If you wait 60 days for repayment, your business could be left with a cash flow shortage, threatening the well-being of your operation. So, you decide to look into options to help manage cash flow.

2.   Explore your options: You could use an online business loan or a credit card to get cash quickly. But your customers are reliable and pay invoices in a timely manner, so invoice factoring is a suitable option.

3.   Sell to a factoring company: You sell the $100,000 invoice to a factoring company and agree to pay a flat factoring fee (sometimes called a factoring rate) of 5% of the invoice value per month. Within 24 hours, the factoring company provides you with 80% of the invoice amount. You now have $80,000 to supplement cash flow and regular business operations.

80% of $100,000 = $80,000

4.   Collection of funds: The customer pays the factoring company within 30 days. Once it receives full repayment, the factoring company pays you for the remaining invoice amount ($20,000) minus the factoring fee of 5%.

$20,000 – $5,000 (5% of $100,000) = $15,000 back to you

Keep in mind that this hypothetical is an example to illustrate how invoice factoring may work in a practical situation. Different invoice factoring services may offer various terms and conditions, which can affect how much money you receive up front and the final payment amount.

Invoice Factoring Rates and Fees

Invoice factoring companies generally make money through the factoring rates and fees they charge. Typically, you will see invoice factoring structured with one of the following:

•  Flat rate/fee: You pay a fixed percentage of the invoice to the factoring company. The rate doesn’t usually change — even if the customer pays late. Flat rates are generally less common than tiered or variable rates.

•  Tiered or variable rate/fee: A percentage of the invoice amount is regularly charged until the factoring company receives full repayment. The longer invoices go unpaid, the more you’ll owe in factoring fees. For example, a factoring company may charge a factoring fee of 1% every 10 days until the invoice is paid; if it takes your customer 60 days to pay, the factoring company would keep roughly 6% of the invoice amount. Some factoring companies may increase the variable rate the longer repayment takes.

Factoring rates and fees can be affected by:

•  The industry your business is in

•  Your customers’ ability to pay their invoices

•  The number and amounts of the invoices

•  Your business’ stability and creditworthiness

Additional Fees

Some factoring companies may also charge additional fees, including:

•  Application fees. These are charges for processing your application and setting up the account.

•  Invoice processing fees. These fees help cover the cost of things like credit checks and record keeping.

•  Service fees. These are charged in intervals to cover costs related to maintaining a current account with your factoring company.

•  Automated Clearing House (ACH) or bank wire fees. When funds are transferred between banks, there may be fees passed on to you from the factoring company.

•  Early termination fees. Some invoice factoring companies may charge a fee if you cancel your contract before the termination date.

•  Due diligence fees. This covers the cost of verifying the creditworthiness of the customers paying the invoices.

Invoice Factoring vs. Invoice Financing

While they sound similar, invoice factoring and invoice financing are two different financial products.

With invoice financing, your invoices are used as collateral to receive a cash advance rather than sold to a factoring company. You receive access to a percentage of the invoice amount either in the form of a line of credit or loan. Like other types of business loans, you pay interest on the amount you borrow.

Another key difference between invoice factoring and invoice financing: With invoice financing, you and your business are still responsible for collecting payment from your customers. As a result, invoice financing allows you to retain control over your invoices and the collections processes, which may be more favorable if you prefer to deal with your customers directly.

Pros and Cons of Small Business Invoice Factoring

Invoice factoring can be a useful tool for business owners in certain situations. However, it’s important to carefully consider the pros and cons of factoring invoices to avoid unnecessary expenses or added stress for your business.

Pros of Invoice Factoring

•  No collateral: With invoice factoring, your invoices serve as collateral. In most cases, you do not have to offer additional forms of collateral to be approved.

•  Maintain healthy cash flow: You can receive immediate cash to cover expenses and maintain healthy cash flow between invoice payments.

•  An option for those with lower credit scores: Even if you don’t have good enough credit to get a business loan, invoice factoring may still be an option. Invoice factoring companies generally focus more on the value of the invoices and the credit scores of the businesses that owe those invoices than on the credit score of your business.

•  Outsource invoice collection: FFor some businesses, it may be helpful to pass the responsibility of collecting invoices to a factoring company so they can focus on other responsibilities.

•  Spend on what you need: Unlike other types of small business loans (e.g., equipment financing), you aren’t restricted to spending the funds you receive on specific business expenses.

Cons of Invoice Factoring

•  Factoring companies have control: After you sell invoices to a factoring company, they may interact with your customers directly. You’ll want to make sure that the company is reputable and behaves ethically in their dealings with customers.

•  It’s typically expensive: With various fees and relatively high rates, invoice factoring can be costly — especially if customers delay payment.

•  Recourse if unpaid: Since there’s no guarantee that an invoice factoring company will be able to collect on unpaid invoices, they may expect you to pay for or replace the invoice, possibly with additional fees.

•  Approval may depend on customers: Invoice factoring companies want to ensure they will receive payment on the invoices they purchase from you. If your customers have a less-than-perfect repayment history, you may have a more difficult time getting approved.

Recommended: Working Capital Loans: Compare Top Options

How Do Businesses Qualify for Invoice Factoring?

Factoring companies evaluate a few different things to determine if a business is eligible for this type of financing.

•  Invoices: Businesses must have outstanding invoices to sell to a factoring company, and the invoices should be from reputable clients with a history of timely payments.

•  Client creditworthiness: Factoring companies focus on the likelihood of timely payments from your clients rather than the credit history of your business. Therefore, clients that consistently pay their invoices on time are a must.

•  Business bank account: An established business bank account is essential to qualify for invoice factoring. Your business bank account will be used for the factoring company to deposit the advance and the remaining balance once the invoice is paid.

•  Accounts receivable reports: Detailed and accurate accounts receivable reports are necessary to demonstrate your business’s invoicing practices and the payment behavior of your clients. These reports help factoring companies assess the risk involved.

While the primary focus is on the creditworthiness of clients, factoring companies also look for signs of business stability. They consider factors like time in business, industry, and overall financial health. It’s also important for businesses to ensure there are no existing liens on their receivables. Factoring companies need a clear right to collect on the invoices, so any existing liens or claims can disqualify the business.

You can improve your chances of qualifying by maintaining good relationships with your clients, ensuring they are creditworthy and have good payment histories. Keeping financial records organized and accurate is also important, as it makes the evaluation process smoother and faster.

Alternatives to Invoice Factoring

Invoice factoring is one of many options that can help businesses maintain cash flow and address funding needs. Here’s a look at some alternatives.

•  Inventory financing: This type of financing is used to pay for products that will be sold at some time in the future. The inventory acts as collateral for the loan.

•  Equipment financing: This is a type of loan used specifically to purchase machinery, vehicles, or other business-related equipment.

•  SBA loans: These are small business loans backed by the U.S. Small Business Administration (SBA) and offered by banks and approved SBA lenders.

•  Personal loans: An unsecured personal loan is based on your personal credit history (not business credit). Some, though not all, lenders will allow you to use funds from a personal loan for business expenses.

•  Commercial real estate loans: This type of business loan is specifically designed for purchasing real estate for business use, such as an office space, warehouse, or storefront.

•  Business line of credit: With this flexible form of business financing, you have access to a maximum amount of funding, or credit. You can borrow what you need (up to your credit limit) as you need it, and only pay interest on what you borrow.

•  Online business loans: Online lenders offer loan options similar to those traditional banks offer but typically have a faster approval process and may have more options for people with lower credit scores.

•  Merchant cash advance: This type of funding allows small businesses (“merchants”) to get a cash advance for business expenses in return for a portion of their future sales or receivables.

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 are the disadvantages of invoice factoring?

The disadvantages of invoice factoring include high fees, potential impact on customer relationships, loss of control over accounts receivable, and the requirement of having creditworthy clients.

What is the average rate for invoice factoring?

The average rate for invoice factoring ranges from 1% to 5% of the invoice value per month.

Who can use invoice factoring?

Generally, any business with outstanding invoices and creditworthy clients can use invoice factoring. However, this type of financing tends to be more common in industries like manufacturing, trucking, and staffing.

Photo credit: iStock/Jirapong

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