When you’re starting a new business or expanding an existing one, you may find that funding is one of the biggest hurdles to overcome. While bootstrapping is an option, it’s not always necessarily realistic when cash supplies run short. Small business grants or loans, however, can help close many financial gaps for business owners.
Whether you decide to use a grant or a loan – or a combination of both – may depend on where you are in your business’s life cycle, what your needs are, and what type of funding you’re able to qualify for. To determine the best financing approach for your business, it’s important to understand the differences between loans vs. grants.
What Are Business Loans?
A small business loan is a sum of money that a financing institution, such as a bank, credit union, or online lender, extends to a small business with the expectation that it will be paid back over time, plus interest. The proceeds from the loan can be used for nearly any business purpose, and the repayment term typically ranges between five and 10 years.
How Business Loans Work
For a secured small business loan, you need to put up a business asset (such as equipment, a vehicle, or real estate) as collateral for the loan. Should you become unable to repay the loan in full, the lender can seize that collateral to recoup their losses.
Unsecured business loans don’t require the borrower to pledge collateral, and are based only on a borrower’s creditworthiness. In some cases, you may be asked to sign a personal guarantee for a business loan, which states that you are personally responsible for repaying the loan should your business default.
For a standard term business loan from a bank, you will generally pay a fixed amount each month (including principal and interest) for the duration of the loan term.
Pros of Business Loans
There are a number of benefits to taking out a small business loan. Here are a few to consider.
• Expedite business growth: The funds from a business loan can allow you to put your plans into action sooner, rather than having to wait until your business has generated enough profit to fund expansion yourself.
• Maintain business ownership: With a loan, you can get an injection of capital without bringing on any investors. This enables you to keep full control of your business and retain all the profits as your company grows.
• Flexible use of the funding: If you receive funding from an investor or a grant, you may be limited in how you can use the money. When you borrow from a lender, so long as the loan isn’t specifically for business equipment or real estate, there are typically no restrictions on how you can spend those funds.
Cons of Business Loans
Small business loans also have some downsides. Here are some to keep in mind.
• Application process can be extensive: For a bank or Small Business Administration (SBA) loan, you’ll not only need to fill out an application, but will also likely need to provide two or three years of tax returns and financial statements, as well as a business plan.
• You could lose assets if you default on payments: If you put a business asset up for collateral, you could end up losing it should you default on the loan. If you sign a personal guarantee, the lender can potentially come after your personal assets.
• Interest rates can be high if you don’t have strong credit: Interest rates typically depend on your credit score, both your business’s score as well as your personal score. While banks often offer lower interest rates than other funding options, it’s not always easy to qualify for those favorable rates. If you have a below-average rating, you could end up paying more for the loan than you’d like.
What Are Business Grants?
Small business grants provide funding to businesses without any requirement that the money be paid back. It is essentially free money that’s provided to business owners who meet specific criteria and agree to use the money for a certain purpose. There are grants available for all types of small business owners, including women, minorities, veterans, and disabled Americans.
How Business Grants Work
Typically, a grant becomes available when a government agency, nonprofit organization, or private business chooses to set aside grant money for a particular need or area of concern. For example, a grant might be set up to encourage minority entrepreneurship in a community, foster research and development in a specific industry, or reward innovation.
Whatever the cause, the agency or business will start a grant by setting aside funds and setting up qualifications and an application process. Unlike loans, grants can’t be spent in any way the business sees fit. The funds must be used as specified in the application.
Pros of Business Grants
Grants have many benefits. Here are some to consider.
• It’s free money: The biggest advantage of a grant is that, unlike a loan, the money does not have to be repaid.
• Accessible information: There is extensive information available online about where, how, when, and who to get grants from. This is important, because you generally need to do a lot of searching to find the right grant for your business. (Two good places to start: grants.gov and the SBA’s grant page.)
• Gain credibility: Receiving a grant increases your business’s visibility. It helps promote your business and idea and lets others know that your work is important. And, once you’ve been awarded one grant, you are generally more likely to receive others, since other organizations will see you as a reliable candidate.
Cons of Business Grants
Grants do have some downsides, however. Here are a few to keep in mind..
• Applications can be time-consuming: Grant applications usually require a lot of paperwork. In addition to the application, you and your small business will also have to provide additional documentation, such as demographics of your market, your specific reasons for applying for the grant, and exactly how you will use the grant funds.
• Difficult to receive: Because grants are free money, there are a large number of small businesses like yours trying to get them. As a result, competition for grant approvals can be stiff.
• Strings attached: Grant money typically comes with specific restrictions and conditions about how they money should be used. In addition, you may be asked to do monthly or quarterly check-ins to provide proof of things such as marketing efforts, publicity, and other steps toward goals outlined in the grant.
Business Loans vs Grants: 7 Important Differences
The biggest difference between a loan and a grant is that a loan must be repaid, and a grant does not. But there are some other things that set them apart from one another. As you explore small business financing possibilities, here’s a closer look at grants vs. loans.
1. Grant vs. Loan Eligibility Requirements
Grants
Small business grants can come from nonprofit organizations, for-profit organizations, and government agencies. Note that the federal government doesn’t make grants (or loans) to businesses directly but assist with programs that do.
Each organization offering a business grant can establish criteria to determine who qualifies. Only businesses operating in select industries and locations or whose owner meets specific demographic requirements may be eligible for specific grants. For example, some organizations may exclusively offer small business grants for women. Others may provide small business grants for minorities. Still others may cater to veterans or disabled entrepreneurs, or businesses that operate in certain industries or communities.
While a lot depends on your business’s industry, focus, and location, it can generally be tougher to qualify for a grant than for a loan.
Loans
With small business loans, lenders are more interested in the fundamentals of the business and the business’s (and business owner’s) financial health. For example, when you’re applying for a small business loan lenders may review your:
• Business credit score
• Personal credit scores
• Personal income or business income
• Profit and loss statement
• Cash flow statement
• Business or personal assets
Recommended: Typical Small Business Loan Fees
2. How Grant vs. Loan Funding Can Be Used
Another important difference between grant and loan options for small business has to do with how you can put the funds you receive to work.
Grants
Small business grants often come with restrictions for how the funds can be used. For example, you may be able to use a grant only to fund efforts to grow your business. Or, some grants may limit you to expenses related to the cost of starting a brand-new business from the ground up.
Loans
With a small business loan, you generally have a lot of control over what you do with the money. For example, you might use a small business loan to upgrade your computer equipment, purchase business vehicles, or open a second business location.
If you’re looking for more flexibility in how you can spend funding, then a small business loan may be a more useful option than a small business grant.
3. Funding Amounts
When considering grants vs. loans, it’s important to understand how much money you may be able to access.
Organizations that make grants to small businesses can limit how much they offer. So for example, you might be limited to receiving $5,000 or $10,000, though some may offer $25,000 or more. The upside is that you don’t have to pay grant money back. However, that money may not be enough to fully meet your funding needs.
With small business loans, lenders can typically set the borrowing limit much higher. SBA 7(a) loans, for example, have a maximum cap of $5 million.
4. Repayment Requirements
As mentioned, the chief difference between a grant and a loan is that a loan has to be repaid while a grant typically does not. But it’s also important to note that small business loans are not all identical when it comes to their repayment requirements.
Short-term loans, for example, may have repayment periods lasting less than one year. Long-term loans may have repayment periods extending over several years. With SBA 7(a) loans you can take up to 25 years to repay what you borrow, depending on what you’re using the loan proceeds for.
5. The Application Process
Regardless of whether you decide to pursue a loan or a grant, you’ll have to apply for it. There are some differences to consider when it comes to applying for a small business loan vs. applying for a grant.
For loan funding you’ll need to meet the lender’s criteria for things like credit score, revenues, and time in business. As you compare small business loan options, it’s wise to take time to check the minimum qualification requirements carefully to weed out loans that you’re less likely to qualify for. Bank and SBA loans typically have stricter qualification requirements than loans from online lenders.
When you’re applying for a small business grant, your business’s financial situation may be less relevant. But it’s key to make sure that you understand the eligibility requirements for the grant and that you meet them before applying. Small business grants meant for women, for instance, generally require businesses to have one or more women owners. Depending on the grant, you will likely be asked to show proof of your eligibility, so bear that in mind.
While some grant applications can be simple, others require writing a grant proposal, which can take weeks to complete.
6. Interest
With a business loan, the interest rate represents the amount you will pay back to the lender on top of principal; it’s usually calculated as a percentage of the total amount borrowed.
Business loan interest rates can vary widely depending on the borrower’s financial history, the lending institution, and what’s happening in the economy.
Annual percentage rate (APR) is the total cost of a loan, including the interest rate and any added fees (such as an origination fee and application fee), and is generally the best measure for understanding and comparing business loan interest rates.
Interest rates on small business loans may be fixed (the interest rate remains the same over the life of the loan) or variable (the rate will change based on current market rates at a predetermined date).
Recommended: APR vs Interest Rate: What’s the Difference?
7. Availability
When debating whether to pursue a loan or grant, you may want to consider how quickly you need the capital. Grantors typically take much longer to approve applications and disburse funds than lenders do. If you need money immediately, a loan may be the only option. Keep in mind, though, that SBA and bank loans can also take a few months to fund. Loans from online lenders, however, often take just a few days to process.
Here’s a side-by side comparison of business grants vs loans.
| Business Grants | Business Loans | |
|---|---|---|
| Eligibility requirements | Varies with grant | Lenders may require a certain number of years in business, minimum annual revenue, and minimum credit score |
| How funds can be used | Specified | Flexible |
| Funding amounts | Can range from $1,000 to $25,000 | Amounts will depend on a borrower’s qualifications, but SBA loans can offer as much as $5 million. |
| Repayment | None | Must be repaid by a certain date |
| Application process | Can be extensive, depending on the granter | Can be extensive, depending on the lender |
| Interest | None | Interest rate varies |
| Availability | Limited | Many |
Choosing Between Business Loans vs Grants
What makes the most sense for your small business depends on a lot of variables that are unique to your situation. As you’re making your decision, some questions you may want to ask yourself might include:
• Can I earmark these funds for a specific purpose?
• How much money do I need?
• Are there any grants for which my small business is eligible?
• Will my business be able to pay back these funds?
• Do I have the time to search out and apply for grants?
• Do I have a personal or business credit score that will allow me to get good terms on loans?
Finding the right option for your small business can take some time. Just remember, you may be able to combine options if that makes the most sense for you – taking out a loan to ramp up inventory, for example, while applying for a grant to help you launch a new product.
Different Types of Grants and Loans
There are myriad different type of grants, including:
• Federal business grants
• State business grants
• Local business grants
• Small business relief grants
• Corporate business grants
• Specialty business grants
There are also many different types of business loans. These include:
• Term loans
• SBA loans
• Business line of credit
• Equipment loan
• Invoice factoring
• Merchant cash advance
• Microloan
EIDL Grants vs Loans
While the SBA’s COVID EIDL (Economic Injury Disaster Loan) is no longer available, the SBA continues to offer EIDLs to small businesses located in a declared disaster area, These loans are designed to help small businesses that have suffered economic losses due to a disaster such as a severe storm, flooding, or wildfire get back on their feet.
You can apply for a non-COVID EIDL relief loan through the SBA. The loan amount will be based on your actual economic injury and your company’s financial needs, regardless of whether the business suffered any property damage.
The Takeaway
Choosing between grants and loans ultimately comes down to knowing what your business needs are and what type of funding fits best in your overall financial strategy. Remember that you can combine more than one option – and that your needs may change over time.
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
Are grants better than loans for businesses?
It depends. Grants are better than loans in that they do not need to be paid back. However, grants can be difficult to get, may require an extensive application process, and typically come with restrictions on how you can use the money that’s awarded.
Is it harder to apply for business grants or loans?
It can be. While the application process varies considerably from grant to grant, in some cases. you will be required to submit a formal grant proposal which could take weeks to prepare.
Are you supposed to repay business grant money?
No, business grant money does not need to be paid back.
Photo credit: iStock/MicroStockHub
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