Business loans come in various types, each designed for a specific need and offering unique features. Below are some of the most widely used loan options for businesses.

1. Accounts Receivable (AR) Loans

When customers take time to pay their invoices, it can restrict cash flow and leave a business short on working capital. Any company that offers credit terms will naturally have an accounts receivable balance at the end of each month. For instance, if your invoices allow customers to pay within 10 days, sales made near the end of the month won’t turn into cash until the next month.

Small businesses that supply larger companies often face challenges getting their clients to follow agreed payment terms. One example is a wood-processing plant in Mississippi that supplied products to utility companies and railroads. Although these customers were reliable and not credit risks, their payments usually arrived 45 to 60 days after invoicing, which caused major cash flow issues. A revolving accounts receivable loan helped stabilize the business by advancing cash against those outstanding invoices.

Banks generally like AR loans because the receivables eventually turn into cash, which helps repay the loan. Typically, banks will lend 70% to 80% of the receivables that are less than 60 days old. Some lenders use tiered percentages based on invoice age—for example, 90% for invoices under 30 days, 75% for those 30–60 days old, and 50% for those 60–90 days old. Invoices older than 90 days are rarely accepted as collateral.

With a standard AR loan, the business submits its receivable schedule to the bank and receives the eligible cash advance. As the month progresses, existing invoices get paid while new invoices are added. At month-end, the total receivable balance is recalculated.

• If the new balance is higher than the previous month, the bank releases more funds (minus interest).
• If the balance drops, the business repays the difference plus interest.

This process repeats monthly, resulting in a continually adjusting loan balance.

Some banks manage the collections directly by requiring all customer payments to be deposited into a dedicated account they control. Others allow the business to continue collecting payments, as long as the company provides accurate updates and maintains enough cash for any required loan payments.

Besides the receivables themselves, lenders often request personal guarantees from the business owners as additional security.

2. Inventory Loans

Most businesses rely on a steady supply of raw materials or finished goods to operate smoothly. Manufacturers can’t produce without raw stock, and retailers can’t serve customers if their shelves are empty.

In our wood-treatment business, large amounts of capital were tied up in pre-cut timber poles and green wooden railroad ties. These items were essential for replacing damaged utility lines, and demand surged after storms. To stay competitive, we needed inventory ready to ship immediately. If the correct pole size wasn’t available, customers would quickly turn to a competitor. Over time, the value of our inventory even surpassed the book value of the facility.

Just like unpaid invoices, inventory can restrict cash flow because it sits idle until sold. We continually had green lumber waiting for treatment and finished poles waiting for buyers. To improve liquidity, we arranged a series of short-term loans secured by our inventory.

However, inventory-backed loans are harder to obtain than accounts receivable loans. Lenders consider inventory riskier, especially if it still requires processing before it can be sold. As a result, most banks lend only about 50% to 60% of finished inventory value, and even less for raw materials or work-in-progress—if they accept those at all.

An inventory loan functions much like an AR loan: the loan amount shifts monthly as the value of eligible inventory rises or falls.

• If the inventory value increases, the lender advances additional capital.
• If it decreases, the business must repay the difference.

For example, our lender agreed to finance 50% of finished inventory and 40% of green lumber. In the first month, we held $250,000 in treated products and $140,000 in green lumber, giving us a borrowing base of $181,000. By the next month, after selling finished goods, converting green lumber to treated stock, and purchasing new materials, the inventory mix changed to $175,000 in finished goods and $185,000 in green lumber. The recalculated loan value came to $161,500, requiring us to repay the prior balance and take out a new loan—resulting in a net payment of $19,500, plus interest.

Lenders typically require periodic physical inventory counts to verify the values recorded in the company’s books. Depending on the loan agreement, the bank may demand more frequent counts than the company normally performs, increasing administrative workload.

As with AR loans, business owners are usually asked to personally guarantee inventory-backed loans. Online lenders such as OnDeck can be a good option for established businesses, while newer companies or owners with lower credit scores may find Fundera more accessible.

3. Equipment Loans

Equipment loans are financing arrangements secured by the machinery or tools a business purchases using the loan funds. These loans typically run for three to eight years and are repaid through scheduled installments that cover both interest and principal. Throughout the loan term, the lender—whether a bank, manufacturer, or financing company—retains legal rights to the equipment and can repossess it if the borrower defaults.

Depending on the lender’s policies and the collateral’s value, business owners may also be required to provide personal guarantees.

Borrowers must keep the equipment in proper working condition and carry insurance that covers liability and property damage. As the loan is paid down, the business gradually builds equity in the financed asset. This growing equity may allow the company to refinance the existing loan or take out an additional loan secured by the same equipment. Any second loan, however, is considered subordinate, meaning the original lender has the first claim on the collateral. Because of this added risk, subordinate lenders typically charge higher interest rates.

In our wood-treatment facility, we regularly used equipment loans from truck manufacturers to finance new trucks and trailers. We often obtained 100% financing and repaid these loans over three years. Since heavy-duty trucks tend to depreciate more slowly than regular vehicles, their market value often remained higher than the outstanding loan balance. This extra value provided additional collateral if we needed to secure other financing.

For businesses with less-than-perfect credit, lenders like Currency may be a suitable option for equipment loans. If fast approval is a priority, OnDeck can fund equipment financing within 24–48 hours.

4. Real Estate Loans

Real estate loans are backed by physical property—such as land, buildings, or commercial facilities—listed in the mortgage or loan agreement. These loans generally have long repayment periods, often 15 to 30 years, with the balance paid down gradually through amortized monthly installments. Lenders typically finance 70% to 90% of the property’s appraised market value at the time of purchase.

For small business owners, it’s important to carefully evaluate whether buying property is more cost-effective than renting or leasing. Ownership comes with long-term financial commitments, maintenance responsibilities, and reduced flexibility. If the business grows and requires relocation, selling or repurposing the original property can be difficult—and may even slow down expansion plans.

5. Working Capital Loans

Businesses with strong equity positions, consistent profitability, or owners with high personal net worth may qualify for unsecured working capital loans from banks or financial institutions. These loans may be structured with regular amortized payments or as a lump-sum repayment at the end of the term, depending on the agreement between the lender and borrower. Working capital financing is designed to manage short-term cash flow gaps, not to purchase assets or long-term investments.

Because unsecured loans lack specific collateral, they carry more risk for lenders. If a business fails or enters bankruptcy, unsecured creditors are paid only after secured lenders have been fully compensated. Due to this increased exposure, unsecured working capital loans usually come with higher interest rates.

6. Letters of Credit

A letter of credit (LC) is a financial arrangement in which a bank or financial institution guarantees that funds will be available to a borrower in the future. Instead of issuing a traditional loan upfront, the lender charges a fee—usually 1% to 5% of the guaranteed amount—for providing this short-term commitment. The borrower can draw funds only if and when the money is needed.

Using an LC instead of a standard loan can be more cost-effective because interest is charged only on the amount actually withdrawn, not on the full guaranteed sum. Additionally, since the LC represents a contingent liability, it does not appear on the company’s balance sheet until funds are drawn. This allows the business to maintain a cleaner financial profile with lower reported debt.

As the borrower accesses portions of the guaranteed funds, the lender’s remaining obligation decreases. The LC expires either when the entire guaranteed amount has been advanced or when the specified term ends. Any money drawn through the LC is then treated like a regular loan, following the repayment terms negotiated beforehand and often documented under a separate agreement.

7. SBA Loan Program

To help small businesses that struggle to secure traditional financing, the federal government offers several support programs—most notably the Small Business Administration (SBA) loan guarantee program. Under this program, the SBA guarantees up to 85% of the loan amount, significantly lowering risk for lenders and encouraging them to work with smaller or less-established companies.

However, borrowers should be aware of certain drawbacks associated with SBA-backed loans:

• Limited Participating Lenders: Only a select group of banks and financial institutions are approved to issue SBA loans, which can limit a borrower’s options.
• Extensive Application Requirements: The SBA approval process demands detailed financial records, business plans, and documentation—often more complex than traditional loan applications.
• Restricted Use of Funds: Loan proceeds must be used strictly for SBA-approved purposes, such as working capital, inventory, equipment purchases, or certain types of real estate.
• Proof of Repayment Capability: Applicants must demonstrate strong management experience, a solid credit history, and adequate equity—typically 25% for startups and 20% for existing businesses.
• Mandatory Personal Guarantees: Any owner with a 20% or greater stake—individually or jointly with a spouse—must personally guarantee the loan. Each guarantor is fully responsible for the entire loan amount, regardless of their ownership share.

The SBA loan program was worth the additional documentation and processing time. When we purchased our wood-treating facility, new EPA regulations required substantial upgrades. Our local SBA-approved bank provided a $500,000, 10-year 7(a) loan, which allowed us to complete the necessary improvements, and we repaid it without difficulty.

While some business owners prefer the flexibility of conventional lending relationships, SBA financing can be a lifeline for companies with limited credit, insufficient collateral, or early-stage financial challenges.

Pros of Small Business Loans

Using debt wisely can be an effective financial strategy for small business owners. When managed responsibly, business loans offer several important advantages:

• Faster Access to Capital:
  Compared to raising equity, securing debt financing typically takes less time. Borrowers usually work with a single lender that has established underwriting and funding procedures. Equity financing often requires approaching multiple investors, each with their own evaluation and approval processes.
• Simple Administrative Process:
  Applying for a loan generally involves completing standard forms and submitting financial documents. In contrast, equity financing may require frequent performance updates, shareholder meetings, and board approvals before certain business decisions can be made.
• Ownership Stays Intact:
  Borrowing does not require giving up a share of your business. Lenders do not participate in profits or losses, allowing owners to maintain full control of the company’s future earnings.
• Full Management Control:
  Lenders are not involved in day-to-day decisions. Their only concern is that loan terms are honored, leaving operational, financial, and personnel decisions entirely in the hands of the business owner.
• Predictable and Transparent Terms:
  Loan conditions—such as interest rate, repayment schedule, total amount borrowed, and collateral requirements—are clearly defined from the start and remain consistent throughout the loan’s term.
• Tax Advantages:
  Interest paid on business loans is typically tax-deductible. This tax benefit lowers the effective cost of borrowing and reduces the business’s overall taxable income.

Pros of Small Business Loans

Although debt can be a valuable tool for small businesses, it carries certain responsibilities and risks. Business owners should consider the following potential drawbacks:

• Repayment Reduces Future Cash Flow:
  While loans provide immediate funds for operations or growth, repaying the debt requires cash that could otherwise be reinvested in the business or distributed to owners as dividends.
• Rigid Repayment Terms:
  Loan conditions—such as interest rate, payment schedule, and total repayment amount—are set when the loan is issued. Lenders are typically unwilling to modify these terms unless offered additional incentives, such as higher interest, extra collateral, or influence over the company’s cash management.
• Lenders Prioritize Repayment Over Business Health:
  Even if a lender is courteous during the borrowing process, they are not partners in the business. Their primary concern is recovering the loan. In difficult times, this can lead to pressure or enforcement actions that may jeopardize the company’s survival.

Conclusion

Small business loans can be a powerful tool for managing cash flow, expanding operations, and acquiring essential assets. When used wisely, they provide speed, flexibility, and opportunities for growth while allowing business owners to retain control and ownership. However, loans also come with obligations, including fixed repayment schedules and potential impacts on cash flow, making careful planning essential. By understanding the different types of financing—ranging from accounts receivable and inventory loans to SBA programs and letters of credit—business owners can choose the solutions that best align with their financial needs and long-term goals. Ultimately, responsible borrowing can support business growth, enhance operational efficiency, and help companies thrive in competitive markets.