No matter how hard you try to plan ahead, unexpected business expenses can happen to even the most organized small business owner. A piece of equipment that’s vital to your operations might break. You might suddenly need more inventory to fulfill a very large order that came in unexpectedly. Maybe you need a little extra working capital to pay your employees while you wait for customers to pay their invoices. In any case, you need some extra money and you need it right away. It’s times like these when many business owners turn to short-term business loans.
What Is a Short-Term Business Loan?
A short-term business loan is a type of loan that’s intended to be paid off much faster than a regular business loan. While longer-term loans from a traditional bank or lender can take several years or decades to pay off, short-term business loans are often paid off in a matter of months, although some can last for up to three years. Exact repayment terms will vary, but most short-term business loans last for one year or less.
Short-term business loans are often used to help small business owners cover temporary cash flow gaps. Seasonal businesses are particularly prone to inconsistent cash flow and make a large portion of their annual revenue in a short period (such as the summer). These businesses may benefit from a short-term loan that provides cash upfront without the longer term debt of traditional financing options, such as bank loans or SBA loans.
Short-Term Business Loan Types
Short-term loans are not specific: any small loan with a short repayment term is technically short-term financing. However, some types of loans and financing options are better suited for short-tern business funding, including merchant cash advances and invoice financing.
Merchant Cash Advance
A merchant cash advance is a short-term business financing option that borrowers repay with a percentage of credit card sales. Merchant cash advances are a good option for many business owners because the remittances are based entirely on your sales. On the other hand, the rates for merchant cash advances can be steeper than term loan options and can be a problem for businesses truly struggling with cash flow.
Invoice financing is a good short-term loan option for businesses that have a period of time between providing a service and collecting payment for it. For example, if you typically require payment from customers within 30 days of the service, invoice financing can provide the upfront capital you need to get through the month and buy more materials for your next job.
Working Capital Loan
A working capital loan is a term loan, but it is typically a smaller loan with a shorter repayment term than long-term loans. Working capital loans do have consistent monthly payments, which can be better if you want to know your exact loan amount and monthly payment amount. A working capital loan isn’t ideal if you have inconsistent revenue and are unsure if you will be able to make monthly payments.
Business Line of Credit
A business line of credit works a lot like a credit card, which is ideal if you aren’t sure exactly how much capital you need. Rather than a lump sum of capital, a business line of credit allows you to use only the amount of cash you need and pay back the money that you use. This flexible financing can be great for business owners who need to fill unpredictable product orders or other surprise expenses.
Pros and Cons of Short-Term Business Loans
Short-term small business loans can help business owners survive a tough time or seasonal slump in revenue, but there are some cons to consider as well. Here’s what to know about short-term business loans.
Pros of Short-Term Business Loans
Short-term business loans are much faster and easier to apply for than regular business loans. Applying for a business loan through a bank involves filling out lots of paperwork and having to wait weeks or months to be approved and receive the funds. When business owners are facing a sudden, unexpected expense, applying for a traditional business loan simply might not be a viable option.
Lenders typically have more relaxed requirements for short-term business loans, making it easier for businesses that don’t meet the standards for a regular business loan to receive financing. This can be especially helpful if you have a lacking credit history or don’t meet the credit score requirement for other loans.
Short-term loans are also an option for business owners who need to borrow a relatively small amount of money. In many cases, business owners are turned down for traditional business loans because they aren’t seeking loans large enough to generate enough of a profit for the lender.
Some business owners use short-term loans specifically because they are short-term in nature. Since many business owners only need funding to get over temporary financial hurdles, they don’t like the idea of being stuck paying off a loan years after the original need for that funding has passed.
Small, short-term business loans can also be used to improve your business credit score. As you make progress on paying off a short-term loan, your regular payments will be reflected on your credit score. With an improved credit score, you’ll have an easier time qualifying for larger business loans with better terms later on if needed.
Cons of Short-Term Business Loans
The biggest downside to short-term loan options is higher interest rates than regular business loans. Because of the fact that these loans have shorter terms, you’ll need to make larger, more frequent payments, sometimes on a daily or weekly basis. Although collateral is often not required for short-term loans, some lenders ask for collateral, especially for equipment loans and other collateral loans.
Uses for Short-Term Business Loans
Funds from short-term business loans can be used for many different purposes, including buying equipment, furniture, inventory, paying employees, emergency repairs and other general business needs. Given the brief nature of these loans, they’re best for handling things like sudden emergency expenses, temporary cash flow interruptions, preparing for a seasonal spike in business, and short-term expansion needs. These loans aren’t intended to be used for large, significant financing needs like purchasing real estate or acquiring another business.
Applying for Short-Term Business Loans
Applying for a short-term business loan is much simpler than applying for a regular business loan. The loan application and application process will vary depending on the lender. If you choose an online lender, you will likely be able to complete the entire application process online. As an applicant, you’ll be expected to provide things like proof of ownership of your business, bank statements, tax returns, P&L statements, and a copy of your driver’s license. Lenders will also check your business or personal credit score. Although your business credit score is still a factor with short-term business loans, lenders who offer them often place less of an emphasis on it. You may potentially be asked to provide collateral. If approved for a short-term business loan, the business owner can receive their funds within 1-2 business days and often as a direct deposit to their bank account.
When Should I Consider a Short-Term Business Loan?