Short-term business loans are a type of financing that can help small business owners access cash necessary to cover emergency expenses, fill gaps in cash flow, buy inventory or take advantage of business opportunities. While there are several types of short-term financing—each with its own characteristics—short-term loans aren’t the best fit for every business.
What Is a Short-term Business Loan?
A short-term business loan is a loan or other form of financing that lets business owners access cash to cover things like short-term payroll needs, emergency expenses or other unexpected cash flow shortages. Short-term business loans generally come with annual percentage rates (APRs) as low as 3% and up to 50% or higher. However, this varies based on the type of financing, lender and borrower’s creditworthiness immediate funds @ Ipass.
Popular types of short-term business financing include:
- Business terms loans. A business term loan is a traditional loan wherein the borrower receives a lump sum of cash and then repays it in equal amounts over a set period of time—the loan term. Interest begins to accrue as soon as the loan is funded, and the borrower cannot access funds again once repaid. This is an excellent financing strategy if you need a large sum of cash up front, like for a down payment on something.
- Business lines of credit. A business line of credit lets a business owner access up to a set amount of cash on an as-needed basis. Interest accrues only on the portion of the loan the borrower has accessed; once funds are repaid, the portion of the credit line can be accessed again during the draw period. Choose this type of short-term financing if you want to access cash on an as-needed basis.
- Invoice factoring. Invoice factoring involves selling a business’ outstanding invoices to a third-party factoring company in exchange for 70% to 95% of the total invoice value. The factoring company becomes responsible for collecting the invoices and then pays the business the remaining invoice balance—minus factor fees between 0.50% and 3% per month.
How Do Short-term Business Loans Work?
Short-term business loans function much like traditional business loans, but with shorter repayment periods. In general, short-term repayment periods range anywhere from three months to three years, but they’re often shorter than 12 months. Not only do shorter repayment terms translate into higher monthly payments, but short-term business loans may also come with more frequent payments.
Traditional installment loans are most commonly repaid on a monthly basis, but short-term loans may require weekly or daily payments to stay current. Due to these characteristics, short-term loans pose a greater risk of falling into a refinancing or debt trap, wherein the borrower is constantly refinancing a loan to decrease and delay payment—accruing interest throughout.
When to Consider Short-term Business Loans
There are several circumstances under which a short-term business loan may be helpful or even necessary. Consider short-term business loans if you’re faced with:
- Interruptions to cash flow. Some businesses—like seasonal operations—are more susceptible to short-term cash flow issues than others. If your business experiences seasonal slowdowns or other regular cash flow issues, a short-term loan may provide the cash necessary to maintain production and make payroll during low-revenue periods. Just make sure you’ll have the funds to repay the loans when you need them.
- Short-term business opportunities. If your business is faced with a lucrative opportunity but needs funds quickly to make it happen, short-term financing may be the answer. Approval times and funding speeds may be faster than with traditional loans—sometimes as fast as 24 hours—and qualifications are often less rigorous. Still, this type of financing should only be used if the financed opportunity has the potential to increase revenue or otherwise improve your business’ bottom line.
- Emergency expenses. Sometimes expenses are unavoidable and can’t be postponed until you have cash on hand. If your business is faced with emergency expenses like building, equipment or fleet repairs, short-term business loans can provide the money you need to cover them.
When to Avoid Short-term Business Loans
A short-term loan can be an accessible solution if your business is faced with emergency expenses or is otherwise in need of cash. However, this type of financing is not a good fit for businesses that can’t repay the loan funds quickly. Avoid a short-term business loan if you’re facing any of these situations:
- Inability to make payments. If cash is tight and you need a short-term loan to fund operating expenses, take a deeper dive into the business’ finances and budget before borrowing. Likewise, evaluate whether the loan funds will increase the business’ revenue or otherwise improve its finances and ability to make payments. Then, determine how much you can realistically afford in payments each month—or week—and find a loan that fits your budget.
- High annual percentage rates. APRs on short-term loans may be higher than for their traditional counterparts. This is due to the fact that qualifications tend to be less stringent and funding speeds faster. A high APR can substantially increase individual payments and the overall cost of borrowing.
- Frequent repayments. Because some short-term loans have abbreviated repayment terms compared to traditional loans, borrowers may have less time to repay the funds. In addition to resulting in high monthly payments, this structure may include daily, weekly or biweekly payments instead of the normal monthly cadence. Don’t commit to a short-term loan if your business is unable to make consistent, on-time payments.
- Partially amortized repayments. Many traditional business loans are fully amortized, meaning the monthly payment is calculated so that the loan is fully repaid at the end of the loan term. However, some short-term business loans are only partially amortized with a balloon payment due at the end of the repayment term. This structure reduces the monthly payment amount but can be dangerous for businesses that aren’t prepared to cover the balloon when it’s due.
- Risk of repeated refinancing. Short repayment terms and large individual payments make it easy for business owners to fall behind on loan repayment. This often results in refinancing a short-term loan multiple times to both reduce and delay payments. While loan refinancing can be an effective way to cover necessary expenses, it can also create a debt trap wherein monthly loan payments exceed what the business can cover.
How to Get a Short-term Business Loan
The process for getting a short-term business loan depends on the type of financing and the lender. However, there are a few general steps to follow if you choose a short-term funding option.
- Evaluate your borrowing needs. Before searching for a lender, evaluate why your business needs a short-term loan. Will the expenditure improve efficiency or otherwise increase the business’ revenue? Do you need a lump sum of cash, or is a line of credit more appropriate? Based on these considerations, determine how much the business actually needs to borrow and what works with your budget.
- Check your credit score. If you have an established company, check its business credit score through Dun & Bradstreet (D&B), Experian or Equifax. Because most business loans are personally guaranteed by the applicant, lenders also look at the business owner’s personal credit score when evaluating their application. Ideally, you should have a FICO score of at least 600 to qualify for a short-term business loan.
- Compare lenders. Once you know what kind of short-term financing you want and how much you need to borrow, compare lenders. If you have an established banking relationship, ask an agent about lending offers. Where possible, evaluate each lender’s borrower qualifications to gauge your approval odds. Finally, read online reviews to identify red flags, and speak with other members of your industry to get lender recommendations.
- Submit a formal application. Visit your preferred lender’s website or contact a customer service representative to determine the formal application process. Many lenders offer online applications, though you may need to speak to an agent via telephone. Some traditional lenders still require prospective borrowers to complete their application documents in person.