7 Types of Small Business Loans - Pros & Cons (2026)

If types small business loans is on your radar, this short guide cuts through the noise. Here is what is worth knowing, and how to put it to work today.

Key Takeaways

• Entrepreneurs and small business owners seeking funds to grow their businesses can either seek equity funds from investors or borrow funds f...
• Seeking new equity is time-consuming, subject to federal and state regulations, and requires sharing future profits.
• In some cases, an owner might even lose control of their company if management decisions must be approved by an external board of directors.

Entrepreneurs and small business owners seeking funds to grow their businesses can either seek equity funds from investors or borrow funds from a lender. Seeking new equity is time-consuming, subject to federal and state regulations, and requires sharing future profits. In some cases, an owner might even lose control of their company if management decisions must be approved by an external board of directors.

On the other hand, warnings against borrowing have circulated in the small business culture for centuries. Stories of aggressive debt collectors, callous bankers, and naive borrowers are passed from generation to generation as evidence of the seemingly inevitable result of taking on business debt. Like other myths and legends, the negative aspects of small business debt are frequently wildly exaggerated.

Here’s why small business loans might be right for you, as well as a look at your options.

Benefits of Small Business Loans

The prudent use of debt by small business owners is a financial strategy that should be embraced, rather than scorned. The benefits of smart debt financing include:

• Speed of Funding. In most cases, the period between seeking and receiving funds is considerably shorter for debt than equity. A borrower typically deals with one funding source with established procedures to underwrite and fund the borrowed amount. By contrast, raising equity funds typically requires multiple investors, each of whom may follow different processes to make the investment decision.
• Administrative Simplicity. Seeking funding from a lender is straightforward and frequently a matter of completing basic forms and providing financial statements. Equity investors require periodic reports on operations, possible shareholders meetings, and board approval before taking certain actions.
• Retained Ownership. Unlike equity, a lender does not share in the profits - or losses - of a company. The business owner reaps the consequences of their management and investment without dilution since lenders have no direct claims on future profits.
• Management Control. A lender does not make management decisions, whether personnel-related, financial, or operational; their sole interest is that the borrower complies with the terms of the loan.
• Clear Terms. The terms of a loan - such as principal amount, interest rate, repayment terms, and collateral, if any - are unambiguously established at the onset of the loan and do not change during its life.
• Tax Benefits. The interest paid on a business loan is generally deductible from taxable income, meaning the business owner effectively shares the cost of the loan with the taxing authorities.

Drawbacks of Small Business Loans

While there are a number of benefits of including debt in a business capital structure, the bottom line is that debt must be repaid at some point if the business is to continue. Borrowers should be aware that:

• Repayment Reduces Future Cash Flows. While borrowing initially provides cash for working capital, the repayment of the debt has the opposite effect, requiring cash that might otherwise be used for investment or dividends to owners.
• Repayment Terms Are Fixed. The terms of a loan are clearly established at the time debt is extended, and lenders are reluctant to amend terms unless they receive additional benefits, such as higher interest payments, additional security, or authority over future cash expenditures.
• Lenders Can Be Hard Taskmasters. No matter how cordial and courteous they are during the initial borrowing period, lenders are not partners; they’re vendors. If the business experiences difficulties in the future, the lender’s sole interest is to protect the repayment of the loan, even if repayment results in the business’s bankruptcy.

Popular Small Business Loans

Business loans are available in numerous forms, each with its own purpose and characteristics. The following are some of the most common.

1. Accounts Receivable (AR) Loans

Uncollected accounts receivable tie up cash and decrease cash flow. Unless a company deals solely in cash, there will always be an accounts receivable balance at the end of the month. For example, if you provide payment terms of 10 days after an invoice’s date, the sales that occur at the end of one month will not be collected until the following month.

Small companies who sell competitive products to bigger shoppers frequently have difficulty enforcing credit terms. One of my investments, a Mississippi wood-treating plant, sold products to utilities and railroads across the country, most of whom paid within a 45- to 60-day period after invoicing. While these shoppers were not credit risks, their slow payments wreaked havoc on our cash flow. A revolving accounts receivable loan solved the problem.

Banks like to lend on accounts receivable because they quickly become cash to repay the loan. For these loans, banks typically agree to advance 70% to 80% of the accounts receivable balance that’s less than 60 days old. Some banks may provide a different percentage of the value based on the age of the accounts, such as 90% of the balance for accounts aged 30 days or less, 75% off the balance for accounts aged 30 to 60 days, and 50% of the balance for accounts aged 60 to 90 days. Few banks will accept accounts receivable aged 90 days or more as collateral, so these accounts have no collateral value.

In a typical AR loan, the company delivers a schedule of the accounts receivable to the bank and receives cash for the calculated values. As the month progresses, old accounts are collected while sales create new accounts. At the end of each month, a new loan balance is calculated.

If the following month’s balance is greater than the previous month’s, the bank advances additional cash equal to the difference, minus interest, to the company. If the following month’s balance is less than the previous month’s, the company repays the difference, plus interest, to the bank. As a result, the loan balance changes each month. In either case, the old loan is repaid and a new loan issued.

Some banks assume collection of the accounts receivable by requiring that invoice payments be made to a bank account established solely for that purpose, thereby ensuring that the bank is aware of all payments the company receives. In other cases, the bank allows the company to continue their existing collection process, relying on the company to present timely reports of collections to the bank and have sufficient cash on hand if a payment on the loan is required.

In addition to the accounts receivable pledged as collateral, the bank might require the personal guarantees of the owners of the company as additional security.

Factoring Alternative

Some business owners prefer to “factor” accounts receivable, rather than borrow against their value. Factoring is the sale of accounts receivable to a third party (the factor) for a discounted face value. If you’re unsure which factoring company is right for you, Fundera by NerdWallet is a lending marketplace that lets you compare multiple offers - including invoice factoring, lines of credit, and term loans - through a single application at no cost to the borrower. Most factoring companies can provide approval within a few days, with advance rates typically ranging from 70% to 90% of the invoice value.

Depending on negotiations between the factor and the company, the factor might assume all or a portion of the collection risk and function. In the latter case, the factor may retain the right to return uncollectible accounts to the company for the funds previously paid for the debt. Small business owners should be aware that tax treatments are different for AR loans and factoring arrangements.

2. Inventory Loans

Maintaining a stock of raw materials and finished products, or inventory, is essential for most companies. A manufacturer without raw materials can’t create products to sell, and a retailer without finished goods can’t meet shoppers’ demands.

Our wood-treating operations invested thousands of dollars in pre-cut timber poles and green wooden railroad ties, which were primarily used to replace weathered and storm-damaged railroad, telephone, and utility lines. Customer demand for these products would peak after each storm, and the ability to deliver our products quickly was essential. If we didn’t have the right-sized pole on hand, our shoppers would turn to a competitor. As a consequence, the value of our inventory exceeded the book value of the facility.

Like uncollected accounts receivable, inventory represents idle assets, earning nothing and using up cash until it’s sold. There was always green lumber waiting for processing and treated poles and ties waiting to be sold. In order to increase cash flow, we initiated a series of sequential short-term loans using the inventory as collateral.

Unlike accounts receivable, banks and financial institutions are not keen on using inventory as collateral, especially if it requires additional investment before it can be sold as finished products. As a result, banks rarely lend more than 50% to 60% of the value of finished inventory, with lower percentages for work-in-progress inventory and raw materials - if they accept either as security.

An inventory loan works similarly to an accounts receivable loan, with the loan balance fluctuating with changes in collateralized inventory. If the collateral value increases from the previous month’s balance, the loan balance increases and additional cash is advanced. When the collateral value falls below the previous month’s balance, the company must repay the difference, lowering the total loan amount.

For example, our bank agreed to loan the company 50% of the company’s finished product inventory and 40% of the green lumber value. In the first month, we had $250,000 of treated products and $140,000 of green lumber, allowing us to borrow $181,000 (50% of $250,000 plus 40% of $140,000). During the following month of operations, we sold our treated products, converted green lumber to treated, and continued to purchase raw materials. At the end of the month, we had $175,000 of finished inventory and $185,000 of green lumber, qualifying for a new loa

Final Thoughts

Before you check out, double-check types small business loans against current offers and any coupons you can stack. Small habits like this add up to real savings over a year.

Originally published at moneycrashers.com.