Before applying for a business loan, you first need to decide what type of business loan works for you. To help you make a decision, we've compiled a list of the different types of business loans to consider. A business loan enables you to borrow money from a bank or financial lender to cover the startup costs of running a business. This includes covering the costs of:
- The lease
- New equipment and inventory
- Staff wages
But before you make any final decisions about which type of business loan you want to apply for, consider how each loan will impact you and your business.
There are a number of options available to Australian small businesses and business owners, but it all boils down to whether the loan is secured or unsecured.
1. Line of credit
A business line of credit is an agreed amount with a lending institution that you can access anytime you need it. A business line of credit is generally between 3 to 12 months. Often with a business line of credit you will only pay the interest on the drawn down amount. A business line of credit can be secured (by inventory, receivables or other collateral) or unsecured depending upon the state of your business. Business lines of credit typically suit businesses that have a stable monthly turnover, have been around longer and have a higher credit score. For any business in need of a continuous injection of funds could be a good fit for a business line of credit.
- Flexible option as you only draw and repay funds as needed
- There is no minimum amount and interest is usually calculated daily on amounts borrowed
- Quick and simple application process typically of 1-2 days
- It can be cancelled at anytime by the lender and is repayable
- Strong likelihood to incur fees even if not used
2. Unsecured line of credit
A subset of unsecured business loans, an unsecured line of credit is a flexible option allowing the customer to redraw funds when needed.
- Revolving term of 12 months
- Useful as a cash flow option
- Great for business with irregular cashflow
- Only incurs fees on the amount drawn upon – no line fees
3. Invoice finance
Invoice finance is also known as “factoring” finance when you sell your invoices to a lender. A lender will then forward up to 80% of the total invoice immediately and take on responsibility for collecting the payment from the supplier.
- Can be used for any business purchase like new machinery or paying a tax debt
- Is an immediate cash injection without waiting for payment of invoices
- Takes away the risk of late or non payment of invoices
- Can cover short term finance issues
- On the downside, it’s usually more expensive than loan finance
- You end up receiving less than the total value of the initial invoice
4. Debtor finance
Debtor finance is another term for invoice finance or factoring finance. Immediately after a business has issued an invoice to its customer, they can be purchased from owners for a fee. This means that up to 80% of the balance due on the invoice is paid to the business owner within 24 hours. Invoice finance is useful for companies focussed on growth. Most Australian businesses offer customers credit terms of 30 to 60 days—or even longer. That can put a strain on many businesses’ cash flow. Fortunately, debtor finance provides immediate cash flow to businesses which can help ease financial stress. Other terms for debtor finance include invoice finance, invoice factoring and invoice discounting.
5. Equipment finance
Equipment finance is a business loan used to purchase a piece of equipment. That piece of equipment—perhaps a truck or piece of machinery—is then used as security for the loan. The type of equipment finance will differ depending on your business needs. Some equipment finance are for equipment hire for a period of time, in which case the lender would be the owner of the equipment. Other equipment finance loans are to assist in buying equipment with a shorter-term loan, in which case the lender will own the collateral until the loan is repaid. This means you cannot resell equipment until loan closure.
- Equipment finance can also refer to a business loan used to lease a particular piece of equipment.
- Offers flexibility to set up a repayment plan that fits in with your cash flow
- Simpler than loan financing, and you may be able to claim GST credits for any GST included in the lease charges
- No equity in the asset for the duration of the loan
- It’s also important to be aware of any early-termination fees as they can be substantial
Let’s breakdown the different types of equipment finance available. Most start from $5,000 with a 1 year term.
Also known as a secured loan agreement this is a fixed-term loan secured on the asset you intend to buy for your business. It’s similar to how a home loan works, but over a much shorter period of time. The equipment is considered your property from the beginning of the loan, but as it is considered collateral for the loan you cannot sell it until the loan has been repaid in full. If you do need to sell the equipment, you will need approval from the lender and pay out the balance of the loan. On top of this there will most likely be an early termination fee as well. Most lenders will work with you to structure the loan so the repayments match your cash flow. This works well for high-value recruitment that has a long life span and is unlikely to become obsolete for the life of the loan. An example might be a retail fit out or an agricultural vehicle.
Commercial Hire Purchase
This is known as a tripartite agreement which takes place between you as the business owner, the seller of the equipment and the finance company. The lender will purchase the equipment from the seller, and then you will gradually purchase it from them in instalments over a period of time. You can expect to pay an upfront deposit and then a series of repayment instalments, with a possible final payment at the end. Once the final payment is made you will gain ownership of the asset and have the right to do what you wish with it. However, for the life of the loan the lender or financier is the legal owners. This works well for medium value assets like vehicles or power tools.
This type of equipment lease can also be known as a capital lease which is usually used for high-value purchases. It’s a common alternative to a chattel mortgage (as above) as it puts you the lessee as the owner taking on all the risk and reward of the asset. The lender will purchase the equipment direct from the seller and rent to you for the duration of the agreement. You will not own the asset during the lease agreement but you are responsible for maintenance, running costs and repairs. Over the term of the lease, the lender or financier will typically recoup full purchase price plus interest on the asset. At the end of the lease you can return the asset to the lender, make an offer to purchase the asset from the lender or lease the asset for another period at a low cost. This last option is known as peppercorn rent.
Sometimes known as a rental agreement, an operating lease offers maximum flexibility for short to medium term financing options. Typically from 12-60 months, a lender will purchase the asset on your behalf and rent it back to you. The lender will own the asset, and at the end of the lease you do not have the option to buy the equipment from the lender. Inseat you will return the asset to the lender who will then sell or lease the asset to a new client. The lender is generally responsible for the service and maintenance during the lease period. Many operating leases allow you to upgrade your equipment even during the term of the lease. This type of equipment finance is best suited to lower value equipment or technology that is rapidly obsolete like IT or telecommunications assets.
When should I use equipment finance?
Most small businesses looking at equipment finance is for cash flow reasons. It could be an option for your small business if you need to fit out a premises or buy major equipment. If you wish to spread the cost of your equipment purchases or need to know a set amount paid monthly for budgeting reasons. There are a number of options available and of course both financial and tax implications to consider with any equipment finance or any other financial product. Generally speaking, equipment finance can be more expensive than a small business loan, particularly than secured business loans.
6. Bad credit loans
A bad credit business loan is a loan for entrepreneurs or companies who have insufficient or troubled borrowing history. A bad credit business loan must be used for commercial purposes only. There are no bad credit loans with automatic approval in Australia, but with a business that’s performing well then your credit history may be overlooked. It’s important to research any bad credit loan lenders, and scrutinise the interest rates. Be prepared to pay a higher interest rate than a standard business loan—secured or unsecured.
Who offers bad credit business loans?
Bad credit business loans are offered by specialised, small, non-bank lenders.
Why do you pay more for a bad credit business loan?
The higher interest rate charged by a lender helps compensate for the risk involved in lending to you. If your business is late in making a repayment, the lender will lose money. If you personally or your business has a history of defaulting on financial obligations many lenders including the major banks may not take the risk of loaning to you again. The lenders that will issue bad credit business loans will need to reap enough returns to make the risk worth their while.
How do you get a bad credit business loan?
Similarly to a standard business loan, you can apply either by directly approaching a lender or with the assistance of a finance broker. However, in Australia currently alternative lenders are not regulated in the same way as the banks, and can impose certain restrictions that could interfere with your business. Similar to any other business loan, prepare a strong business case, prepare your documentation and look for the right lender for your situation.
Is a bad credit business loan the only option?
If you find that less reputable lenders are the only ones offering a loan, it’s important to weigh up how helpful this will be to your business. If the high rates are likely to lead to more defaults and black marks against your credit rating, then it may be worth taking the time to work towards rebuilding your rating.
What should you look for in a bad credit business loan?
Apart from trying to secure the lowest interest rate possible, there are a few other things to look for in a loan. Be on the lookout for any hidden fees, and potential penalties that could be incurred throughout the duration of the loan. Ask if your lender charges early payment penalties. Trying to pay off your loan as quickly as possible makes smart financial sense, and neither you or your business should be penalised with a hefty prepayment penalty. A bad credit business loan should only be applied for to cover genuine and legitimate needs for the business.
7. Short-term loans
A short term loan is what the name implies—a loan that is paid off over a short period of time. A short term business loan will typically have a repayment period of 12 months, but can be up to 36 months.
- Approval usually within 24 hours, some can even give pre-approval in minutes
- Businesses with poor credit history may still be eligible for a short term business loan
- A short-term period can mean higher interest rates compared to longer term business loans
- Some short term business loans can have inflexible repayment options
Short-term loans could be appealing to someone whose business is starting up, fast-growing, having cash flow problems, or in an emergency situation.
8. Car finance
A single car or a full fleet of vehicles needed for your business can all be used through business car finance. From truck finance to company cars on leases, there’s plenty of options to consider.
- Highly competitive market making it pretty easy to access
- Choice of repayment schedules and loan types to suit your business’s cash flow
- Can claim deductions for interest payments
- Overall borrowing capacity is reduced
Some of the types of car finance we’ve discussed above in the chattel mortgage and line of credit, but let’s dive into a few of the others.
A third party finance company buys your business vehicle and then gradually sells it back to your business. Similar to a chattel mortgage you can opt to pay the loan off in equal instalments or left with a balloon payment to be repaid at the end of the contract. Unlike a small business loan or chattel mortgage you have to pay an up front deposit.
A rental agreement where a third party finance company purchases a vehicle and loans it back to your business.
Similar to an operating lease, but with a finance lease you have the option to purchase the vehicle for an agreed residual repayment. This can be useful for truck finance if the value of the truck is higher than the residual payment (although the opposite can be true with depreciation). Tax deductible.
A novated lease is another tripartite agreement which your employees can lease a vehicle using salary sacrifice. This allows them to make substantial tax savings on the purchase price of their car and any running costs. Employees will have to pay Fringe Benefits Tax, but your business will be responsible for managing this for them.
If your business needs to purchase 15 or more vehicles for your business then fleet purchasing can be a great choice, opening you up for substantial discounts. Look for a dealer with a dedicated fleet department to get the ball rolling quickly. Fleet purchases can be funded with any of the business car finance options we’ve outlined from chattel mortgages, hire purchase or small business loans.
9. Merchant cash advance
A merchant cash advance can be a good option for small business owners who don’t have a great deal of cash flow. The benefits of a merchant cash advance is getting a lump sum upfront.
- Free choice to use the borrowed amount however you choose
- Lenders will collect repayments from your daily cash sales
- Will get an agreement with lender for a percentage of daily credit card sales as repayments
- Can be a good option for businesses with a good history or daily sales for 12+ months
- May only be available to businesses with daily credit card sales
10. Business overdraft
A business overdraft is used to help cover cash flow shortfalls or make purchases. The funds from a business overdraft can help give your business access to assets required to start afloat in the meantime.
11. Low or no-doc loans
Like it’s namesake, a low doc business loan does not require you to produce full documentation as per a standard business loan. However, any business loan, even a low doc business loan, may still require the last 6 months of bank statements to get approved. Low doc business loans work the same as a regular business loan. The only key difference is that they do not require the same amount of paperwork of documentation to apply. Low doc business loans can be used for a multitude of business purposes to help small business owners.
No doc business loans are for business owners who cannot provide any proof of income. Understandably, this type of low doc business loan also comes with higher interest rates due to the increased risk faced by the lender.