When most people think of a small business loan, they think of the traditional five- or 10-year term loans available from the bank, the credit union, or an SBA-guaranteed loan. When borrowing to meet needs like purchasing expensive, heavy equipment, expanding into a new location, or building a new warehouse, a longer-term loan can be a good fit because the longer term allows the borrower to reduce the amount of the periodic payment over the course of the loan and better match to the productive term of the equipment. Nevertheless, there are some loan purposes where the longer-terms of these more traditional small business loans might not be the best fit. In those situations, short-term business loans can be a better fit.
Fortunately for small businesses, their local bank is not the only place to borrow, there are loan options available for a variety of loan purposes, and loans with shorter terms are available to meet the financing needs of shorter-term projects.
When Should a Business Consider Short-Term Business Loans?
The first question any business should ask before it borrows is, “What is the loan purpose?” This will help determine how much capital they need to borrow, what loan terms make the most sense (short-term vs. long-term), and even where they might look to secure the funding.
Depending upon the loan purpose, some small business borrowers chose a shorter-term loan to minimize the total dollar cost of the loan. According to a survey commissioned by the Electronic Transactions Association, 57 percent of small businesses would choose a shorter-term loan in order to minimize the total fees and expenses when presented with a short-term investment opportunity. Because APR does not represent the total dollar cost of a loan, this was true even if the shorter-term loan included a higher APR than the longer-term option.
The two most identified loan purposes of the small businesses participating in the survey were to purchase equipment (54 percent) or to purchase inventory (51 percent)—both purchases tend to be very total dollar cost sensitive. What’s more, these small businesses were anticipating a 5X return for every dollar they borrowed, making the total dollar cost of the loan a key consideration for them.
Some popular reasons for considering a short-term business loan might include:
- Project start-up costs: There are times when ramping up a new project requires upfront costs that might exceed a business’ ability to cover with cash flow, but will be recouped in 60 or 90 days as their customer(s) pay their invoices. In that case, the ability to get in and out of the financing quickly at a lower total dollar cost could make more sense than making payments on a longer-term loan for several years.
- Bridging a seasonal cash flow gap: Many seasonal businesses sometimes borrow to meet short-lived cash flow demands during lulls that exist between their busy seasons to cover expenses during the down time. Doing so requires the business ensure that it has sufficient cash flow during that slow period to make the larger periodic payments often associated with a short-term loan.
- Purchasing quick-turnaround inventory at a discount: A short-term loan could be a good opportunity for purchasing inventory at a discount that will turn quickly and allow the business to capture additional profits.
- Cover the costs of emergency repairs of critical equipment: When equipment necessary to the operation of your business fails, a short-term small business loan can help get operations moving again without a four-year or longer loan obligation.
And, many times, short-term business loans may come with faster approval rates than more traditional long-term financing at the bank – which helps when time is of the essence.
Why Does Loan Purpose Matter?
In the same way technology companies like Expedia, Airbnb, and Kayak are changing the way we plan a vacation, companies like Zillow are changing the way we buy a house, companies like Uber are changing the way we hail a cab, and companies like Amazon are changing the way we buy just about anything, technology has changed the way many small businesses get a small business loan. One of the ways they’re doing it is by focusing on specific loan types, loan terms, and other criteria that match particular business use cases.
Most people would never buy a new car with a 30-year auto loan; and some small business financing options may be better suited to meet shorter-term business needs. For example, the type of loan a business would need to purchase inventory at a discount could be very different from financing the construction of a new warehouse or the purchase of a new location for a growing restaurant. Sometimes it might not make sense to borrow for several years when the value of the asset you’re borrowing for has a much shorter lifespan or productive term.
When loan term drives the borrowing decision, it enables businesses to answer some important questions like:
- How much capital do I really need to borrow?
- Is there a lender that specializes in the type of loan I need?
- What loan term makes the most sense?
Using a short-term business loans to build your business credit profile
A short-term business loan can also be a tool to help a business create a stronger business credit profile. Unlike some other lenders, OnDeck reports your business credit history with us to a number of business credit bureaus; so long as you make timely payments, that positive credit history helps your business build a strong profile. This can be particularly valuable for younger businesses as it has the potential to help create additional small business loan options down the road.
Since 2007, OnDeck has helped over 50,000 small business owners access over $5 billion in loans with terms from three months to 36 months.