Short-Term Business Loan: Pros & Cons
Even with the best planning, budgeting, and forecasting, there are times when you’ll need a short-term business loan. Perhaps you had great success with your new marketing strategy. Maybe you have a big order to fill and you need to purchase inventory right away. Imagine that a major piece of equipment breaks down and you can’t fill your orders without it.
There are many reasons you might need urgent funding. See how a short-term business loan can help cover shortfalls when challenges arise.
What Is A Short-Term Business Loan?
When you need capital, you’re likely to apply for a small business loan from the bank, the SBA, or other lending institutions. Regular small business loans come with repayment terms of several years or longer, depending on the loan type. You can borrow large amounts, and the process of securing the funds takes longer than usual.
However, a short-term business loan must be paid off much more quickly. Typically, the loan’s repayment term is less than a year, although you can find some short-term loans with repayment terms up to three years.
What Can Short-Term Business Loan Funds Be Used For?
These loans address your need for immediate capital. Loan funds can be used for:
- Project startup. You know that your great idea is going to result in rapid revenue. Therefore, you just need the money to get going
- To purchase inventory for the upcoming holiday or season
- Make payroll when unexpected emergencies have used up your working capital
- Replace or repair equipment
- Bridge a seasonal cash flow gap
- Purchase inventory in bulk or at a temporary sale price
Where Can I Find Short-Term Business Loans?
The average short-term loan is around $20,000. Loan amounts can also be as little as a few thousand dollars.
In general, banks don’t provide these loans with terms of less than three years. However, you might be able to access ones with shorter terms if you already have a relationship with your bank.
Your best resources are the online alternative lending industry and private small business financing companies.
How Do I Apply?
The process of applying for this loan is easier, but you still need to prepare documents that demonstrate your ability to run a business. Typically, you’ll need to provide:
- Business bank statements
- Business tax returns
- Proof of ownership of your business
- P&L statements
- Copy of your driver’s license
- In some instances, you might need to provide collateral
- If you’re an entrepreneur, you’ll need to provide cash flow projections and sales forecasts for the first three to five years
Lenders will often check your credit score but it may be less important than when you’re applying for a long-term small business loan.
What Are The Benefits?
If you want to take advantage of an opportunity to invest in your business, then you might not have weeks or months to wait for a long-term bank loan. With a short-term loan, you get the capital, use it right away, and pay it back in a brief amount of time. The debt goes on and off your books quickly. There’s no long-term drain on your operating budget.
Here are the other benefits to this type of loan:
- The qualification requirements are usually more relaxed, opening funding opportunities that may have been closed to you before
- You can borrow a smaller amount sufficient to cover the cost of purchasing inventory, equipment, launching a new product line, and so forth
- You can build a strong credit history more quickly
- As you demonstrate your capacity to pay off debt, you improve your ability to qualify for long-term financing in the future
What Are The Pitfalls?
A business loan with a shorter term addresses your need for immediate capital, but there are some potential pitfalls.
- A more lenient application process translates into higher APRs
- Many lenders require frequent payments, perhaps even weekly. This can affect your cash flow, especially if you keep low balances in your checking account
- If you can’t pay the debt off at the end of the term, then it’s easy to roll this loan over into another. This will harm your credit, though, rather than improve it
How To Decide If A Short-Term Business Loan Is Right For You
As noted above, there are many reasons why you might want to pursue this option. To begin the process, identify why you want it in the first place. This is a question you should ask yourself before applying for any kind of small business financing.
- What is the purpose of the loan?
- How much do you need?
- Is your funding objective short-term?
- Does the ROI (return on investment) outweigh the high APR of the loan?
- Do you have the time to wait for a regular small business loan with better terms?
- Will you be able to maintain healthy cash flow while repaying it?
- Do you have the cash in the bank to cover frequent payments?
Conclusion
If your small business has the working capital to sustain more frequent payments, then a short-term business loan can help you achieve your business objectives much quicker. This is especially critical if you need to gear up for the season, replace equipment, or take advantage of a unique buying opportunity.
Ultimately, it could be cheaper than other types of financing, even though the APR will be higher. Therefore, carefully consider the pros and cons before signing.
