Types of small business finance

Small business loans come in many different forms and for many different purposes. Whether you're just starting out, looking to expand or you simply require assistance with day-to-day cash flow, there is a type of funding for you.

However, with hundreds of business lenders and at least a dozen types of financing available, it can be confusing to know which is the right option. Types of small business financing include secured and unsecured loans, lines of credit such as overdrafts and credit cards and more specific types of funding, including invoice finance, equipment and trade finance.

Learn more about small business loans

Getting the right business loan

Whilst an established business with a long credit history may be able to easily get approval on a secured term loan from a bank, a newer, smaller operation may find they cannot get the funding they need to get their business off the ground.

Without careful research, you could end up with an ill-suited loan. That could mean poor interest rates, inflexible terms, too much capital or a loan duration not matched to its original purpose. A bad loan can force you to change your financial projections or even take out subsequent loans. That can leave you with multiple debts to service, which is never a good idea.

Unscrupulous lenders will look to take advantage of small business owners - who are often in need of financing to keep their operations afloat. They'll entice them in with low-interest rates and only later sting them with hidden fees. Make sure you go through their terms and conditions with a fine-tooth comb and not just for the charges. Find out what is the application process, are early repayments allowed, can you amend how much and when you pay?

Types of small business loans

There are a wide range of finance options available to the Australian business market. Here are some of the most common:

Secured business loan

What is it?

A fixed-term loan secured against some form of collateral, such as personal or commercial property, but also equipment, machinery, vehicles or other business assets.

The lender is often a bank. Repayments are over a set period of time with interest (which can be fixed or variable) and fees. Should the borrower default on payment, then it's possible that the collateral could be repossessed by the lender and sold to recoup the funds.

Compared to other forms of business funding, it can offer favourable rates, fees and charges, however, due to eligibility criteria and the requirement of collateral, it can be difficult for small businesses to get approval.

Used for:

  • Core debt, rather than as day-to-day working capital
  • Starting or growing a business
  • Large purchases, such as equipment or vehicles
  • Business premises

Unsecured business loan

What is it?

Unlike a secured loan, unsecured loans are not backed by collateral such as property or equipment. This means there is a greater risk to the lender, as in the case of default as there are no assets to repossess. As such, interest rates tend to be higher.

This is also a term loan with repayments at given intervals. It is usually considered a short-term business loan, as the amount and length tend to be lower.

Unsecured loans are often taken out by businesses who are unable to get a traditional secured loan from a bank, due to lack of suitable collateral or credit history. They are typically offered by fintechs and non-bank lenders, although traditional banks now frequently have unsecured offerings.

Used for:

  • Shorter-term expenses such as:
  • Marketing
  • Unexpected operational expenses
  • Stock opportunities

Business overdraft

What is it?

A line of credit attached to a business transaction account. It allows businesses to continue to make transactions and draw on funds when their balance is at zero. Funds may be drawn and redrawn up to an agreed credit limit without reapplication. Interest is charged at a daily rate and there are also fees, which can be fixed or based on a percentage of the limit.

Used for:

  • General working capital
  • Short term or unexpected expenses such as stock opportunities
  • To assist with operations or orders whilst awaiting payment

Business line of credit

What is it?

Similar to a business overdraft, it is a revolving line of credit that can be drawn from, repaid and drawn from again without repeated applications. The main difference is that whilst most business transaction accounts have an overdraft, a line of credit must be applied for separately. It generally has a larger limit, is suited to more established companies, is used for greater expenses and is usually secured by some form of collateral.

Used for:

  • Operating expenses
  • Ongoing working capital needs
  • Marketing and sales expenses
  • Managing expected and regular seasonality

Business credit card

What is it?

Just like a regular credit card but used for business expenses and with multiple cardholders. Used for short-term expenses and usually paid off within the same month during the interest-free period. Comes with reward benefits, such as travel. Not generally recommended as a form of business finance.

Used for:

  • Day to day expenses
  • Office equipment and supplies
  • Not recommended to be used for operating expenses

Equipment finance

What is it?

Finance used by businesses to fund the leasing of necessary equipment. This could include large manufacturing or agricultural machinery, vehicles or office equipment, such as computers or furniture. Rather than owning the equipment outright, it is purchased by the financier, leased to the borrower and used as collateral for the loan.

In the event of a default, the equipment could be repossessed. It is used by businesses who otherwise would not be able to purchase equipment that is essential for their operation.

Used for:

  • Purchase of equipment such as vehicles, manufacturing equipment, office equipment

Trade finance

What is it?

Finance used by importers and exporters to facilitate easier trade and reduce the inherent risks associated with dealing in international markets.

It introduces a third party into the transactions who helps to alleviate the potential issues. It does this by releasing payments early to the supplier, thereby removing risks that they won’t get paid. And by offering protections to the buyer that they will receive the goods.

Used for:

  • Alleviating the risks associated with overseas trade for the:
  • Importers, by offering protections that the goods will be received and extending credit to allow them to pay invoices earlier
  • Exporters, by releasing funds following the shipment of goods thereby easing cash flow issues

Invoice finance

What is it?

A type of loan used by businesses to ease cash flow issues by allowing them to access funds tied up in unpaid invoices. Typically, a supplier will have to pay for the cost of delivering a product or service up-front, but then wait 30-60 days to get paid creating cash flow gap.

There are two main types of invoice finance:

  • Invoice factoring - the accounts receivable ledger is purchased by a third party, known as a factor in exchange for a percentage of the funds up-front (often around 80%). The remaining balance, minus any fees is transferred upon collection. Collections become the responsibility of the factor.
  • Invoice discounting - a loan or a line of credit is secured against the invoice ledger, rather than it being purchased outright. Like factoring, around 80% of the total is advanced immediately. The difference is that discounting is usually confidential, and the collections remain the responsibility of the business.

Used for:

  • Accessing funds tied up in unpaid invoices
  • Easing the burdens caused by cash flow gaps

Supply chain finance

What is it?

A type of finance used by large buyers, such as supermarkets to facilitate and improve transactions within their supply chain. It means their suppliers can get access to funds early and the buyers themselves can delay payment without penalty. It improves cash flow for both parties, who both pay a fee to a financier.

Similar to invoice finance, but as it is initiated by the buyer rather than the seller, is often known as ‘reverse factoring’. The larger business will have a better credit rating, so can secure better terms from the financier.

Improves relationships between large buyers and their suppliers, however, it is often a prerequisite for small companies if they want to do business.

Used for:

  • Facilitating trade between large businesses and their smaller suppliers

P2P business loan

What is it?

Peer to peer lending, also known as crowd lending. A newer form of lending where borrowers are matched with an investor or group of investors through a third-party platform. The platform operator takes fees from both parties. Can produce favourable rates for both borrowers and lenders.

Used for:

  • Small businesses who are ineligible for other forms of funding
  • Short term, unsecured loans

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