What to Know About Short-Term Business Loans and Debt Financing

applying for a short term loan

Last Updated February 22, 2023

Being a small business owner comes with plenty of ups and downs. The day-to-day machinations can be thrilling to take part in. It’s exciting to watch as your business chugs along, perfecting its craft and meeting the needs of the customers for whom you started this business in the first place.

In the world of a small business, however, there are occasions when cash flow can be a problem. Whereas many small business owners’ first thought would be a term loan from a bank, these loans can have long repayment periods, high-interest rates in some cases, and hefty personal credit requirements for the small business owner in question. Furthermore, new businesses often don’t have the history to qualify for a bank loan.

In many situations, then, it makes more sense to secure a short-term business loan.

If you’re considering taking out a short-term business loan for your company, use this guide to look at the issue from all sides. We’ll take you through the standard options out there in the world of debt financing, why you might want a short-term loan, standard interest rates, and the typical requirements to qualify.

What Is a Short-Term Business Loan?

A short-term business loan is a form of debt financing often used by small businesses when there is a cash flow need that is pressing (cash required as soon as possible) and which can be repaid quickly.

When we use the term “short-term business loan,” this refers to several different ways that businesses can solve their cash flow problems. Likely the most common and well-known type of short-term debt financing is via a standard loan. In this situation, a business is given capital quickly (within one to two days) with a repayment period that is shorter than that generally offered in a term loan from a bank.

There are other forms of short-term loaning, however, which we’ll cover in more detail below. In brief, short-term business loans can take many forms. We’ve considered the traditional borrowing of cash, but some business owners have the option to take advantage of their credit and cash flow history to open up lines of credit for short-term use.

According to the Corporate Financial Institute, short-term loans are generally between six months and eighteen months. If the repayment period is longer, these loans are considered medium-term or long-term loans.

A short-term business loan will also typically be for cash amounts that are smaller than in those loans offered by banks. The loan amount can range from just $100 to upwards of $100,000.

What Are the Most Common Reasons You Might Need a Short-Term Business Loan?

As mentioned above, businesses often take advantage of short-term loans when cash flow needs are immediate and when the amount needed is relatively smaller than that typically granted by a bank. Here are some of the most common reasons you might need a short term business loan:

  • Emergency repairs: for those small businesses working with expensive equipment to deliver their product, having an unexpected breakdown can have the forebodings of a death knell. Many small business owners seek short-term loans to repair broken equipment. The costs of repairing or replacing this equipment will be relatively low, and the repaired equipment will ensure the cash to pay back this loan.
  • Start-up / Expansion costs: expansion always costs more than stasis. Whether you’re starting a brand new business or seeking to expand your already running small business, there can be plenty of costs associated with new space, new equipment, and new personnel. A short-term loan can provide momentary relief as your business begins to get its new cogs turning.
  • Purchasing inventory at a discount: for those businesses with a high level of inventory rotation, there are situations when the supplier might be selling a lot of items for a massive discount. In these situations, businesses will often secure a short-term business loan to buy the inventory, which will then quickly pay for itself as it flies off the shelves.
  • Seasonal cash flow issues: many businesses naturally see more business in the Summer or Winter depending on the nature of their work. Some businesses will take out a loan to stay afloat in between peak seasons.

Types of Short-Term Business Loans

When many people think of short-term loans, they think of borrowing a lump sum and paying it with interest over a set period. While this kind of financing exists (called a “term loan” or a “short term loan,” there are plenty of other options for small businesses.

Merchant Cash Advances

Merchant cash advances (MCAs) can be an excellent option for small business owners with a strong revenue source.

In a merchant cash advance, you borrow a sum of money, and in exchange, you open up your credit facility to the lender for the duration of the loan. In simpler terms, you pay back the money, not through payments but a percentage of your customers’ credit card transactions. A small percentage of your sales will then go to the lender until your loan is paid.

There are some reasons to be wary of this kind of loan, however. Although the cash is granted very quickly and business owners like the idea of it because only a small amount of each credit transaction goes towards the repayment of their debt, the rates of interest on these loans can be incredibly high. According to NerdWallet, an MCA will generally run from between 40 and 350% APR.

Read more about how to get out of a Merchant Cash Advance.

Invoice Financing

Invoice financing is another popular option amongst small business owners. In invoice financing, you take an as of yet unpaid invoice that you’ve written for work you’ve already done and use it as collateral with a lender. The lender will take this invoice and grant you the amount that is owed to you on your invoice upfront. Then, when the party to whom you originally issued the invoice pays you, you pay the lender.

Remember, though, that there are interest rates associated with invoice financing. These rates generally range from about 15 to 68% APR.

Invoice financing is, it should be noted, different from invoice factoring. In invoice factoring, rather than using your invoices as collateral, you sell them to a lender, or factoring company. The lender then negotiates with the client to receive payment on the invoice. It’s important to note that there are still rates and fees associated with invoice factoring.

Related: Invoice Financing vs. Invoice Factoring

Business Lines of Credit

Securing a business line of credit is typically for long-term use, but some lenders online can offer shorter-term credit lines. This type of loan can be a good idea for some businesses because it allows you to only take out the money you need. Business lines of credit will also have lower interest rates, usually, than a business credit card.

Vendor Credit

In certain situations, a business needs a service in the short term that they simply can’t pay for at the moment of service. In these situations, it can make sense to work with the vendor on vendor credit. In a vendor credit situation, the vendor provides their services with a promise of repayment over a certain period of time, typically with some interest. This kind of credit of course hinges on your own personal credit and often your relationship with the vendor.

Typical Requirements to Qualify for a Short-Term Business Loan

Whereas bank loans have much more expansive requirements for small businesses to secure a loan, many online lenders have less stringent requirements. There are a few common requirements, however.

  • In business for a year. Many online lenders won’t offer short-term loans to brand new businesses, especially if the business owner’s personal credit score is low.
  • Demonstrable annual revenue. There is very often a threshold of annual revenue businesses have to meet before qualifying for a short-term loan. This can vary, but the minimum threshold is typically $20,000 (though some lenders will go lower, even down to $10,000).
  • Proof of ability to make periodic payments. Most short-term business loans require periodic payments so as not to default. Expect to be able to provide proof of your ability to repay your loan.

How to Figure Out Which Short-Term Business Loan Option Is Right for Your Business

Now that you have many options in front of you, it’s time to assess if a short-term business loan is right for you. If you think it is, you’ll need to decide which short-term loan option is best.

There are a few things to keep in mind when making this decision. First of all, you need to consider how long it will take you to repay your loan. If this is a situation involving buying a large amount of inventory at a discount price and flipping it quickly, you’ll be able to repay your loan much quicker.

The speed with which you can repay your loan is an important factor to keep in mind, because the best option for your small business may not be the loan with a lower APR. Take, for example, a situation where you need to borrow $1000 with a six-month repayment period. The APR on this loan may be 24%. This would mean that the total amount of repayment when considering interest would be $1120.

Consider another loan for the same amount; say this loan is for a year. The APR on this loan is 15%. That seems like a better deal, but in fact, the borrower will pay more in this situation. The total amount of repayment on this loan will be $1150. If you can repay faster without extra stress, in this situation, it makes more sense to take the first loan with a higher APR.

Another thing to keep in mind is your revenue. If you have a steady revenue stream and can pay it back quicker, a merchant cash advance might make sense. Remember, though, that MCAs tend to have insane interest, which means the quicker they’re paid off, the less you’ll pay in the end.

If you need cash on hand for various things that come up (buying extra inventory, minor repairs, etc.), a business line of credit can be an excellent option. These options tend to be a favorite amongst small business owners for their lower APR and the only-use-what-you-use nature of the borrowing.

If you have some or many outstanding invoices, you might consider invoice financing. The nice thing about invoice financing is that you’ll be using money you’ve already earned. Remember, though, that you’ll still pay interest on these loans.

Typical Interest Rates on Short-Term Business Loans vs. Traditional Loans

We’ve gone into this in some detail above, but bank loans are typically for a longer-term and for larger amounts than what we think of when we speak of short-term loans. That said, banks generally offer significantly better APR than short-term lenders because the period of repayment is significantly longer.

Whereas bank loans in the US may have APRs between 3 and 8%, short-term, online lenders may have rates ranging from just under 10% to well over 100% (as we mentioned, some MCAs have rates as high as 350%!)

Short-Term Business Loans and Debt Financing

Though short-term business loans tend to have higher interest rates than longer-term loans from banks, these quick-to-get and easy-to-qualify loans can be an excellent option for small businesses that just need quick cash flow. Remember that APR isn’t everything and that short-term loans are not a one-size-fits-all situation. Do your research, and good luck!