What Kind of Loan Makes Sense for Your Business?

Every business eventually reaches a moment where growth requires outside capital. A company may land a major customer and suddenly need inventory. Maybe it wants to purchase equipment, hire employees, expand locations, or smooth out uneven cash flow.

At that point, business owners face an important question: should they raise equity or borrow money? The answer depends on the business, the industry, the company’s assets, and the owner’s appetite for control and risk. This article will focus primarily on the basics of borrowing.

Equity vs. Debt: The First Big Decision

Before choosing a loan product, business owners need to decide whether they want to raise equity or take on debt. Most established companies ultimately use a combination of both debt and equity financing.

Equity can provide liquidity without requiring monthly payments. Investors may also bring industry expertise, strategic relationships, and operational guidance. For this reason,  Phil Buffington of Balch & Bingham LLP  advises business owners to think carefully about alignment when bringing in equity partners.

For all of its benefits, equity does dilute ownership and, as Michael Weis of Weis Burney LLC  points out, even if the investor doesn’t have control rights, at the end of the day they will be someone else you’re responsible to when running the business.

Debt financing, by contrast, allows owners to maintain control. However,  it comes with a major downside: it must be repaid. Each financing option will come with different legal obligations, costs, reporting requirements, and operational consequences, which is why it is crucial to understand the nuances and specifics of the financing option you choose to ensure it is right for your business and your circumstances. Ultimately, any repayment obligation will create leverage risk. If cash flow declines, debt payments can quickly become a burden.

Borrowing Basics

Commercial lending is no longer dominated exclusively by banks. Private credit funds, fintech companies, marketplace lenders, and specialty finance companies now play major roles.

“Direct lenders, particularly in the middle market, have really taken a dominant position and have eaten a tremendous amount of market share from banks in that space,” observes Andrew Hutchinson of Much Shelist, P.C.

These lenders often move faster and offer more flexible underwriting. However, flexibility usually comes at a price. Alternative lenders often charge higher interest rates and fees. Some products, especially merchant cash advances, can become extremely expensive.

The Two Core Loan Structures

Once a company decides to borrow money, lenders typically structure the financing as either a line of credit or a term loan.

Line of Credit

A line of credit works similarly to a business credit card. The borrower can draw funds, repay them, and borrow again. This is commonly used to manage working capital needs, payroll, inventory purchases, and short-term cash flow fluctuations. Interest accrues only on the amount actually borrowed.

Many revolving credit options also include a ‘sweep’ provision, meaning incoming receivables are automatically used to pay down the outstanding balance.

Term Loan

A term loan is more straightforward: the borrower receives a lump sum upfront and repays it over a fixed schedule. Term loans are commonly used for purchasing equipment, vehicles, real estate, or funding acquisitions. Unlike a line of credit, a term loan balance decreases over time and generally cannot be re-borrowed once repaid.

Cash Flow Lending vs. Asset-based Lending

Most commercial loans fall into one of two broad categories:

1. Cash flow lending
2. Asset-based lending (ABL)

The distinction is important because it affects underwriting, collateral requirements, reporting obligations, and lender remedies.

Cash Flow Lending

Cash flow loans are underwritten primarily based on the borrower’s ability to generate revenue and earnings, not their underlying current assets.

These loans work best for businesses with:

• Consistent revenue streams
• Strong EBITDA
• Predictable customer relationships
• Limited hard assets

Cash flow lenders typically evaluate:

• EBITDA
• Debt service coverage ratio
• Historical financial statements
• Revenue stability
• Management quality
• Industry trends

Important to note is that cash flow loans frequently include financial covenants requiring the borrower to maintain certain leverage ratios or minimum liquidity levels. Failure to comply may trigger defaults even if payments remain current.

Asset-based Lending (ABL)

Asset-based loans focus less on earnings and more on collateral value.

These loans are secured by assets such as:

• Accounts receivable
• Inventory
• Equipment
• Real estate

The amount available under the loan is often determined by a ‘borrowing base,’ which calculates lending availability as a percentage of eligible collateral. For this reason, ABL borrowers usually face more intensive reporting requirements. The legal framework for ABL lending is heavily tied to Article 9 of the Uniform Commercial Code (UCC), which governs secured transactions and lender perfection rights.

Specialty Financing Options

Not every business fits neatly into a conventional bank loan.

Several specialty financing products serve companies with unique operational needs.

Factoring

With factoring, a business sells accounts receivable to a third-party ‘factor’ at a discount. The factor advances cash immediately and then collects payment directly from customers.

Factoring is commonly used by:

• Staffing companies
• Government contractors
• Trucking companies
• Apparel businesses

The lender’s primary focus is often the creditworthiness of the account debtor rather than the borrower itself.

Purchase Order Financing

Purchase order financing helps businesses fulfill large customer orders. The lender pays suppliers directly so the borrower can manufacture or deliver goods. Once the customer pays, the lender is repaid.

Purchase order financing is common in:

• Wholesale distribution
• Import/export businesses
• Seasonal inventory businesses

Equipment Financing

Equipment financing allows businesses to purchase machinery or vehicles using the equipment itself as collateral.

These structures may take the form of:

• Equipment loans
• Capital leases
• Finance leases
• Sale-lease back arrangements

Merchant Cash Advances (MCAs)

Merchant cash advances provide upfront cash in exchange for a percentage of future receivables or credit card sales. These products are frequently used by restaurants, retailers, and businesses with heavy card transaction volume. But they can be costly. Rates on MCA are typically higher than other alternative lending options.

Hard Money Loans

Hard money lenders provide short-term financing secured primarily by real estate.

These loans are often used by:

• Real estate investors
• Developers
• Construction companies
• House flippers

Hard money loans are fast but expensive. The loan-to-value ratio (LTV) is critical in these transactions because it measures how much is borrowed relative to the property value.

The Importance of Knowing Your Lender

Business owners often focus heavily on whether the lender approves the loan. But borrowers should also evaluate the lender. Some private lenders may be willing (and eager) to take ownership positions if defaults occur. That possibility makes default remedies, collateral provisions, guarantees, and lender enforcement rights extremely important.

Borrowers should understand:

• Whether the loan is recourse or non-recourse
• What collateral is pledged
• What constitutes default
• Whether personal guarantees apply
• What rights the lender has after default

Final Thoughts

Business financing is rarely one-size-fits-all. The right loan structure depends not only on the amount of capital needed but also on the company’s cash flow, available collateral, growth strategy, industry risks, and long-term business goals. A traditional bank loan may offer lower pricing and stability, while private credit or specialty lenders may provide the flexibility and speed some businesses need to seize growth opportunities.

Ultimately, successful borrowing comes down to preparation, transparency, and selecting the right financing partner for the company’s unique circumstances. Thoughtful planning and careful review of loan terms can make the difference between financing growth and creating future financial strain.

To learn more about this topic, view What Kind of Loan? The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles about borrowing and lending.

This article was originally published on May 15, 2026.

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