The funding opportunities for a start-up business may be limited by many factors: the available equity, the business plan, the lenders' priorities, and the estimates of market share. In the cannabis industry, funding can be scarce as investors are nervous, meaning there may be fewer choices. For many businesses, funding often comes down to two sources, term loans and lines of credit. Both have advantages and disadvantages that can have far-reaching effects as your business grows.
As the name suggests, a term loan is a type of lending where the business owner is expected to pay back the money over a set period of time. Owners who choose a term loan for their business will receive a lump some of cash up front, with the understanding that this money will be repaid over time at specific intervals (usually monthly) with interest.
Most term loans are amortized, meaning that the amount you repay each installment will be the same, although other business owners stagger their loans so that they pay less up front but have a larger financial commitment as the months and years go by. An amortized loan of $10,000 at a 5% interest rate, for example, will have a monthly repayment rate of about $300 per month for the next three years. While this business owner will end up paying nearly $1000 extra in interest over this term, this is often a small price to pay in exchange for badly-needed startup funds that can help a business get off the ground.
Term loans for a business are not fundamentally different from a personal loan for a car, home, or for college tuition, which is why they are appealing to many people. They may require collateral, however, including collateral in the form of your business.
If a term loan is analogous to a car loan, a line of credit is analogous to a credit card. You aren't actually paying your own money when you use a credit card: instead, the bank pays the sum and adds it towards your total extended credit, which is due at the end of the statement period. Unlike a simple credit card, a line of credit is usually for much more money (hundreds of thousands or even millions of dollars), but it also comes with interest for the credit extended, meaning that you do not get away with only paying the total amount for a statement period like you would with a personal credit card.
A line of credit for a business may be more practical than a lump sum because it can be repeated indefinitely: an owner spends whatever amount they need, pays it off at the conclusion of a statement period, and has a new line of credit available for the next statement period. Collateral may be less important, or even unnecessary, if you have a good credit history and faithfully pay off the amount owed at the end of a statement period.
Credit also provides some flexibility during cash crunches: if you cannot pay off the total amount, you can pay down a portion with the expectation that you will be able to pay off most or all of the rest of the statement in the future. Not paying the full amount for each statement comes with two major risks, however: first, that your line of credit may shrink for the next statement, and two, that you will be assessed more interest on the outstanding statement, resulting in you owing more money.
Generally speaking, a term loan is better for a big, one-time payment, like opening up a new facility. Lines of credit are better for everyday purchases, and for businesses that anticipate requiring cash during times of volatility to smooth out rough patches. What you choose should depend on your financial needs, as well as the interest rates you will be charged.
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