From term loans issued by banks and credit unions to micro-loans geared towards B-Corps, there are many small business loans available to US-based entrepreneurs. In this post, we take a look at a few different types of business loans. We consider which make the most sense for interior design firms at varying stages of growth. While last week’s post weighed the pros and cons of debt vs equity financing, we will focus solely on debt in this week’s post. Stay tuned for our 2023 Summer Finance Series to learn more about equity financing and grant opportunities available to design business owners.

Pros and Cons of Taking on Debt as an Interior Design Business Owner

Last week, we delved into the advantages and disadvantages of taking on debt instead of selling equity.

Before considering which loans might make sense for your firm, let’s review the pros and cons of debt financing as a small business owner:

Advantages of Debt Financing

• The lender is not involved in major business decisions.
• Lenders no longer have any influence over your business, your credit score or your personal assets once the loan is repaid.
• Making regular payments can boost either your business credit score or your personal credit score. In some cases, paying off debt could impact both credit scores.
• Interest payments on business loans are usually-tax deductible.
• Business owners who use personal loans solely for business expenses can also deduct those interest payments.
• Debt financing can be less expensive than equity financing because interest payments are deductible, while shareholder dividends are not.
• It is often easier to borrow money than to sell equity.
• There are many types of debt financing options available to business owners. These include business credit cards, business lines of credit, merchant cash advances, SBA loans, small business loans and others.

Disadvantages of Debt Financing

• Most business owners must pay interest on the debt they borrow.
• Debt can be very expensive when interest rates are high. If borrowing through an online lender, the origination fees can also be hefty.
• Unlike equity, business owners must repay their loans, lines of credit and other debt in full plus interest.
• Accumulating too much debt can make businesses unattractive to other investors.
• Some lenders require business owners to stake collateral as a personal guarantee that they will repay the loan.
• Missing payments could mean losing those assets.
• While making on-time payments can boost your credit scores, failing to make payments can negatively impact your credit rating.
• If your business revenue fluctuates from month to month or season to season, it might be difficult to make regular payments.

Small Business Loans and Other Debt Financing Opportunities for Interior Design Firms

Debt financing can buoy growing businesses in a number of ways. It can help owners hire new employees and build-out existing departments.

Business debt can also prevent owners from dipping into their personal savings. It can cover startup costs for emerging interior design firms. Debt can finance a new studio space, equipment or product line.

There are dozens of borrowing options available to design business owners — even those currently working as sole proprietors. However, the repayment terms, interest rate, and fees involved will differ based on the type of business financing you choose. From SBA loans to RLOCs and from CRE mortgages to cash advances, below are a few debt financing options available to small business owners.

Keep an eye out for upcoming workshops and subscribe to our newsletter for more about managing your firm’s capital structure.

Term Loans

A term loan is a traditional loan issued by a bank, credit union or other financial institution in one lump-sum. Both personal loans and some small business loans are term loans.

According to an article for the National Bank of Commerce, the lump sum a borrower receives is determined by one of three factors. Elise Popelka writes that the “value of collateral” or “the value of assets the loan will be used for” determines this amount.

Alternatively, the loan amount might depend wholly on the “borrower’s overall creditworthiness.” This might occur if the borrower has applied for a short-term loan, and has not specified how they plan to use the funds.

Either way, the borrower pays back their small business loan in monthly or quarterly installments over a predetermined period of time. These installments include interest payments and principal payments.

Business owners who opt for a variable interest rate can expect their monthly payments to change over time. Those who opt for a fixed interest rate should pay the same amount each month.

Some term loans must be repaid within three or five years, while others might be repaid over the course of a decade or longer. The latter are called “long-term loans.” Banks that issue long-term loans often require the borrower to use personal or business assets as collateral.

The terms of a traditional business loan will depend heavily on the borrower’s industry, credit profile, cash flow projections, business history and other factors.

SBA Loans

Unlike term loans, SBA loans are issued only by certain lenders that have been pre-approved by the Small Business Administration. There are several different types of SBA loans available to business owners. Some allow borrowers to use the funds however they see fit, while others covers costs related to a specific business expense.

For example, business owners can use SBA 7(a) loans to refinance another loan, purchase real estate, buy equipment or finance business operations. According to this resource from the SBA, “the maximum loan amount for a 7(a) loan is $5 million.”

Alternatively, SBA 504 loans are designed to help business owners make major purchases like commercial real estate or expensive equipment. The cap for SBA 504 loans is also $5M USD.

The approval process for an SBA loan is often more complex, involved and time-intensive than that of a traditional term loan. Though competitive, interest rates might be higher — even for applicants with exceptional business or personal credit scores.

However, the payback period can be much longer — making an SBA loan more affordable on a month-to-month basis. SBA loans can have variable or fixed interest rates.

Learn more about SBA loans and other programs offered by the Administration here.

Equipment Loans

Like the name suggests, equipment loans are used to finance the purchase of equipment for your business. Similar to a mortgage, the loan amount is determined by the appraised value of equipment you plan to purchase.

As noted above, some SBA loans are designed specifically to cover the purchase price of necessary equipment. However, the SBA is not the only organization that issues equipment financing loans.

Online lenders like Lending Tree and traditional financial institutions like Bank of America or US Bank both offer business equipment financing. Like certain term loans and SBA 7(a) loans, equipment loans require the borrower to make a down payment.

According to Dan Casarella in this article for the U.S. Chamber of Commerce, term and lending limits vary. However, most “lenders have term limits of up to 25 years and a minimum of $1 million.”

Business Credit Cards

To establish business credit and cover certain expenses, you might apply for a business credit card. Business owners who maintain a balance on their credit cards can run into the same issues as those with personal credit debt.

Because of this, a business credit card might not be the best choice for financing major purchases or ongoing expenses. The fees and interest rates associated with business credit cards often exceed those associated with loans and lines of credit. Interest rates are variable,

Business Line of Credit

Like a business credit card, a business line of credit is a form of unsecured debt. A LoC allows borrowers to borrow money against their account at their own discretion. Regardless of their credit limit, business owners pay interest only on the amount they have actually borrowed.

Lenders tend to be more selective when issuing a business line of credit than a traditional term loan or business credit card. As Donna Fuscaldo writes in an article for Business.com, bank borrowers must have “strong revenue and [several] years of positive history to qualify.”

If applying for a LoC online, you will need six months of business history, revenue of $25K+, and a credit score over 500.” While online lenders are less selective, interest rates are usually higher, limits are lower and payback periods are shorter.

Revolving Line of Credit

Every business line of credit is not a revolving line of credit. Some lines of credit are closed once the full balance is paid. Others are kept open in perpetuity — allowing the account holder to continue borrowing up to their credit limit.

Startup Loans

For the interior designer planning to open her own firm or transition from a sole proprietor, startup loans can be an excellent financing option.

Unlike certain term loans, SBA loans and lines of credit, startup loans are available to owners with short credit and business histories.

Microloans

Also intended for startups, SBA microloans provide business owners with up to $50k. While SBA microloans help for-profit businesses, other microloans are designed specifically for B-Corps and nonprofits.

Private individuals might also fund microloans through peer-to-peer lending programs. Some companies offer grants instead of or in addition to microloans. Interest rates and loan amounts are both typically low for microloans.

Merchant Cash Advances

A quasi hybrid between debt and equity financing, merchant cash advances provide borrowers with a lump-sum up front. Repayment is usually based on the company’s recorded past and estimated future sales.

According to this Government of California advisory, “small businesses periodically pay either a percentage of their receivables or a daily fixed amount.” 

Unlike a long-term bank loan, no collateral is needed. A merchant cash advance is most often used as a form of emergency or last-minute financing. Merchant cash advances are used to cover expenses during periods of unstable cash flow. However, the payback terms can be too steep for certain owners.

Personal Loans

A small business owner with a less-than-ideal personal credit score or minimal business credit history might opt for a personal loan. Personal loans allow business owners to borrow smaller sums of money — typically up to $50K at a time. These short-term loans usually have payback periods of one to five years.

Most personal loans are unsecured — meaning no collateral is needed and no assets are forfeited in the event of a default. However, interest rates tend to be higher for personal loans than term loans — mainly to offset this risk to lenders.

As we note in our post about debt vs equity financing, “paying back personal loans will not improve your business credit score.” However, interest payments made on personal loans might be tax-deductible if you use the funds solely for business expenses.

Commercial Real Estate Mortgages

Some interior design business owners choose to purchase commercial studio space. Buying commercial real estate with a mortgage can provide business owners with a predictable monthly payment while they build equity. There are also a number of tax deductions, credits, and passive income opportunities associated with commercial real estate ownership.

Unfortunately, commercial real estate loans usually come with higher interest rates than residential real estate mortgages. However, those who opt for a loan through the SBA might be able to secure a lower interest rate.

Refinancing a Mortgage

As business owners pay off their mortgage, they gain equity in the property — allowing them to leverage that investment. Some choose to cash-out refinance their commercial real estate mortgage in order to finance business growth.

Invoice Factoring

Similar to merchant cash advances, invoice factoring or invoice financing also allows you to borrow against your firm’s sales. Instead of borrowing against your future sales, invoice factoring allows you to borrow against unpaid invoices.

According to Julia Kagan in an article for Investopedia, “businesses pay a percentage of the invoice amount to the lender as a fee.” Kagan notes that invoice factoring can be attractive to lenders because it poses a lower risk of loss when compared to lines of credit.

Businesses that offer credit to clients or customers are most likely to choose invoice financing as a method of borrowing cash quickly. Unpaid invoices are used as collateral when businesses ask to borrow from lenders. However, clients typically have no idea that this arrangement has been made.

Demographic or Specialty Loans

Like the grants listed below, specialty loans are designed for certain demographics. For example, some loans are only available to minorities, women, or businesses located in specific geographic areas.

Women in business who are seeking funds to establish or expand their companies can find resources through the SBA’s Office of Women’s Business Ownership.

How Much Will Debt Cost My Business?

Business debt often incurs additional costs beyond the loan’s principal and interest payments. Below are a list of common fees associated with borrowing money as a business owner:

• Origination Fees
• Loan Application Fees
• Underwriting Fees
• Collateral Appraisal Fees
• Prepayment Penalties
• Payment Processing Fees
• Late Payment Fees
• Over-Limit Fees
• Closing Costs

Grants for Interior Design Business Owners

Beyond debt and equity, small business owners can also apply for grants. Many grants offered by the federal government and other organizations are geared towards businesses in tech or R&D.

However, there are some designed to help businesses in the construction industry, entrepreneurs with export businesses, and minority-owned businesses in any industry.

The federal government also funds grants and other opportunities designed specifically for women in business. Others are designed for businesses in rural areas, those that have been impacted by natural disasters, and those in economically-depressed areas.

Though not intended specifically for designers, below are a few grants available to women in the interior design industry:

• #MomsMeanBusiness Campaign
• The Papaya Grant
• Cartier Women’s Initiative
• Fearless Strivers Grant Contest
• The Girlboss Foundation Grant
• EnrichHER Grant
• Go. Be. Elevate Fund
• Hello Alice Small Business Growth Fund
• Ladies Who Launch
• WomensNet Amber Grant for Women

Which Small Business Loan or Debt Financing Option is Best for Your Firm?

Each firm’s history, needs, trajectory and financial picture differs from the next. A small business loan from the SBA might be perfect for your firm, while an RLoC would better suit a peer’s company.

In many cases, a firm’s capital structure will include multiple types of debt. You might have a business credit card, a revolving line of credit and an equipment loan to cover expenses and finance operations.

Your firm’s capital structure might also include an equity partner or investment from friends and family. Grants might provide an additional infusion of much-needed capital.

Still not sure how to form your firm’s capital structure? Stay tuned for our Summer Finance Series to learn more.