Term loan: Definition, types, and pros and cons for small businesses

From expanding product and service lines to dealing with short-term cash shortages, business owners may need a small business loan for many reasons. Almost half (45%) of small businesses report cash flow problems, highlighting the importance of effective financing options. Before picking a financing option, assess your reasons for pursuing it and determine which funding type suits your needs.

One option for funding is a term loan, which can be useful for growing your business or managing cash flow fluctuations. Let’s look at the various types of term loans and the distinct advantages and disadvantages they can present for businesses.

What is a term loan and how does it work?

Types of term loans

Term loan examples

Pros and cons of term loans

How to apply for a term loan

Credit cards vs. term loans vs. lines of credit

Explore your funding options

What is a term loan and how does it work? 

Small businesses use term loans to finance things like expansion, equipment purchases, or working capital. Some of the differences between term loans and lines of credit are that term loans typically provide you with a lump sum of funds while lines of credit are accessed on an as-needed basis.  

They usually also differ on interest rates and repayments, with the latter sometimes having variable interest rates and requiring repayment only when funds are outstanding. Additionally, term loans differ from lines of credit in the following ways:

Term loans can also be secured or unsecured. A secured term loan may require you to put up personal or business assets as collateral. 

Term loans offer businesses a fixed sum of cash to address specific needs over a period of time. While a fixed rate term loan provides stability, predictable repayment terms, and flexibility, an adjustable rate loan can typically offer a lower initial rate but less predictability in the future. The duration of a term loan can vary depending on the borrower’s needs and the lender's requirements. 

Smarter financing with AI

Managing loans, credit, and cash flow can be overwhelming without the right tools. That’s where QuickBooks AI agents come in. The Finance AI agent uses automation and real-time insights to help you better understand your financial position, predict cash flow gaps, and make more informed funding decisions.

By combining financing options like QuickBooks Capital with AI-driven insights, you can streamline your operations, reduce guesswork, and focus more time on growing your business.

Types of term loans  

Businesses can consider several term loan types for their financing needs, including: 

Short-term

Short-term loans typically have a repayment period of less than one year and are usually for immediate cash flow needs, inventory purchases, or small projects. These loans have more flexible qualifications and faster funding processes than other types of term loans but may come with higher fees. 

Medium-term

Medium-term loans, on the other hand, have a repayment period ranging from one to five years. These loans are commonly for equipment purchases, expansion plans, or larger projects. They often have higher loan amounts than shorter-term loans, giving businesses a reasonable repayment period and manageable monthly payments.

Long-term

Long-term loans have longer repayment periods. Repayment periods for these loans are usually more than five years. They are for major investment projects, property acquisitions, or business acquisitions. 

Long-term loans generally have lower interest rates versus short- and medium-term loans but may have stricter qualifications. Additionally, the funding process can be slower versus shorter-term loans. Note that longer-term loans may have a higher interest rate given the potential higher risk profile. 

Ultimately, the choice between short-, medium-, or long-term loans depends on your business’s needs.

Term loan examples 

You can get a term loan for various purposes. Here are some real-life examples of what small businesses often use term loans for: 

• Expansion and renovation: A local restaurant wants to expand its seating area and renovate the interior—they take out a term loan to cover the costs of construction, furnishings, and equipment.
• Inventory purchase: A clothing store wants to stock up on inventory and hire for the holiday season—they take out a term loan to purchase a large amount of merchandise. 
• Equipment purchase: A small manufacturing company needs to upgrade its machinery to increase production—they use a term loan to buy new equipment. 
• Working capital: A seasonal business, like a landscaping company, experiences cash flow dips during the offseason—they get a term loan to cover operating expenses and payroll until business picks up again.
• Debt consolidation: A small business has multiple high-interest loans and credit card debts—they use a term loan to consolidate these debts into one with a lower interest rate. 
• Technology upgrades: A retail store wants to implement a modern point-of-sale system and upgrade its e-commerce platform—they secure a term loan to cover the costs of software and implementation.
• Franchise purchase: An entrepreneur wants to buy into a popular franchise and open a new location—they secure a term loan to cover the initial franchise fee, equipment, and startup costs. 

What can you use a term loan for? 

You can use a term loan for various purposes, such as opening a second location, expanding or remodeling a property, hiring more employees, buying new buildings or spaces, or purchasing equipment. 

Pros and cons of term loans 

Term loans are a valuable financing option for businesses seeking set loan terms. Along those lines, they offer several advantages for businesses over other financing options.

Term loan pros

Term loans offer several advantages that make them appealing for long-term business financing.

• Allows businesses to borrow large amounts of money, making them suitable for funding major investments or expansion projects. 
• Long repayment terms may be available, which can help businesses manage their cash flow by spreading out the payments over an extended period.
• Can contribute to building a business's credit history, where regular and timely payments can lead to a good business credit score.
• Typically has a fixed interest rate, allowing businesses to plan their budget more effectively.

Term loan cons

However, there are also drawbacks to term loans, including: 

• May require collateral, such as business assets to secure the loan. 
• May be more difficult to qualify, especially for businesses with a lower credit score or being in business for a short period of time. Stricter qualification requirements are often imposed on long-term loans. 

It’s important to consider the collateral requirements, potential challenges in qualifying, and the approval and funding time frame when deciding on your term loan.

How to apply for a term loan 

When applying for term loans, there are several steps to follow as you complete an application.

Here are some suggested steps to help find the best term loan for your business needs: 

1. Evaluate qualifications: Start by assessing your business's qualifications, including your credit score, annual revenue, and time in business. Lenders often have specific requirements in these areas, so it's important to understand where you stand before applying. 
2. Compare lenders: Research different lenders to find the one that offers the most favorable terms and conditions. Consider factors such as interest rates, repayment periods, qualification requirements, and the total cost of credit. This will help you find a lender that aligns with your unique financial situation and goals. 
3. Prepare documentation: Gather the necessary documents to support your loan application. This typically includes financial statements, tax returns, and any other documents the lender requests, like a business plan. 
4. Submit application: Once you have all the required documentation, follow the lender's instructions to complete and submit the application. Ensure your application is accurate and includes any additional information or forms they may require.

By following these steps, you can confidently apply for term loans to finance your business needs.

Credit cards vs. term loans vs. lines of credit

Both credit cards and term loans can help cover expenses for your business, but they serve very different purposes. Understanding the differences can help you decide which option is better suited to your needs.

Credit cards: Flexible but limited

Business credit cards give you access to revolving credit. In other words, you can borrow up to a set limit, repay, and borrow again as needed. This makes them ideal for everyday expenses like office supplies, travel, or short-term cash gaps.

However, credit cards typically come with higher interest rates than loans, especially if you carry a balance. They may also have lower credit limits, which might not be enough to cover larger investments.

Term loans: Structured and scalable

Term loans provide a lump sum of money upfront with a fixed repayment schedule. They’re best for bigger expenses, such as purchasing equipment, expanding operations, or consolidating debt. Because of their structured terms, they often come with lower interest rates than credit cards.

The trade-off is that term loans can require more paperwork, stricter qualifications, and collateral for larger amounts.

Lines of credit: Flexible and reusable

A business line of credit works like a hybrid between a loan and a credit card. You can borrow funds up to a set limit, repay, and then borrow again as needed. This flexibility makes them useful for covering cash flow gaps, unexpected expenses, or seasonal fluctuations.

Lines of credit usually have lower interest rates than credit cards, but they may come with annual fees or require collateral for higher limits.

Explore your funding options 

Term loans are a popular financing option for businesses. When applying for a term loan consider the repayment term and the impact it will have on your business's cash flow. You can explore funding options through QuickBooks Capital without affecting your personal credit score.

One option is QuickBooks Term Loan, which is an unsecured loan with no origination fees or prepayment penalties. Loans may range from $1,500 to $200,000. The application and decision process takes just minutes with no impact on your personal credit score—and you can get funding in as fast as 1-2 business days¹. 

Getting flexible business funding with minimal paperwork can be imperative for your business.