An Overview of Traditional Financing

“Traditional” financing generally means a loan or line of credit secured through a financial institution under conventional terms, usually based on the “four Cs”: character, collateral, capital, and capacity. The process for securing such financing is fairly standardized, with lenders looking at your credit history, your business plan, and your assets when assessing your qualifications.

The most common source of traditional financing is loans from large or small banks. Large banks can be the hardest to get loan approval from, with an application process that depends heavily on rigid, numerical factors such as your credit score. Smaller banks may have higher interest rates but are more likely to give your application detailed attention and work with you to find a way to get you a loan.

Borrowers who are having trouble getting approval from a bank on their own can also turn to the Small Business Administration to try to get an SBA-backed loan. Having the SBA guarantee the loan essentially eliminates risk for the lender, making these loans very popular but also competitive.

Similar to banks are credit unions, which also offer financing on generally favorable terms. The difference between a bank and a credit union is that a credit union is a non-profit organization owned by its members. Credit unions have restrictions on joining, generally limiting membership to certain communities such as residents of a local area or associates of an educational institution.

Because they’re non-profits, credit unions can sometimes offer lower interest rates than banks, but this is not always the case, especially as larger banks often have access to tax advantages and other benefits that the inherently small credit unions don’t. Approval rates tend to be similar to that of small banks and higher than for large banks; according to Biz2Credit’s Small Business Lending Index, recent credit union approval rates for small business loans are around 45%, versus 50% for small banks and 15% for large banks.

Whether it’s through a bank or a credit union, traditional loans and lines of credit have competitive interest rates compared to their alternative financing counterparts. So, if you have the financial records to secure traditional funds, it’s generally a small business’ best option. If you and your business have good credit, a strong business plan, and the collateral or personal investment necessary to show a lender you’re a low-risk borrower, take advantage of traditional financing.

The downside to traditional financing is that the approval process can be drawn-out and complex, especially if you’re credit isn’t great or you’re in a high-risk industry. Many small business owners face repeated rejection before finding a lender willing to give them financing, while many others give up or are so intimidated by the process they don’t even try the traditional route. If you’re having trouble securing traditional funds, you may want to look to alternative sources of financing to build your business.