Funding can make or break a burgeoning small business. Various grants and loans are available to entrepreneurs who want to invest in software, sales tools, and other growth-enhancing assets. However, these two funding sources are quite different.
Small business owners seeking funding should clearly understand the difference between grants and loans so they can determine which resource is best for them.
Small business grants vs. loans
The biggest difference between grants and loans is whether you have to pay the money back. Typically, a business that receives a grant goes through an application process where they show they qualify and agree to spend the money in the manner specified by the grantee. However, the business does not have to pay it back unless it violates the terms of the grant.
Loans are often easier to obtain than grants because the lender is typically motivated by receiving the amount of the loan back plus interest. Banks and credit unions that issue loans expect the loan to be repaid according to highly specific terms that are laid out to the borrower.
Understanding eligibility requirements for grants and loans
Applying for a grant is a low-risk option for small businesses, but they often come with eligibility requirements that must be met. Additionally, grant recipients may need to report back to the grantmaker on how the funds were spent or provide documentation of the company's progress.
Unlike grants, loans don’t require proof of progress, and depending on the type of loan, it can typically be spent on any business expense the owner sees fit. Because the money is expected to be repaid so that lenders see a return on their investment, loan applications often come with different requirements that businesses must meet to obtain funding. For example, many lenders require businesses to be incorporated before they can apply for financing — this helps to more clearly separate the assets of the business from an owner's personal assets.
For small companies that only need a tiny boost to improve their business, the SBA offers microloans.
How to apply for a grant vs. a loan
Whether you seek a loan or a grant, the first step is assessing your funding needs. Does your business need capital quickly, or are you looking for a financial boost for long-term growth? Your answer determines how you proceed.
The grant application process can be lengthy and highly competitive. To boost your chances of being awarded, follow these steps:
- Do your homework. Start by researching the types of grants available to your organization. Note specifics such as the application deadline and funding distribution timeline and ensure you meet the eligibility criteria for the grants you wish to apply for.
- Draft the proposal. Most grants require you to submit information about your organization; they may even require a lengthy proposal or application. Prepare a well-written, compelling proposal that adequately addresses your business needs and highlights its mission.
- Establish a reporting system. If your organization receives a grant, you must comply with its specific requirements, such as reporting responsibilities that detail how the funds are spent. Establish systems to track your budgets, timelines, and expected deliverables.
Loan applications focus more on your business's financial health. Here's what you need to know about the application process to improve your chances of being approved for a loan:
- Find a reputable lender. Begin the process by evaluating different lenders and their proposed terms. Ensure you find a reputable lender who offers manageable terms, as you'll be legally responsible for repaying the funds, likely with additional costs in return.
- Compile your documentation. Before you can be approved, most lenders require financial and business records, including credit reports, cash flow statements, tax returns, and a detailed business plan. If your credit history or records are weak, some lenders work with underfunded or newer businesses struggling to secure funding. However, these loans often have higher interest rates and stricter repayment terms.
- Prepare for lender interviews. Sometimes, you may have to interview with lenders before receiving funding. During these meetings, you'll discuss timelines to secure financing, repayment plans, and collateral needed to obtain the loan.
Top options for small business grants
When seeking government-based grants, the best place to start is Grants.gov, a centralized online site where you can learn about and apply for federal grant opportunities from more than 20 agencies, such as the U.S. Department of Justice and the U.S. Department of Health and Human Services. These grantmaking agencies award over $500 billion annually to businesses of all types. Keep in mind that these agencies often want research and other deliverables in exchange for the grant.
Additionally, many nonprofits, private corporations, and local governments offer grants. These grants typically target women- and minority-owned businesses or businesses located in a certain city or state.
Learn how to apply for business grants.
Best options for small business loans
Small businesses have turned to loans for thousands of years to help them start or grow their operations. In our modern age, U.S. small businesses have popularly used the U.S. Small Business Administration's (SBA) loan program to secure funding.
These are the most popular SBA loans:
- 7(a) loans: The 7(a) loan program is the most common type of loan the SBA offers. This loan is used for working capital; purchasing real estate; refinancing business debt; and purchasing equipment, furniture, and machinery. The maximum 7(a) loan size is $5 million.
- 504 loans: The 504 loan program helps companies in need of long-term financing that will in turn "promote business growth and job creation." Among other uses, borrowers can purchase buildings, land, and machinery or equipment. The 504 loans are only offered by certified development companies, so be sure your business is eligible if you are seeking this type of loan. The maximum 504 loan size is $5 million.
- Microloans: For small companies that only need a tiny boost to improve their business, the SBA offers microloans. These loans can help businesses by giving them a cash infusion for working capital or funds to purchase inventory, furniture, machinery, equipment, and other selective use cases. However, SBA microloans can't be used for existing debts or real estate purchases. The maximum loan size for a microloan is $50,000, and the average size loan totals $13,000.
Additionally, small businesses can use the SBA's Lender Match tool to find an appropriate bank or credit union for their funding needs. Businesses can also seek help from fintech companies and private banks. But always closely review the loan terms before entering an agreement.
Learn more about how to apply for a small business loan.
How to combine grants and loans for maximum flexibility
Combining grants and loans is a smart way to fund your organization, providing immediate and long-term financial support. However, before pursuing external funding, carefully evaluate your business's financial situation to avoid overleveraging or taking on more debt than you can afford to repay.
When combining funding options, consider the terms or conditions you are agreeing to. Some grants may limit your eligibility for additional funding, and certain loan terms may conflict with grant requirements. Without proper planning, your business could be forced to return grant funding or lose access to a loan.
Another factor to consider is the urgency of your organization's funding needs. Grants are far more limited and often have lengthy approval processes that can take weeks, months, or — in rare cases — even years to receive funding. Loans, in contrast, are usually approved more quickly — sometimes within days, though it depends on the lender.
Therefore, plan and prepare your applications early. You may apply for a loan — which can be done in minutes — while simultaneously exploring grant options to secure the capital your business needs when you need it.
This article was originally written by Sean Ludwig.
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