Looking to fund your small business? When evaluating business loans vs government grants, it's essential to understand how each option can serve your needs. Grants provide funds you don't repay, while loans offer more flexible financing with repayment terms.
The right choice depends on your business's financial situation, immediate needs, and long-term goals. Though grants can be appealing, they're highly competitive and often restrictive.
If grants don't suit your situation, compare our best business loan lenders to find financing that meets your business needs. Let's look at both options to help you make an informed decision.
Key Insights on Government Grants vs. Business Loans
Business loans can be used for almost any reason but must be repaid (with interest).
Business grants are available to specific types of businesses and business activities.
Business loans make sense if you need fast funding and don’t qualify for a business grant.
If you’re in a field that is pioneering new research or part of an underprivileged community, you might qualify for several business grants.
Understanding Business Loans vs. Government Grants
What Are Business Loans?
Business loans provide capital from financial institutions that must be repaid over time. These loans typically fall into short-term (up to 24 months) or long-term (up to 25 years) categories, with interest charged as an annual percentage rate (APR) throughout the loan term.
Most lenders require at least one year of business operations, business financial documentation, and a personal credit check. Some loans may also require business assets as collateral. You can secure business financing through traditional banks, credit unions, or online lenders.
What Are the Requirements of Business Loans?
Most lenders require at least one year of business operations, financial documents, and a personal credit check. While some loans require collateral, getting loans without collateral is also possible. You can secure financing through banks, credit unions, or online lenders, each with different requirements and timelines.
Here are the primary types of business loans available:
- SBA loans: Small Business Administration (SBA) loans are business loans backed by the US government. They usually have lower rates and generous repayment terms, making them ideal for larger loans.
- Term loans: Similar to a mortgage, term loans provide a lump sum you repay through fixed monthly payments over a set period, typically several years. Your credit profile, business performance, and market conditions determine your interest rate. These loans work well for specific, one-time business investments.
- Business lines of credit: This flexible financing option works like a credit card, providing access to a predetermined amount of funds. You only pay interest on the amount you use, and the credit line replenishes as you make payments. It's ideal for managing cash flow, unexpected expenses, or seasonal fluctuations.
- Equipment financing: These loans help businesses purchase essential equipment while spreading the cost over time. The equipment typically serves as collateral, making approval easier and rates more favorable than unsecured loans. Terms often align with the expected lifespan of the equipment.
Pros and Cons of Business Loans
Pros:
- Flexible use of funds for virtually any business purpose
- Predictable repayment schedule for easier financial planning
- Opportunity to build business credit history with timely payments
Cons:
Must repay loan (with interest)
May require more documentation to be approved
Regular payment obligations that can impact monthly cash flow
What Are Government Grants?
Government grants provide businesses with funding that doesn't require repayment for qualifying organizations. These grants come from federal, state, and local government agencies, each with programs designed to support businesses that meet specific criteria aligned with public objectives.
Government grants come in several ways:
- Federal grants: Substantial funding opportunities from federal agencies, typically focusing on research, innovation, or industries considered nationally important.
- State grants: Programs designed to support businesses contributing to a state's economic development, often with less competition than federal options.
- Local grants: Community-focused funding to stimulate economic growth in specific cities or regions, frequently benefiting small businesses and startups.
- Minority-owned business grants: Specialized funding to support businesses owned by historically underrepresented groups, promoting greater economic opportunity.
- Research and development grants: Funding for innovative projects with potential commercial applications or public benefit, especially in science and technology.
- Community organization grants: Support for nonprofits and businesses addressing specific community needs and services.
Government grants come with specific usage guidelines. Federal grants, for example, typically can't be used to pay off debts, expand your business, cover startup costs, or handle day-to-day expenses.
Each grant program clearly outlines how to use the funds, and using them incorrectly could mean having to pay the money back. Always review all requirements before applying for or spending grant money.
Pros and Cons of Government Grants
Pros:
- Creates opportunities for underserved communities and business owners
- Provides validation and credibility that can attract additional funding
- Often includes valuable mentorship and business development resources
Cons:
Very competitive (hard to win grant funds)
Only available to certain businesses
If you don’t meet the requirements, you may be forced to repay
What Is the Difference Between a Loan and a Grant?
While both loans and grants provide essential business funding, they serve distinctly different purposes and come with unique conditions. Here are the key differences between business loans and government grants:
- Repayment obligations: With business loans, you must pay back everything you borrow plus interest. Grants typically don't require repayment—unless you fail to meet the specific requirements or misuse the funds.
- Accessibility and competition: Most businesses with decent credit can qualify for a loan. Grants are much more competitive and often target specific industries, causes, or business owner demographics.
- Application complexity: Loan applications focus on your credit and ability to repay. Grant applications are typically more involved, requiring detailed proposals that show exactly how you'll use the funds and how your business aligns with the grant's mission.
- Funding timeline: Loans can often be approved and funded within days or weeks. Grant applications usually involve lengthy review processes that can take months before you know if you're approved.
- Usage flexibility: With loan funds, you generally have the freedom to use the money for almost any legitimate business need. Grant money comes with specific guidelines about how it must be spent, often with reporting requirements to prove you're using it appropriately.
How Do You Choose Between a Loan and a Grant?
Expert intel: According to Ben Loughery, CFP® and lead financial planner at Lock Wealth Management, business loans are ideal if you value funding flexibility and predictability over no-cost but restrictive capital. While grants provide free funding, they come with lengthy application processes and strict usage rules.
Here are a few things to consider when choosing between a business loan and a grant:
- Timing considerations: Government grants often take months from application to receiving funds. If your business needs money quickly or you're facing a time-sensitive opportunity, a business loan will typically get you funding much faster.
- Working capital needs: Most grant programs don't cover day-to-day operating expenses. If your established business needs cash to manage growth or smooth out cash flow, business loans designed for working capital will likely be your better option.
- Demographic eligibility: If you're a business owner from an underserved community, you may qualify for special grant programs designed to level the playing field. These programs often provide funding, valuable business resources, and support. It's worth researching grants specifically created for your demographic.
- Growth and operational funding: Most grants won't cover common business needs like expansion, equipment purchases, or stocking up on inventory—except in very specific programs. For these typical business expenses, various loan products (like equipment financing, inventory loans, or term loans) are usually more accessible and practical.
When to Apply for a Government Grant
Winning a grant can give you access to funding without the need to repay. Here’s when to consider applying for a grant:
- If your business fits specific criteria: Some industries have better access to grants, particularly those involving technology research, innovation, healthcare, or businesses owned by underrepresented groups.
- When you want to avoid taking on debt: If you qualify for a grant and prefer not to burden your business with loan repayments, grant funding can provide capital without affecting your balance sheet or future cash flow.
- If you have time for the process: Grant applications require patience—often involving detailed proposals, supporting documentation, and waiting periods that can extend for months. If your funding needs aren't urgent, the wait could be worth the non-repayable funding.
- When your project aligns with grant objectives: Grants typically fund specific initiatives that match the grantor's mission. If your business plans align with available grant objectives—such as community development, environmental sustainability, or research advancement—you have a stronger case for approval.
Can You Use Both?
Yes, there’s no restriction on using grant funds and getting a business loan simultaneously. For example, you might consider using a grant to fund research and a loan to cover the operational costs of your business.
This gives you free funding for specific business needs and access to more flexible financing using a business loan or line of credit.
Conclusion
Both business loans and grants can boost your business by giving you access to much-needed funding. Business grants don’t need to be repaid, but they are competitive and for specific use cases only.
Business loans offer fast funding and more flexible terms, but you’ll have to repay the loan (plus interest) fully. You can find a list of government grants available from the government on the SBA website and compare different types of business loans to find the one that fits your business best.
