4 Questions to Ask Before Getting a Commercial Business Loan
Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It may not have been previewed, commissioned or otherwise endorsed by any of our network partners.
Whether you’re just getting your small business off the ground or you’ve been operating smoothly for years, there’s a chance you’ll find yourself in a situation in which you need funding.
Commercial loans, also called business loans, provide financing to sole proprietors, partnerships, corporations and other business entities. Commercial business loans can be secured or unsecured and can be paid back in installments or in a single payment.
The application process for a commercial business loan can be simple or extensive, depending on what type of financing you’re looking for. Before getting started, here are four questions to consider when seeking a commercial business loan.
What is the purpose of the loan?
Commercial loans come in several forms to meet a variety of business needs. Before deciding which loan option to pursue, you should first know how you want to use the funds.
A few common reasons you might seek a commercial loan are:
- Purchase equipment
- Purchase inventory
- Expand your business
- Cover a lapse in cash flow
- Pay for emergency business expenses
- Hire employees
Commercial business loans could also help you with startup costs, but new business owners shouldn’t turn to a loan to fund the bulk of the enterprise, said Jack Craven, president and founder of John F. Craven, CPA, LLC in New York. He advises entrepreneurs to turn to friends and family when first starting out — a bank likely wouldn’t loan a new business owner more than $20,000 to $50,000 anyway.
“You shouldn’t go to a bank to finance the equity investment in a business,” he said.
According to Craven, the frequency of your funding needs would also affect which loan option you choose. Some businesses have expenses at certain times of the year and could benefit from having continuous access to funding.
“A lot of businesses are seasonal and therefore need a seasonal line of credit open to get them through the lean months,” he added.
Once you figure out what you need to pay for within your business, you can move forward in choosing the right loan.
What are your commercial loan options?
In addition to a traditional bank, you could obtain a commercial business loan from an online lender or a finance company. No matter what avenue you take to obtain business financing, Craven recommends sticking with reputable financial institutions.
Term loans are typically small business loans that span three to 10 years. You can use a term loan to cover a large expense, such as a building remodel, and pay back a little at a time. Term loans generally range between $25,000 and $200,000 and usually have low interest rates compared to other financing options. Most term loans require fixed monthly payments, and you can use the funds however you want. However, term loan applications also require a lot of paperwork, and it could be months before you receive the money.
SBA loans are long-term business loans backed by the U.S. Small Business Administration. The SBA works with lending partners across the country that issue loans to small business owners. These loans generally have low interest rates, and several types are available. Microloans come in smaller amounts up to $50,000, while 7(a) loans and 504/CDC loan amounts could be $5 million or higher. Small businesses that do not meet the requirements for traditional business financing might be approved for an SBA loan, though the application process is lengthy and takes about two to three months.
Lines of credit
A business line of credit provides a lump sum that you can draw from as needed to cover immediate business expenses. You can borrow as much as you need and only pay interest on that amount. Once you’ve paid off the funds you withdrew, the full amount becomes available again. The interest rate would be based on your personal credit and the financial state of your business. If you are a low-credit applicant, you may end up with higher interest rates, and you may have to provide collateral to secure the line of credit.
Equipment financing allows you to purchase large items for your business, such as manufacturing equipment, vehicles and shelving. The hard assets act as collateral on the loan, and the lender may cover up to 80 or 90 percent of the cost. Terms typically range from six months to 10 years and require monthly payments. You may need good credit to qualify for the loan, and you would likely have to make a down payment of 10 to 20 percent of the price of the equipment.
Merchant cash advance
Although it’s not a loan, a merchant cash advance gives you access to a given sum of money to cover business expenses. A merchant cash advance company purchases a portion of your future receivables — typically your credit card sales — in exchange for funding now. The company takes a cut of your sales every day until the advance is paid off. Merchant cash advances have low application requirements, but they come with high fees and fast repayment terms, making them a risky financing option.
Do you qualify?
To qualify for a commercial loan, your business would have to be profitable, according to Craven. If it’s not, a lender may be skeptical about your ability to repay the debt.
“You’ll have the answer the question of how you are going to pay back this loan,” Craven said. “That’s the most important issue.”
Most small business owners have to provide a personal guarantee when obtaining business financing, which puts them personally on the hook for the loan, Craven said. A personal guarantee signifies that you yourself would be liable for the loan if your business defaults and is unable to pay off the debt.
It’s difficult for new entrepreneurs with little business history to obtain financing without signing a personal guarantee. Because you would be guaranteeing the loan, your personal financial history would be a factor in whether you qualify.
General qualification requirements from traditional lenders could include:
- Minimum of two years in business
- Personal credit score of 680 or higher
- At least $100,000 in annual revenue
- Collateral to secure the loan
However, you may be able to qualify for a loan from an alternative online lender without meeting such strict requirements. Some lenders ask for just one year in a business and a personal credit score as low as 500, though interest rates could be too high to be worth it in some cases.
If you’re confident that you meet a specific lender’s minimum requirements, you can get started on your loan application.
Is your application ready?
The loan product you’re seeking would determine the length of the application and the amount of detail you would need to provide. For example, SBA loan applications are several pages long and demand multiple documents for review. On the other hand, a merchant cash advance application requires little paperwork and can be approved in one to two days.
If you’re applying for a standard term loan, an application would call for the following documents and information:
- Financial statements, such as balance sheets and profit-and-loss statements
- Recent tax returns
- Employer Identification Number
- Your business’ legal entity
- Business plan
A lender may also look at how you manage your resources, including your methods for processing payments and accounts payable. You may also have to prove that you’ve put your own money into the business; a lender may not want to risk lending money if you don’t have your own funds on the line.
The time by which you’d receive the funding after submitting a loan application would also depend of which product you are applying for and the extensiveness of the lender’s underwriting process. For instance, term loans typically have a lengthy timeline.
Bottom line on commercial loans for your business
To save time and resources, it would be best to prepare as much as possible before applying for a commercial business loan. Taking time to understand why you need financing and how you’ll pay off debt could help you choose the right product for your needs and prevent you from wasting time chasing the wrong type of loan.
After applying, you may want to hire a lawyer or financial adviser to look over the loan agreement before you sign on the dotted line, Craven said.
“I think a lot of times, people don’t understand what a personal guarantee is, for example, or what the terms of the loan are,” Craven said. “They see the cash without having a clear idea of what they’re going to be paying back.”
By making sure you do your homework before entering into a loan, you can help ensure you make the right decision for you and your business.