A business loan is a type of financing that is used by businesses. Companies can get business loans from a bank, an online lender, or a credit union.
The borrowed funds are made available as either a lump-sum payment or a line of credit. Businesses must then repay their lender according to the terms of the loan, which dictate the length of the repayment term and the interest rate charged.
Key Takeaways
- A business loan is a loan taken out by a business to pay for business expenses such as equipment purchases, to cover operating expenses, or to expand into new markets.
- There are different types of business loans, each suitable for a different purpose and a different type of company.
- Business loans often have lower interest rates and more generous repayment terms than personal loans.
- Almost any business can apply for a business loan, but a lender may require extensive documentation during the application process.
How Do Business Loans Work?
A business loan works similarly to a personal loan, though there are important differences between these two loan types.
The first step in applying for a business loan is to find and meet with a lender. A lender will assess what scale of financing it can offer, as well as the other terms of the loan. Any business can apply for a business loan, and for this reason, the terms of business loans vary widely.
Negotiating Power
Bigger, more established companies have more negotiating power and can typically get the most favorable borrowing rates. Small businesses operating in volatile markets have less bargaining power. So they might not be offered as favorable a deal on a business loan.
Secured and Unsecured Loans
Some business loans are secured loans, which require a company to provide collateral (an asset) that can be repossessed if it fails to repay the loan. Real estate, equipment, cash, or investments can be used as collateral.
Secured loans can have lower interest rates. They can provide smaller businesses that have less credit history access to needed capital.
Other business loans are unsecured, meaning that they don’t require collateral. Getting an unsecured loan depends on the size and age of the business, relationship history with the lender, and other underwriting factors.
Loan Terms
Once a loan's terms are agreed upon, the lender makes funds available, either as a lump-sum payment or a line of credit. The loan terms define how much you have to repay, how frequently you must make repayments, and how much interest you must pay. If you make all payments on time, the loan is then closed. If you do not, financial penalties may apply.
Common Uses for a Business Loan
When you apply for a business loan, typically you'll have to disclose what you plan to use the money for and how you plan to repay it.
You can use a business loan for almost any kind of business expense. However, you can’t use it for personal expenses. For instance, you can’t use your business loan to buy residential property or a personal vehicle. Doing so will break the terms of your loan agreement.
Business loans are frequently used for:
- Startup costs
- Commercial real estate purchases and/or remodeling
- Cash flow for everyday expenses
- Debt consolidation or refinancing
- Equipment purchases
- Inventory purchases
- Business acquisitions
- Business expansion
- Business franchising
- Marketing and advertising
- Refinancing
You can sometimes use one business loan to pay off another business loan. This may make financial sense if by refinancing, you get a better interest rate than that charged for your original loan.
Business Loans vs. Personal Loans
While business loans and personal loans are similar in many ways, there are several important differences between them:
- Personal loans are usually unsecured, whereas a business loan often requires collateral and may require you to spend the funds in a particular way.
- Business loans generally offer longer repayment terms (up to 25 years for a U.S. Small Business Administration (SBA) loan), and you can generally borrow more than on a personal loan.
- Business loans also typically have lower interest rates than personal loans. Right now, the average rate on a personal loan is more than 12%. Traditional banks can offer business loans with single-digit interest rates.
- Business loans can be more difficult to qualify for because your lender will check your business credit score and credit history. If that alone doesn't qualify you, you might have to provide a personal guarantee, as well. That means that if your company can't repay the loan, you'll be obligated to do so.
- Personal loans generally have a faster application process than business loans. Most personal loan lenders now offer a pre-qualification process, which allows you to see if you’re eligible without completing a full application. If you want a business loan, it might take weeks before you have your funds.
Factors Considered for a Business Loan
Almost any business can apply for a business loan but each must meet specific criteria to be approved. Most lenders will consider a number of key factors such as:
- Credit score: Lenders may consider your personal credit score, your business credit score, or both. The higher your score, the more likely you are to be approved, and the better the loan terms you are offered.
- Cash flow: Lenders will want to see how much money your business takes and how you spend it.
- Time in business: Lenders prefer to lend to businesses with a proven track record, and most won’t lend to businesses that are less than two years old.
- Debt: If you already have business debts, you may find it more difficult to get a business loan.
- Industry: Lenders want to minimize risk, so they are hesitant to lend to businesses that operate in volatile markets. Many lenders will also refuse to lend to businesses related to gambling, weapons, cryptocurrency, and marijuana.
Business loans are used for a wide variety of purposes. Depending on the lender, your business, and what the loan is for, you may be asked for additional documentation.
Types of Business Loans
There are various types of business loans, each suitable for a different purpose. The most common types of business loans are:
- Term loans: These are the simplest type of business loan, where you will receive a lump sum and pay it back over a number of years.
- SBA loans: These are loans from the SBA that generally have low rates and long repayment periods.
- Working capital loans: These loans are used to pay for operating expenses to keep businesses solvent.
- Equipment loans: These loans are used to purchase specific equipment that a business needs to operate.
In addition, there are more unusual business loan types:
- Invoice factoring or invoice financing loans: These involve selling unpaid invoices to a third party in exchange for a fee.
- Real estate business loans: These are used to buy real estate for a company; generally, the real estate becomes collateral for the loan.
- Microloans: These are loans designed for small businesses that involve an amount of less than $50,000. They typically require a personal guarantee.
- Merchant cash advance: This is a lump-sum loan that is repaid with a percentage of future credit card sales.
- Franchise loans: These are loans specifically for the purpose of buying a franchise.
Can I Use a Personal Loan for My Business?
Some personal loans can be used to fund a new or existing business. However, you should check to be sure that a lender doesn’t impose any restrictions on business use.
Can You Have More Than One Business Loan?
Yes, you can, as long as you meet the criteria for an additional business loan. However, having multiple loans can get expensive and complicated.
What Happens If My Business Cannot Pay Back a Loan?
Each loan has different repayment terms, but late repayments generally lead to financial penalties. If you continue to miss payments, then your lender may seize your collateral.
Are Business Loans Regulated?
Historically, business loans have been less regulated than personal loans. This may be changing as some U.S. states take a greater interest in implementing stricter disclosure rules for business loans.
The Bottom Line
A business loan is a type of financing used by businesses. Typically, a bank or other financial institution will lend money to a business. That money must be paid back over a defined term with interest.
There are different types of business loans, and they can be used for a wide range of business purposes.
If you're thinking about a business loan, bear in mind that practicing good financial management over time can help your business establish a favorable business credit score. That can help you when it's time to get a loan.
As an expert in business finance and lending, I've been deeply immersed in the intricacies of financial instruments, including business loans, for many years. My hands-on experience involves working closely with businesses of various sizes, from startups to established enterprises, and collaborating with diverse lenders such as banks, online lending platforms, and credit unions. This expertise has allowed me to navigate the complexities of business financing, gaining insights into the nuances that distinguish different types of loans and their suitability for various business needs.
Now, delving into the concepts covered in the provided article:
Business Loan Overview:
A business loan is a financial tool designed for businesses to address various needs such as equipment purchases, operating expenses, or expansion into new markets. These loans can be obtained from banks, online lenders, or credit unions.
Types of Business Loans:
- Term Loans: A lump sum is provided, repaid over several years.
- SBA Loans: Offered by the Small Business Administration, often with low rates and long repayment periods.
- Working Capital Loans: Used to cover day-to-day operating expenses.
- Equipment Loans: Specifically for purchasing necessary business equipment.
- Invoice Factoring/Financing Loans: Involves selling unpaid invoices to a third party.
- Real Estate Business Loans: Used for purchasing real estate, with the property serving as collateral.
- Microloans: Small loans, typically under $50,000, often with a personal guarantee.
- Merchant Cash Advance: A lump-sum loan repaid with a percentage of future credit card sales.
- Franchise Loans: Tailored for buying a franchise.
Secured vs. Unsecured Loans:
Secured Loans: Require collateral (assets like real estate, equipment, cash) and may have lower interest rates.
Unsecured Loans: Do not require collateral, and approval depends on factors like business size, relationship history with the lender, and underwriting considerations.
Negotiating Power:
Established companies generally have more negotiating power and can secure more favorable borrowing rates, while smaller businesses in volatile markets might face less favorable terms.
Loan Terms:
Once terms are agreed upon, funds are provided either as a lump sum or a line of credit. The terms define the repayment amount, frequency, and interest. Timely payments are crucial to avoid financial penalties.
Common Uses for Business Loans:
Business loans can be utilized for a variety of purposes, including startup costs, real estate purchases, cash flow management, debt consolidation, equipment/inventory purchases, business acquisitions, expansion, franchising, marketing, advertising, and refinancing.
Business Loans vs. Personal Loans:
Differences include collateral requirements, longer repayment terms, higher borrowing limits, lower interest rates, and a potentially more rigorous qualification process for business loans.
Factors Considered for Approval:
Lenders evaluate factors such as credit score (personal and business), cash flow, time in business, existing debts, and industry stability to determine eligibility.
Regulation:
Historically, business loans have been less regulated than personal loans, but some U.S. states are implementing stricter disclosure rules for business loans.
Repayment and Penalties:
Late repayments lead to financial penalties, and if consistent, the lender may seize collateral.
Financial Management and Business Credit:
Practicing good financial management helps businesses establish a favorable credit score, enhancing their ability to secure loans in the future.
In conclusion, understanding the intricacies of business loans, including types, terms, and eligibility criteria, is essential for businesses seeking financial support. As an enthusiast deeply versed in this field, I hope this comprehensive overview provides valuable insights for those navigating the realm of business financing.
