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The world of small business financing can be confusing. There's no way around that. Getting a grasp of all the different loan products available, and understanding which is the best option for your specific business, can sometimes feel like learning an entirely new language. But, all is not lost. We are happy to say that small business term loans, which the following article covers in-depth, is probably the most straightforward financing option available to business owners.
Whether you're purchasing inventory in bulk or considering expanding to a second location, term loans can provide you with the funds to make a long-term investment in your business possible.
Business term loans not only provide the financial security you need to invest in big purchases, but also allow you to budget and plan more effectively with the consistency of regularly scheduled payments.
If you're considering small business financing, here's a quick and simple guide that gives you the rundown on term loans and how you can use them to fuel growth for your business.
Chances are if you've ever taken out a mortgage or borrowed money to buy a car, you've used a term loan.
A term loan provides a lump sum of capital upfront, which is then paid back at fixed intervals (weekly, bi-weekly, monthly) over the life (term) of the loan. They're called term loans in reference to the length of the repayment term.
There are certain things that set term loans apart from other business funding options. Those include:
Term loans are designed for more established businesses, typically with at least two years of operating history. Due to the larger dollar amount, and the fact that business term loans are delivered in one lump sum, these loans are often used for growth investments versus covering day-to-day operating expenses.
There are actually three kinds of small business term loans: short-term, intermediate-term, and long-term loans. Each option can serve a different purpose for your business.
This table highlights how each type of small business term loan compares:
The type of term loan that's most appropriate for you depends largely on how you plan to use the loan and how quickly you expect to see a return on your investment.
Using a short term loan to take advantage of a deal on inventory, for example, might make sense if you anticipate being able to sell the inventory quickly and use part of the profits to repay the loan. An intermediate or long term loan, on the other hand, might be more suitable for projects that may take several months or years to begin generating revenue for the business.
Term loans are among the most straightforward forms of small business financing.
You can work with a company who will help you compare lenders, and figure out the best fit based on how well you meet their borrowing requirements and your unique financing needs. Complete the application and assuming you're approved, the lender delivers the entire loan amount to you, minus any origination or other processing fees they may charge.
Once you have been approved and received the loan, the process is pretty straightforward; you repay the loan according to the payment schedule set by the lender, at the rate spelled out in your loan agreement. You could pay off a term loan ahead of schedule by increasing your monthly payments, or by simply paying off the outstanding balance in its entirety. However, it's important to check with the lender to determine whether any prepayment penalties would apply.
Interest rates for term loans typically run in the range of 7% to 30%, although it's possible to find small business term loans with rates that are higher or lower. The rate you'll pay for a term loan depends largely on your credit profile and your business's financials.
While most term loans have a fixed interest rate, you may encounter a term loan with a variable interest rate. With a variable rate loan, your rate (and in turn, weekly, bi-weekly or monthly payment) may increase or decrease over the term of the loan as underlying index rate changes. If rates drop, you could save on interest, but if rates go up, you'll end up paying more. Fixed-rate term loans offer more predictability with your payments, which tends to be favorable.
Borrowing amounts for business term loans are set by individual lenders; you may find term loans as low as $25,000 or as high as $1 million. The middle ground for term loans offered by online lenders is usually somewhere between $25,000 and $500,000.
Term loans can serve your business funding needs in a number of ways. The following use-cases are some of the most common ways to put a term loan to work.
When your business is growing, meeting rising customer demand often hinges on the quality of your staff. If you need to expand your team, a business term loan can help cover the expenses of recruiting and training new employees, as well as meeting payroll - without putting a dent in your working capital.
Equipment may be essential to keep your business running, but replacing it can be expensive. Term loans allow you to repair or replace equipment for your business as needed, whether it's a point-of-sale system for your retail store, kitchen equipment for your restaurant, or a specialized piece of manufacturing equipment for your custom cabinet shop.
Your equipment needs may also include vehicles or heavy equipment. Buying vehicles for your business can also be pricey, but it may be an unavoidable expense if you operate a food truck or rely on delivery vans or trucks to get your products out to your customers. An intermediate or long term loan could make sense for those purchases if the loan term matches the useful life of the vehicle.
When you find the perfect piece of real estate, you have to move - fast. This could mean a new office space for your growing team, or a second storefront for your brick and mortar business. With a small business term loan, you can get a large lump sum of funds, quickly, which makes bringing your physical expansion visions possible.
Business term loans can also be useful for expanding your product line if you need to cover the initial costs of production or market research. A term loan can help you get your new product to market without draining your cash reserves.
If you have multiple small business loans at varying interest rates, refinancing them into a single term loan could be a good decision. Not only could you streamline your monthly payments this way, making it easier to manage cash flow, but you may be able to get a lower interest rate on a term loan compared to what you were paying across multiple loans. That could provide an additional cash flow boost if it saves your business money on interest costs.
There are a number of reasons that term loans are so popular among small business owners. Here are a few advantages of business term loans:
#1 Lower interest rates: Due to their longer repayment terms, term loans are typically available at lower interest rates than short-term borrowing options like a line of credit or a business credit card.
#2 Flexibility in use: Business term loans can also offer flexibility in that lenders may offer a range of loan repayment terms to choose from. You can then select the term that best fits your timeline and budget for repayment. The flexibility associated with term loans is also evident when it comes to how they can be used. A term loan can satisfy one - or several - funding needs for your business.
#3 Predictable payment structure: With a small business term loan, your repayment schedule is set once you sign your offer at a predetermined cadence for a fixed amount of time. And assuming you have a fixed rate, this means your weekly, bi-weekly, or monthly payment will be the exact same every single time - which takes the guesswork out of budgeting.
Business term loans can be an attractive financing option but they may not be the right fit for every business. Some downsides include:
#1 Fees: Like any other form of funding, lenders can charge a variety of fees for small business term loans. That includes origination fees, late payment penalties, monthly or annual loan fees, and prepayment penalties. Fees add to the cost of the loan, especially if these fees are rolled into the loan payment. When fees are included in the payment, rather than being paid outright, you're paying interest on the principal and the fees. That raises the total cost of borrowing over time.
#2 Newer businesses may not be eligible: For younger businesses, a term loan can be difficult to qualify for. Most lenders only extend term loans to businesses with an established operating history (at least two years), so if you own a brand-new venture or are just starting up, a small business term loan may not be a viable funding option.
#3 Higher credit requirements: With less-than-stellar credit, you'll face a higher interest rate (if you qualify at all). Both your personal and business credit are taken into account, so it may be worthwhile to spend some time getting them in tip-top shape before applying.
The first step in preparing for a business term loan is comparing loan options from different lenders. Look at the minimum requirements to qualify for a loan, as well as the borrowing limits, annual percentage rate (APR), loan fees, and repayment terms. Assessing all those factors together can help you identify which lender is best for your business.
Next, review your personal and business credit reports and scores. Credit history isn't the only thing lenders take into account for small business term loans, but it's a big factor. Specifically, check your credit reports for errors or inaccuracies that could be costing you credit score points. And compare your scores to get a sense of how they align with the minimum score lenders are looking for. It may even be worthwhile spending a few months getting your business and personal credit score in tip-top shape prior to applying - at the very least, you'll likely get a better rate.
Take a deeper look at the lender's qualification requirements as well as their terms and conditions. How many years in business do they prefer borrowers to have? How much annual revenue will you need to qualify for a loan? How do your business financials compare to the lender's desired performance?
Preparing financial statements can help you get a better sense of your business's overall health. You'll also need to have certain documents on hand to apply for a term loan so it's helpful to get those organized sooner rather than later. The documents you'll need include:
Term loans can be secured or unsecured, meaning you may or may not need collateral to qualify. Before you get too far along in the application process, check to see if the lender requires collateral for a term loan and if so, what type of collateral is needed. Keep in mind that even if a loan is unsecured and no collateral is needed, a personal guarantee may still be required. This guarantee makes you personally liable for the loan if your business defaults on the payments.
As you evaluate a business term loan offer, don't focus solely on the interest rate number. Look at the annual percentage rate instead, which can offer a more accurate idea of what a loan will cost.
The annual percentage rate, or APR, represents the total annualized cost of borrowing over a one-year period, including the interest rate as well as any fees the lender charges. The higher the APR, the more you'll pay in interest over time.
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