When looking for a loan for your business – whether to finance an expansion, acquire equipment, support seasonal revenue fluctuations, or any one of a number of other needs – it’s important to remember that not all loans are created equal. In fact, some loan structures may limit your ability to grow because of the stress rapid repayment could put on your cash. You can avoid this situation by considering all of the loans available to you and selecting the one structured in your company’s best long-term interest.
The key to identifying the best loan for your situation is to choose a financing package that allows your company to succeed even under “worst-case scenario” situations. But keep in mind that a loan’s alignment with your needs is determined by more than just its interest rate. While interest rates are certainly one important consideration, the amortization and structure of a loan will have the greatest impact on your cash flow and long-term stability.
Here are some practical tips to help you secure the right financing for your business:
Understand the Types of Loans Available
The most appropriate loan(s) for your company will depend on your reasons for seeking financing, as well as the length of the loan and its specific terms. Most small businesses have these options available to them:
Working capital lines of credit (LOC). Many small businesses take advantage of a working capital LOC to manage the fluctuations in revenue and expenses associated with seasonal work, growth or other circumstances. These loans typically require the pledging of current assets and a personal guarantee. Working capital loans tend to be short-term and are sized to match your cash conversion cycle. The advantage of an LOC is that you can access funds as needed, and you won’t pay interest until you actually draw the funds. LOCs can be used to help manage cash flow and unexpected expenses. Interest is typically paid monthly and, ideally, the line will be rested, or paid in full, at some point during the year. Lines of credit typically have a variable rate of interest, benchmarked either against Prime or LIBOR.
Conventional term loans. These loans are typically put in place to provide a repayment that matches the useful life of the asset being acquired. Permanent working capital is often included in these loans, which offers an appropriate amortization to repay the loan. Traditionally banks have offered up to five-year terms with amortizations that match the use of proceeds. In recent years, banks have been willing to look at seven- to 10-year terms, often with rate resets. Pricing for these loans is either fixed or variable.
SBA small business loans. While there is a perception out there that SBA loans are cumbersome and less flexible than conventional loans, the benefits offered (longer term and amortization; reduced risk exposure for banks) can make SBA loans the best strategy for both you and the bank. Loan amounts can be as high as $5 million, and even higher for manufacturers. While SBA 7(a) loans tend to have higher fees than conventional term loans, the fees can be rolled into the loan and the loans are always structured as fully amortizing, so there’s no renewal risk to the borrower.
In addition to the SBA 7(a) loan program, the SBA also offers 504 loans that are intended for fixed assets and real estate. The 504 program can offer up to a 25-year fixed rate on up to 40% of the eligible project.
Evaluate and Compare Key Terms of the Loan
To determine if the financing you’re considering makes sense for your business, you’ll need to evaluate its key terms and compare them with those of other lenders’ proposed loans. These are the most important terms:
- Term and amortization. You may want to take as long an amortization as possible to provide working capital flexibility. Most lenders will not penalize prepayment if cash flow allows.
- The loan’s interest rate, how it varies over time, and how it resets if you get a loan that has a term shorter than the amortization.
- When the principal is due. (Will you have an interest-only period? Will the loan be principal plus interest, or principal and interest? Are there seasonal needs, where a seasonal payment structure may better match your true cash flow?)
- Covenants imposed on your business as part of the loan, such as maximum debt-to-equity ratio or minimum cash threshold held by the company.
- Security or collateral required.
- Loan origination and other fees (underwriting, administration, processing, etc.).
- Financial statements required by the lender after closing.
- Prepayment (without penalty) options available.
Partner with a Business Banking Expert
Work with an experienced business banker. His or her insights will help ensure that you’re not burdening your company with a loan that’s difficult to repay, and that you match the useful life of your assets to the structure of your financing. He or she will also help look for opportunities to obtain grants, local economic development dollars and other resources that might be available to complement your cash equity.