If you are on this page, chances are you want to know what loan is in business. You have come to the right place.
Starting a business requires a lot of discipline, determination, effort, time, and money.
You can have a million-dollar idea, but if you do not have the financing to implement it, that is all it will ever be; an idea.
This is why funding is an important thing in business.
There are various ways to obtain funds for a business; one is getting a loan.
This article intends to shed light on this source of business funding by answering the question, “what is a loan in business?”
Loans are a common concept, and a lot of people know about this concept on a personal level.
Typically, the concept remains the same when it comes to business.
However, business loans can be a bit overwhelming for someone new to it.
This article will serve as your ultimate guide on business loans.
It will also discuss several types of business loans, their benefits, and how you can apply for them.
This way, you could fully understand what business loans are and which type would fit your business well.
To learn all these, read this article to the end.
Meaning of Loan in Business – What is a Loan in Business
The dictionary defines a loan as anything (usually money) that is borrowed and will be paid back with interest.
When it comes to business loans, this definition stays true.
However, business loans are typically used to facilitate business processes.
Therefore, an accurate definition of a business loan is any money borrowed for the purpose of facilitating a business’s expenses and operations.
The business will also pay back with interest.
Let’s give a breakdown of how business loans work.
You need to expand or grow your business but do not want to disrupt your cash flow or use your savings.
In this case, you can simply opt for a loan instead.
Now, you would look for the best place to get and apply for the loan.
If your application is approved, the lender will give you the money after concluding the loan terms.
You would then use the funds to do what you want to do for your business.
You would pay back the loan and the agreed interest when the loan term is due.
Terms to Know When Getting a Loan – What is a Loan in Business
Business loans are more complicated than regular loans.
Therefore, to avoid getting confused, you should familiarize yourself with certain words you may come across when trying to get a business loan.
These refer to valuable items that a borrower (in this case, a business) has.
Business assets include buildings, vehicles, inventory, and equipment.
Closing costs simply refer to the costs of securing loans.
Not all loans come with these costs, but some do.
Although most lenders would give you a rundown of the fees you would pay to obtain a loan, you should ask to know the different fees if you do not get a list.
This way, you would avoid getting any hidden charges that would surprise you further down the road.
Closing costs often cover title insurance, origination fees, survey charges, commercial real estate appraisal, flood certification, etc.
Your company’s cash flow refers to the total money that goes out and comes into your business for your daily business operations.
When a company earns more than it spends, its cash flow is positive.
This means that it would have enough funds to pay back debts, pay expenses, return shareholders’ money, reinvest in the business, and so on.
Cash flow is very important because it shows that a company can operate optimally.
Down Payment – What is a Loan in Business
This refers to the upfront payment that the borrower would pay for the loan.
The down payment requirement can be between 10 to 30% of the total loan amount.
However, the down payment rate is often based on different factors, including the loan type.
Collateral – What is a Loan in Business
Collateral refers to the asset that the borrower gives to get the loan.
So, in case the borrower can’t pay back the money, the lender would assume ownership of the collateral.
The collateral is often as valuable as the loan amount.
Collateral examples include personal assets, equipment, real estate, inventory, etc.
This refers to the timeframe and schedule for the borrower to repay the loan.
Current liabilities are debt obligations the business has to pay within the loan’s operating cycle.
These liabilities include wages, short-term debt, income taxes, accounts payable, etc.
A personal guarantee is an agreement that states that a borrower would use their cash flow or assets to cover a loan in a situation where the business cannot pay back the loan by itself.
A lot of lenders require borrowers to sign this agreement before they approve their business loans.
Most of the time, the business owner would have to be the one to sign this agreement.
Interest Rate – What is a Loan in Business
Interest rate is the percentage of money added to the main loan amount the borrower has to pay back to the lender.
When looking for a loan, you need to look for one that does not have a very high-interest rate.
However, certain factors often determine how high or low the interest rate would be.
These factors include your business type, industry, or niche and its risk, the company’s credit, how long you have been operating your business and your credit and finances as the business owner.
Factors Lenders Consider for Loans Approvals – What is a Loan in Business
Lenders do not just approve the loans to everyone that applies.
If they did this, they would lose more money than they make because only some people who get a loan are often able to repay.
So, before a lender approves a loan, they have to vet the borrower and the business properly.
They would typically check several factors to determine whether or not a borrower qualifies for the loan.
Also, these factors tend to influence the loan’s terms, rates, and how much money would be approved.
Here are 6 important factors that lenders consider during a loan approval procedure.
A positive cash flow will increase your chances of getting approved for a loan because the lender will be confident in your ability to repay the loan.
Not all lenders will ask for your business’s cash flow.
However, if they ask, a positive cash flow will serve as a qualifying factor.
A lot of lenders will only give out loans to businesses that have assets to secure them.
This way, they can be sure that if the business cannot pay back the loan, they will have something to fall back on.
The collateral amount often depends on different factors, such as the borrower’s credit rating, the loan’s purpose, the collateral nature, etc.
Some creditors will even require both personal and business assets.
Another requirement most lenders ask for collaterals is for them to be easily liquidated.
So, collaterals include corporate bonds, certificates of deposits, stocks, treasury debt, etc.
Some lenders may also accept properties as collateral, although liquidating these would be a lot more stressful, and the property’s value would also be uncertain.
Examples of property collateral that lenders accept under this category include buildings, fixtures, homes, inventory, equipment, vehicles, and so on.
Creditors also approve the loan amount based on the collateral’s value by calculating the loan-to-value ratio.
For instance, a lender can offer you an 80 per cent loan-to-value ratio.
With this ratio, if the collateral is worth 50,000 dollars, the loan would be 80 per cent of 50,000 dollars which would be 40,000 dollars.
This is calculated based on credit history, credit use, debt versus income, and payment history.
A lot of lenders often consider you and your business’s credit score during the loan approval process.
However, the credit score requirements often differ from one lender to the other.
Your credit score’s quality also influences the loan’s terms, especially its interest rate.
A high credit score will help you get a loan with a lower interest rate.
But when you have a poor credit score, lenders will not want to approve your loan.
Those that approve your loan despite your poor credit score will charge a high-interest rate.
Business Plan – What is a Loan in Business
Financial entities, especially banks, will ask for a copy of your business plan before approving a loan.
A business plan will convince the lender that your business is sustainable.
Annual Revenue – What is a Loan in Business
This refers to your company’s annual income, gross sales, and income your business generates.
Some lenders often have a minimum for the avenue revenue.
This minimum would be based on factors like the type of loan you want and the loan’s duration.
Types of Business Loans – What is a Loan in Business
No two businesses are the same.
Businesses typically come in different shapes, industries, and sizes.
And every business has its specific operation processes.
This is why different business loans focus on meeting the specific needs and objectives of various businesses.
Each business loan comes with its benefits and considerations, and you’d find that certain types are better for some businesses.
Therefore, you need to know the different types of business loans to ensure you choose the ideal one for your business.
With that said, here are 5 common types of business loans.
Business Line of Credit
This flexible loan gives you access to a specific amount of funds.
You can use your line of credit at any time when the need comes up, and you can either pay back over time or immediately.
The good thing about a business line of credit is that you won’t have to pay interest if you do not use the money.
For instance, let us say you get a line of credit worth 100,000 dollars from your bank.
You would get checks or a card that you can use to access the money.
If you do not use the money, you will not have to pay back interest.
And, if you spend a part or all the money, you will pay the interest according to the amount you spend.
For instance, a loan of 100,000 dollars was approved for you, but you only used 30,000 dollars.
Instead of paying interest for 100,000 dollars, you will pay for 30,000 dollars.
Many companies use a line of credit because it offers flexibility and fast access to funds.
This type of loan is great for financing companies’ short-term operation needs.
This is because they can use the line of credit several times during the loan’s duration.
Applying for a Line of Credit
You can get this type of loan from an online lender or bank.
If you apply to a bank, you should have about 1 to 3 years of positive credit score and strong revenue.
Tax returns, business financial statements, and bank account information are other requirements to get a line of credit loan from a bank.
The requirements and restrictions are often fewer with online lenders than with banks.
However, online lenders’ credits tend to be lower while their interest rates are higher.
Family and Friends Loans – What is a Loan in Business
Most new businesses often seek loans from their friends and family members.
However, you can also use family and friends’ loans to grow and expand a business.
Even though this type of loan is informal, you do not want to get into problems with your friends or family.
So, to reduce the chances of misunderstandings, ensure you properly document the terms of the loan.
The terms of family and friends loans are often very flexible and great.
You most likely won’t find these terms outside family and friends.
For starters, the repayment plans are typically adjustable.
The interest rates are usually not that high.
Finally, you’d find it easier to get a loan from a friend or family member.
Applying for a Family and Friends Loan
You can informally apply for the loan by word of mouth.
But if you want them to take you more seriously, you could use a more formal approach.
Present your business plans for the money and any other document to help them believe the money will be put to good use.
Business Term Loan
This is a common financing option among businesses because of its reliability.
A business term loan is a huge capital that a business gets and then pays back according to a particular repayment schedule and interest rate.
The loan’s term is usually between 1 to 5 years.
Business term loans are usually available within days, and the business owner can use the funds for any business operation.
Business term loans are quite flexible, and you can use them for various things.
Applying for a Business Term Loan
You can apply for this type of loan from any bank of your choice.
However, the application process is usually long and demanding.
Some documents you need to apply for this loan include a driver’s license, bank statements, credit score, balance sheet, tax returns (business and personal), and so on.
Business Credit Cards
Business credit cards are similar to personal credit cards, except you would be using the card for your business processes.
The lender will determine the card’s interest rate and credit limit depending on the company’s annual income and credit rating.
Business credit cards give you access to funds you can use anytime.
Likewise, you can use the funds for any business process of your choice.
You can also earn rewards by using your card and then redeem these rewards for gift cards, meals, travel, and other business expenses.
Small Business Administration (SBA) Loans
Small business administration loans are often offered by private lenders but are also backed up by the government.
As the name implies, these loans are specifically meant for small businesses.
SBAs are usually secured, meaning that you have to use collateral to get the loan.
There are 3 different types of SBAs:
7(a) loan program
This is the primary type of SBA; the loan amount ranges from 350,000 to 5 million dollars.
Microloan programs offer the smallest SBA loan amount.
It typically ranges from 10,000 dollars to 50,000 dollars.
CDC/504 loan program
These are specifically aimed at small businesses with long-term modernization or expansion plans.
CDC/504 loan terms are usually between 10 to 25 years, based on the loan’s purpose.
The maximum amount of these loans is 5 million dollars.
Each type of SBA loan has its specific benefits.
For instance, 7(a) loans are very versatile.
The business owner can use it for any business operation, including buying properties like land or a building, financing new construction, acquiring an existing company, and so on.
Companies with difficulty getting a loan can apply for and receive SBA microloans.
Applying for an SBA
How you apply for an SBA loan typically varies between the different types of SBAs.
The same thing goes for the eligibility criteria.
Conclusion on What is a Loan in Business
Businesses can take out loans and use them to carry out certain business operations and activities.
However, there are certain factors that lenders consider before they give out loans to businesses.
If you want to get a loan for your business, you should consider these factors.