Definition: A loan for equipment, real estate and working capital that's paid
off like a mortgage for between one year and ten years
Term loans are your basic vanilla commercial loan. They
typically carry fixed interest rates, and monthly or quarterly
repayment schedules and include a set maturity date. The range of
funds typically available is $25,000 and greater.
Bankers tend to classify term loans into two categories:
Intermediate-term loans. Usually running less than three
years, these loans are generally repaid in monthly installments
(sometimes with balloon payments) from a business's cash flow.
According to the American Bankers Association, repayment is often
tied directly to the useful life of the asset being financed.
Long-term loans. These loans are commonly set for more
than three years. Most are between three and 10 years, and some run
for as long as 20 years. Long-term loans are collateralized by a
business's assets and typically require quarterly or monthly
payments derived from profits or cash flow. These loans usually
carry wording that limits the amount of additional financial
commitments the business may take on (including other debts but
also dividends or principals' salaries), and they sometimes require
that a certain amount of profit be set-aside to repay the loan.
Term loans are most appropriate for established small businesses
that can leverage sound financial statements and substantial down
payments to minimize monthly payments and total loan costs.
Repayment is typically linked in some way to the item financed.
Term loans require collateral and a relatively rigorous approval
process but can help reduce risk by minimizing costs. Before
deciding to finance equipment, borrowers should be sure they can
they make full use of ownership-related benefits, such as
depreciation, and should compare the cost with that leasing.
The best use of a term loan is for construction; major capital
improvements; large capital investments, such as machinery; working
capital; purchases of existing businesses. Fortunately, the cost of
such a loan is relatively inexpensive if the borrower can pass the
financial litmus tests. Rates vary, making it worthwhile to shop,
but generally run around 2.5 points over prime for loans of less
than seven years and 3.0 points over prime for longer loans. Fees
totaling up to 1 percent are common (though this varies greatly,
too), with higher fees on construction loans.
What do banks look for when making decisions about term loans?
Well, the "five C's" continue to be of utmost importance.
- Character. How have you managed other loans
(business and personal)? What is your business experience?
- Credit capacity. The bank will conduct a
full credit analysis, including a detailed review of financial
statements and personal finances to assess your ability to
repay.
- Collateral. This is the primary source of
repayment. Expect the bank to want this source to be larger than
the amount you're borrowing.
- Capital. What assets do you own that can be
quickly turned into cash if necessary? The bank wants to know what
you own outside of the business-bonds, stocks, apartment
buildings-that might be an alternate repayment source. If there is
a loss, your assets are tapped first, not the bank's. Or, as one
astute businessman puts it, "Banks like to lend to people who
already have money." You will most likely have to add a personal
guarantee to all of that, too.
- Comfort/confidence with the
business plan. How accurate are the revenue and expense
projections? Expect the bank to make a detailed judgment. What is
the condition of the economy and the industry--hot, warm or
cold?
Use the following guidelines when selecting a business bank:
- Ask friends where they bank and if they are satisfied.
- Forge a relationship with a bank long before you will need a
loan. You'll find out how they treat you. Get to know some folks at
the bank on a first-name basis. Start building a relationship.
Believe it or not, banks want to talk to you even if they cannot
lend you money.
- Scan your newspaper for evidence of who is making the kinds of
loans you are seeking. Not all banks can be the best at everything.
Some are better at business loans; some are better with consumer
deals.
- Visit two to four banks to find your fit. Be upfront; tell them
you are considering a loan and that you are talking with other
banks. Then listen to their pitch.
- Think about working through the SBA or other
economic-development groups to secure better terms. They are not
only for businesses that cannot get funding any other way.