A Basic Guide to Bank-Term Loans
What it is: Term loans are the standard commercial loan, often used to pay for a major investment in the business or an acquisition. The loans often have fixed interest rates, with monthly or quarterly repayment schedules and a set maturity date.
Bankers tend to classify term loans into two categories: intermediate- and long-term loans.
Intermediate-term loans usually run less than three years, and are generally repaid in monthly installments (sometimes with balloon payments) from a business's cash flow.
Long-term loans can run for as long as 10 or 20 years and include additional requirements such as collateral and limits on the amount of additional financial commitments the business may take on.
Upside: Term loans are often the best option for established small businesses. If your financial statements are sound and you're willing to make a substantial down payment, you can receive financing with minimal monthly payments and total loan costs. The loans are best used for construction, major capital improvements, large capital investments, such as machinery, working capital and purchases of existing businesses.
Related: Why Business Loans Are Up for Grabs
Downside: 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.
Also note that when it comes to loans more than $100,000, you need a complete set of financial statements and must undergo a complete financial analysis by the lending institution.
How to get it: Large U.S. banks are active in business lending. But it is also worth checking out local community banks with a focus on business lending because they have more leeway when it comes approving loans. Their officers can also be a wellspring of useful advice about how to secure financing.
The degree of financial strength required to receive loan approval can vary tremendously between banks, depending on the level of risk the bank is willing to take on. Search for a prospective bank on the FDIC's website and then click on "latest financial information."
Find "performance and condition ratios" and zero in on the "total risk-based capital ratio," which regulators require to be above 10 percent if a bank is to be considered well-capitalized. The higher ratio, the more secure the bank is financially.
Additional guidelines to consider 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, it will help you find out how they will treat you. Believe it or not, banks want to talk to you even if they cannot lend you money.
- Scan local business news stories 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, while some are better with consumer deals.
- Visit two to four banks to find your fit. Be upfront, and 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.
Banks consider the following "five C's" when making decisions about term loans:
- 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: The bank does not want to be left holding the bag. So 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 or apartment buildings -- that might be an alternate repayment source.
- Comfort/confidence with the business plan: How accurate are the revenue and expense projections? Expect the bank to make a detailed judgment.