Term Loan

By Entrepreneur Staff

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Term Loan 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.

More from Expansion Financing

Factoring

A financing method in which a business owner sells accounts receivable at a discount to a third-party funding source to raise capital

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Angel Investor

An individual who invests his or her own money in an entrepreneurial company

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Friends/Family Financing

Monies, usually in the form a loan, that a business owner gets from either family members or friends in order to help finance their startup or growing business

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Government Grants

An award of financial assistance in the form of money by the federal government to an eligible grantee with no expectation that the funds will be paid back. The term does not include technical assistance which provides services instead of money, or other assistance in the form of revenue sharing, loans, loan guarantees, interest subsidies, insurance, or direct appropriations

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