So, you need to buy some new capital assets for your business, but you haven’t got enough cash in the business. What do you do?
One solution to explore is to seek out a commercial loan. Whether you are looking to get your business off the ground, plug a cash flow gap or fund an expansion project, a business loan could provide the funding without you losing any equity; it’s a debt-based finance solution.
Find out more about debt funding options:
Download our guide on Funding for Business Growth
Let’s have a look at the basics of commercial loans, how they work, how to get one and, crucially, important key questions to ask you provider.
- What’s a commercial loan
- How does it work?
- Securing a commercial loan
- Things to consider
- 8 things you need to know about commercial loans
What is a commercial loan?
A commercial loan is a debt-based funding arrangement between you and a lender such as a bank. It’s typically used to fund capital expenditures and to cover operational costs.
This type of loan is available to businesses of all sizes; whether you’re a small start-up or a large established business. But, actually securing the funding can be a difficult hurdle. Most lenders will request evidence of your company’s financial stability, including consistent cash flow, to reassure them that the loan can be repaid.
Different lenders will have different criteria so finding a lender whose terms you can easily meet will give you the best chance of securing the funds you need.
How a commercial loan works
Commercial loans are granted to assist businesses like yours with short-term, and longer-term funding needs for operational costs or for purchasing equipment for example. A commercial loan may be extended to help your business meet basic operational needs including funding your payroll or to purchase supplies used in the production and manufacturing process.
You may have to post collateral to secure a commercial loan, usually in the form of property, plant or equipment that the bank can recover from the business in the event of default or bankruptcy. Sometimes cash flows generated from future accounts receivable are used as a loan’s collateral. Mortgages issued to commercial real estate are one form of commercial loan.
Securing a commercial loan
Your credit worthiness plays a starring role when a financial institution is considering you for a commercial loan. When applying for the loan you will be required to present documentation – generally in the form of balance sheets and other similar documents – that proves your company has a favourable and consistent cash flow. This assures the lender that you will be able to repay the loan according to its terms. They will also look at your personal credit ratings.
If you’re approved for a commercial loan, you can expect to pay a rate of interest that falls in line with the prime lending rate at the time the loan is issued. Some funders require monthly or quarterly financial statements from your company through the duration of the loan and often require you to take out insurance on any larger items purchased with funds from the loan. Generally, a personal guarantee from directors is required but this can be insured.
Things to consider
While a commercial loan is most often considered a short-term source of funds for your business, there are some banks or other financial institutions that offer longer-term or renewable loans that you can extend indefinitely. This allows you to get the funds you need to maintain ongoing operations and to repay the first loan within its specified time period. These are akin to revolving credit facilities.
After this, the loan may be rolled into an additional or “renewed” loan period. A business might seek a renewable commercial loan (or invoice discounting) when it has to acquire the resources it needs to handle large seasonal orders from certain customers while still being able to provide goods to additional clients.
What you need to know about commercial loans
- You need to know how much you can borrow in order to assess if a lender’s product meets your business needs.
- You’ll want to know how much the loan is going to cost you in the long term for your business planning purposes. The costs will be made up of arrangement fees, underwriting fees and charges and interest accrued over the loan period.
- Find out if the loan is transferrable. This is relevant if you are considering selling the business. You need to know if any commercial loans you have can be transferred to the new owners of the business. Best to ask this up front if selling the business is in your plans.
- Check to see if the loan agreement contains any financial covenants. Covenants are conditions which forbid you, the borrower, from undertaking specific actions or other restrictions. Violations of a financial covenant may result in an acceleration clause being triggered requiring you to repay all remaining payments of the loan immediately. You need to be aware of, and be sure you can meet the terms of, any covenants before you agree to the loan. Some funders require that you notify them before you take out further loans. Failure to notify them could result in you inadvertently breaching your agreement.
- Some lenders will need you to take out personal guarantee which makes you personally liable if the business defaults on the commercial loan repayments. A personal guarantee is your legal promise to repay credit issued to your business for which you serve as an executive or partner. You can get Personal Guarantee Insurance (PGI) to cover yourself for this.
- If you find that your business is in a position to repay the loan early, find our if there are any penalties for paying the loan back early.
For more on financing options for business growth:
Download our guide on Funding for Business Growth
Speak to an expert. Call us on 0203 327 0567.