According to Bloomberg.com, 8 out of 10 businesses fail within the first 18 months of operation. Every business faces its own set of challenges, but one common factor contributing to the majority of business failures is a lack of access to working capital. Companies need this to keep business operations up and running. It’s vital for entrepreneurs to familiarize themselves with the business financing options that are available to them.
One of the most common types of business financing for SME’s are term loans. Term loans provide businesses with flexible funding that can be put towards any business need, be it covering a short-term cash flow gap or investing in a long-term opportunity like opening a second location.
If you’re planning on applying for a term loan to boost your company’s working capital, here is our guide to understanding what they are, how they work and where you can get them:
What is a Term Loan?
A term loan is a straight-forward business financing resource wherein companies receive a lump sum of money upfront which is to be paid back (plus interest) in fixed installments over a specific time-frame, or term.
The repayment period for business term loans can range from a few months to ten years. Lenders usually base the terms and conditions of the loan on the borrowing company’s structure, cash flow stability, credit background and purpose for the loan. Lenders may require the borrowing business to pledge an asset to serve as added security to mitigate their risk for providing the loan. Offering up collateral will typically afford business owners better loan terms and lower interest rates.
3 Types of Business Term Loans
Term loans are classified into three types: short-term loans, intermediate/medium-term loans and long-term loans. Each classification is based on the repayment period, or term, of the loan. Here’s how they work:
The primary use for short-term loans is to address pressing business needs like meeting the business’ day-to-day expenses or covering short-term cash flow gaps. These loan amounts typically range from $2,500 to $50,000 and the repayment terms run from three to 18 months. These repayments could be due on a daily or weekly basis, depending on the agreement you and the lender have agreed on.
One thing to note about terms loans is that the shorter the term for the financing, the higher its interest rates will be. Because this type of financing is short-term, the interest rates associated with the loan may be higher compared to the other two types.
Both start-ups and established businesses can benefit from short-term financing. Of the three types of term loans, short-term loans provide the least amount of funds. That means they present the least amount of risk for the lenders. For that reason, most won’t require short-term loan borrowers to have an extensive credit background, which is particularly beneficial for start-ups as they have not been in business long enough to build one up. Furthermore, these lenders typically won’t require business owners to provide collateral. This makes it a more attractive option for businesses that need the additional capital but don’t have company assets to pledge for it.
Intermediate-term loans are a great financing option for established businesses looking to renovate their establishment, expand their products, buy equipment or refinance existing debt. Once approved, the business owners can receive a loan amount of $50,000 to $500,000 which can have a maturity period of two to five years. Repayments are usually made once or twice a month, depending on the terms set by the lender.
Medium-term loans usually require businesses to have a good credit score (680 or higher), and your business must be operational for at least a year in order to be considered.
Long-term loans are for long-term business strategies that will foster the growth and expansion of your business, such as setting up an additional warehouse, opening another business location or acquiring another company. With this type of financing, businesses can receive anything from $250,000 to $2,000,000 and repayments are made within five to ten years.
One of the best features of a long-term loan is its affordability. Since it’s a long-term commitment, lenders usually charge lower interest rates compared to the other two types. This type of term loan offers the most amount of funds, so lenders really only give it to mature businesses with a strong track record for repayments. If you’re relatively new in the industry, this type of term loan most likely won’t be feasible for you.
Long-term loans are a secured type of financing, which means lenders will require the business owners to present a company asset to serve as the guarantee for the loan. The collateral could be real estate, equipment or any type of high-value asset with a low depreciation rate.
Where to Get Term Loans for Small Businesses
There are multiple avenues from which business owners can receive term loans. Banks offer the best terms and lowest interest rates compared to credit unions and alternative lenders. However, they require businesses to submit a plethora of documents including business plans, audited financial statements and collateral, among others. The extensive documentation along with the comprehensive financial background checks that banks perform could lead to a long approval process for your term loan.
A more time-sensitive option is to apply for term loans from alternative online lenders. Businesses looking for quick access to their term loans can get approval from alternative lenders within one to three weeks after submitting their application. Even businesses with a less than ideal credit score can apply. However, alternative lenders may charge a higher interest rate than banks to lessen their risk for providing the loan.
If you’re looking for quick loan approval and your business can afford the higher interest rates, then applying from alternative online lenders would be your best choice. If you’re not in a rush to get additional funding and you have a good credit background, a business term loan from banks would be a more viable option.