What is a Commercial Loan?
A commercial loan is a loan that is extended to businesses by a financial institution. Commercial loans are generally used to purchase long-term assets or to help fund day-to-day operational costs.
Understanding a Commercial Loan
It is unfeasible for small and mid-sized businesses to access equity and bond markets for financing due to regulatory hurdles, associated costs, and the time required to secure the funds. Therefore, small and mid-sized enterprises use debt products such as commercial loans and/or lines of credit.
You can use commercial loans for any purposes required for the business – acquiring assets, purchasing supplies, meeting daily operational costs, paying payroll, etc. In the loan application process, the business must specify how they will use commercial loans.
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Process for Securing a Commercial Loan
Depending on the lender, the process to secure a commercial loan may be different. The general process for securing such a loan is as follows:
Pre-approval (Qualifying Process)
The lender (bank) will begin a pre-approval process for the business by evaluating the financial history and income of the business. In addition, the lender will investigate the existing debt of the business and the purpose of the loan. Through a pre-qualifying process, the lender can gain a rough idea of how much the business would be able to borrow and the relative riskiness of the borrower.
Commercial Loan Application
After the pre-qualifying process, the business must complete and submit a loan application. In the application, financial statements or similar documents dating back at least three years are generally required. This is to help ensure that the business can repay the loan.
Review of the Loan Application Package
Once you submit the application, a loan officer will review these due diligence documents. They will investigate things such as credit history, available collateral of the business, the current and projected income of the business, etc. A big part of the diligence process is the financial analysis.
Loan Underwriter/Loan Committee
If the loan officer approves your loan and considers it appropriate, a complete and formal credit application is submitted to a credit adjudicator or loan committee. The adjudicator reviews all relevant information and decides whether to approve or decline the loan. The process can take up to a week, and the business sometimes has to provide additional documentation during the review.
If approved, the processor will present the company with a term sheet. A term sheet is a formal document that outlines the parties involved, amount of financing, available collateral, fees, use of the loan, and the interest rate on the loan. After reviewing the term sheet and signing a letter of intent, you might have to pay for third-party reports, e.g., appraisal reports.
Loan Package and Closing Documents
Upon completing third-party reports, the complete loan application package is resubmitted to the loan underwriter for final approval. If approved, the business is required to sign finalized loan documents. Generally, businesses employ a closing agent (e.g., an authorized representative, an attorney, etc.) who handles all closing documents and completes any remaining paperwork.
Pros of Commercial Loan
Access to Capital
A commercial loan provides additional cash for a business. You can use cash to purchase new equipment, satisfy payroll expenses, etc.
Easier Application Process
Although the application process for a commercial loan may seem daunting, it is easier than raising money in the equity or debt markets. There are regulatory hurdles and significant costs and time required to raise money through equity and/or bond markets.
A commercial loan does not dilute the business owner’s equity. For example, a business may issue equity to raise money. In doing so, the owner would be diluting their own equity in the business. As such, a commercial loan allows an owner to raise money without diluting their stake in the business.
Cons of Commercial Loan
Paperwork and Application Process
A commercial loan requires a significant amount of paperwork and involves a tedious application process. For example, a business may be required to submit an outline of its business plan and give a presentation outlining its business goals and objectives.
Inflexibility in the Use of Funds
When applying for a commercial loan, the business must specify what the money will be used for and how it will pay back the loan. This results in inflexibility of the funds, as the business is required to commit to its original plan(s).
A commercial loan comes with a stated interest rate, which may be floating or fixed. As such, the business is required to make monthly payments on the money it borrows.
How Do Commercial Loans Work?
The loan terms associated with commercial loans are slightly different to standard business loans. Lenders are more likely to take a bespoke view of your business and tailor the finance to your own needs.
Typically commercial finance combines two or more financial products to help meet the desired loan amount. An example would be using a term loan for capital to grow, alongside another kind of commercial lending to help with working capital finance. In this example, you can equip your business with two types of commercial loans, one for cash flow stability and the other for long-term growth.
- A commercial loan is a loan extended to businesses by a financial institution.
- The loan is commonly used by small and middle-market corporate borrowers.
- Advantages of a commercial loan include access to capital, an easier application process, and retaining equity ownership of the business.
Where to Get a Commercial Loan?
While you may immediately think of a bank for where you should go to get a commercial loan for your business, there are other options. Here are some details about banks and other options for lenders:
Banks: Banks typically provide good rates and long-term options to keep payments reasonable for the business. However, they tend to be more selective and the process for acquiring a loan is longer.
Commercial lender: A commercial lender is not a bank, but is still able to issue loans. You can expect lower costs and faster approval compared to banks, but the interest rates are usually higher and the loans are short-term.
Hard-money lenders: Private companies usually dole out hard-money loans, which are short-term and require little time or documentation for approval. However, these lenders typically charge higher interest rates.
Crowdlending: Crowdlending happens on marketplaces where borrowers and lenders are matched according to need. There is little regulation on these platforms, so engage at your own risk.
What are the Types of Commercial Loans?
Here are a few of the many types of business loans:
Business line of credit: A business line of credit is similar to a credit card in that it’s revolving. It’s useful if you need a lump-sum of cash, want to choose when and how you use it. And want to avoid paying interest on any amount you don’t end up using.
Business credit cards: This is a common loan that small businesses take on. So they can track expenses, manage spending, and purchase items they may not be able to afford with cash.
Construction loans: Construction loans are specifically to build new property, renovate existing property, or make repairs. You can use the loan funds to pay a company to perform the work and to pay for the cost of materials.
Hard money loan: These loans usually have short loan terms of mere months up to two years. They are mostly issued by private investors who charge a higher interest rate, but they can be useful for business owners who need money quickly and expect to pay off the loan quickly, too.
Blanket loan: If you have multiple properties, then a blanket loan may be a good option as long as you understand the downsides. While a blanket loan may be very convenient for you to manage funds, they usually involve hefty payments and strong penalties if you default on the loan.
Real estate loan: Real estate loans are for purchasing new business property. Loan terms typically range from five to 20 years, and it’s not uncommon to have a balloon payment after a specific number of years of the term.
How do small business Commercial Loans work?
As with all loans, commercial loans have certain requirements a lender will need your business to meet. This is often in the form of assets offered as security and some examples offered for a secure commercial loan are:
- Shares or a stake in the business
The lender may also negotiate on the term of your loan if your business is looking to borrow a larger amount of money compared to the assets you can offer.
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