Business Term Loans: Back to the Basics
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Business Term Loans

As a small business owner, you’ll likely need to cover starting and ongoing expenses to help your business grow. However, not all business owners have cash on hand to pay for these costs on their own. 

If you need additional funding, small business loans, like business term loans, offer the necessary capital that can help you realize your business goals.

What Is a Business Term Loan?

A business term loan, also simply called a “business loan” or “term loan”,  is a type of conventional installment loan for small businesses. The funds from a business loan can generally be used toward any business-related expenditure. 

For example, it can be used to launch a new business, expand or purchase an existing business, and refinance existing business debt. You can also use a business loan toward day-to-day expenses, like investing in updated equipment, purchasing inventory, or padding cash flow during the slow season to ensure you have enough for payroll.

How a Business Loan Works

When you borrow a business loan, you’re agreeing to receive an advance of money that must be repaid over an established period, plus interest. Business loan interest rates can be fixed or variable. Fixed interest rates will never change, while variable rates can increase or decrease due to market conditions.

In its 2022 Q2 report, the Federal Reserve Bank of Kansas City found that average fixed business loan rates for new loans averaged 4.76%. New variable-rate business term loans averaged 5.35%, according to the same report.

Business Loan Terms

All term loans have defined business loan terms which is the time period you have to repay the loan in full. Short-, mid-, and long-term business loans are available from various lenders. Business loans with a short repayment term typically must be repaid within a year. 

Mid-term business loans are generally up to five years while long-term business loans offer repayment windows beyond five years.

Business Loan Requirements

Different lenders have varying business loan requirements. To get a business loan, you’ll likely need to meet certain criteria.

Credit Score

Your personal and business credit scores are reviewed as part of the business loan application process. Lenders want to know whether lending money to you would be a high risk.

Each lender sets its own minimum credit score, though the higher your personal and business credit scores, the more likely you’ll meet this business loan requirement. The FICO score is a common scoring model that’s used for consumer credit scores. A “good” credit score is 670 or higher. 

Like personal scores, there are also various scoring models used for a business credit score. Generally, business credit is scored from 1 to 100, with 80 or higher considered “low risk”.

Age of Business

How long you’ve been in business matters when it comes to meeting a lender’s business loan eligibility requirements. The minimum required time in business depends on your lender. 

However, online financial institutions generally require that businesses operate for at least six months before the application date. Traditional lenders typically have a longer business age requirement of at least two years or longer.

Business Financial Documents and Reports 

Lenders also ask for a variety of financial documentation to determine the financial health of your business, and your ability to repay the loan. Some paperwork you might need to supply to your lender includes:

  • Annual revenue reports
  • Profit and loss statements
  • Business bank statements
  • Other business debt statements
  • Income tax returns

The details on these documents show lenders your cash flow, working capital, and debt-to-equity ratio among other financial indicators.

Business Plan and/or Loan Proposal

A business plan outlines your business goals and what you plan to do to reach them. Additionally, some lenders might require a loan proposal that outlines how you intend on using the loan funds and your game plan for paying it back. 

Preparing a strong business plan and loan proposal can increase the likelihood of getting your loan application approved. They demonstrate to the lender that you have a purposeful strategy for managing your business, and the funds you’re borrowing in support of it.

Collateral

Like other types of small business loans, business term loans can be unsecured or secured. Unsecured business loans don’t require collateral to get approved for the loan; the caveat is that they typically come with higher business loan rates and fees. 

For secured loans, lenders need a financial guarantee, or collateral, as part of their business loan requirements. If you’re unable to make your loan payments it will take possession of the collateral that’s defined in your loan agreement.

Examples of collateral are real estate, inventory, or business equipment. You can also agree to a blanket lien which allows lenders to seize any of your business assets to satisfy the debt if you default.

Pros and Cons of a Business Term Loan

Benefits of a Business Term Loan
  • Access to capital. If you don’t have an external investor on board, a business loan provides access to a lump sum of cash to keep your business moving forward. 
  • Multipurpose use. Loan funds can be used for a variety of business needs, whether you need money to purchase inventory or set up a brick-and-mortar storefront.
  • Can offer fast funding. Fast business loans are typically offered by online lenders. Depending on the lender and your borrowing situation, some fast business loans can be funded within one business day or less, after approval.
  • Flexible business loan terms. Business loan terms can be as short as a three- or six-month repayment period, or as long as five years or more. This gives you a flexible runway to pay back the loan, in small increments, over a longer time frame.
Disadvantages of a Business Term Loan
  • Usually requires collateral. Although there are unsecured business loan options, typically, lenders require collateral to guarantee a loan. If you default on the loan, you could lose your collateral, whether that’s your business’s inventory or a lien on the business itself.
  • Can have a variable rate. Some loans have variable business loan interest rates. If rates increase significantly, you might not be financially prepared for a higher monthly payment which can make it difficult to keep your loan in good standing.
  • Application can be lengthy. Some lenders, particularly traditional banks and credit unions, can have longer underwriting review timelines or require extensive paperwork that might delay funding. If you have an urgent business expense, a business loan might not always be the right choice.
  • Might incur prepayment penalties. Not all lenders charge prepayment penalties, but some do. Although repaying your business loan early might seem like a good idea, it can cost you if your lender charges a prepayment penalty fee.
Pros & Cons
of a Business Term Loan
Pros
Access to capital.

If you don’t have an external investor on board, a business loan provides access to a lump sum of cash to keep your business moving forward.

Multipurpose use.

Loan funds can be used for a variety of business needs, whether you need money to purchase inventory or set up a brick-and-mortar storefront.

Can offer fast funding.

Fast business loans are typically offered by online lenders. Depending on the lender and your borrowing situation, some fast business loans can be funded within one business day or less, after approval.

Flexible business loan terms.

Business loan terms can be as short as a three- or six-month repayment period, or as long as five years or more. This gives you a flexible runway to pay back the loan, in small increments, over a longer time frame.

Pros & Cons
of a Business Term Loan
Cons
Usually requires collateral.

Although there are unsecured business loan options, typically, lenders require collateral to guarantee a loan. If you default on the loan, you could lose your collateral, whether that’s your business’s inventory or a lien on the business itself.

Can have a variable rate.

Some loans have variable business loan interest rates. If rates increase significantly, you might not be financially prepared for a higher monthly payment which can make it difficult to keep your loan in good standing.

Application can be lengthy.

Some lenders, particularly traditional banks and credit unions, can have longer underwriting review timelines or require extensive paperwork that might delay funding. If you have an urgent business expense, a business loan might not always be the right choice.

Might incur prepayment penalties.

Not all lenders charge prepayment penalties, but some do. Although repaying your business loan early might seem like a good idea, it can cost you if your lender charges a prepayment penalty fee.

Where to Find the Best Small Business Loans

Traditional banks and credit unions offer small business loans, including business term loans, and many let you apply in person or initiate the process online. Alternative lenders, or online lenders, also offer business loans. 

When searching for a business loan, always compare a handful of loan offers to ensure you get the best business loan interest rates and terms. Using a small business loan calculator can help you understand what your loan payment might look like for each option.

A convenient way to shop for a term loan is by using a business loan broker, like Llama Loan. We connect you to financing solutions that fit your needs. The online application takes just a few seconds, and you’ll receive tailored financing options that help you reach your business goals. Get Started Today.

The Bottom Line

Business loans are a common financing option for many business owners. There are many options to choose from — whether an unsecured or secured loan, fixed or variable interest rate, or a short-or long-term loan. 

Despite the advantages that a business loan offers, it’s not always the best financing solution for all businesses. Before deciding on a business loan, compare other small business loan options to find one that’s most financially prudent for you. 

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