As a business owner, finding the right sources of funding to support your business’s growth, operations, and long-term goals is crucial. One of the most common ways to secure financing is through commercial loans. These loans, often offered by banks, credit unions, and other financial institutions, can provide a significant boost to your business’s financial standing and help you overcome challenges such as cash flow issues, equipment purchases, or expansion plans. However, securing a commercial loan is not always straightforward and requires careful planning, understanding of loan terms, and a clear strategy for repayment.

This article will help you understand commercial loans, their types, and how they can be used to fuel your business’s success. It will also address the most frequently asked questions (FAQs) to give you clarity on the process, eligibility, and considerations before applying for a loan.

Key Takeaways

1. Commercial Loans Help Fuel Business Growth: Whether you need to purchase equipment, manage cash flow, or expand operations, commercial loans provide the necessary capital.
2. Know Your Loan Options: There are various types of commercial loans, including term loans, lines of credit, SBA loans, and equipment financing. Each serves different business needs.
3. Loan Terms Are Crucial: The loan amount, interest rate, and repayment terms must align with your business’s financial capacity and long-term goals.
4. The Application Process Requires Preparation: Be ready to provide financial documentation and a clear business plan to secure loan approval.
5. Repayment Ability Is Key: Before taking out a loan, assess your business’s ability to repay it without jeopardizing day-to-day operations.

What Are Commercial Loans?

Commercial loans are financial products designed to help businesses borrow money to fund their operations, expansion, or other financial needs. Unlike personal loans, which are typically for individual use, commercial loans are intended for use by businesses, whether small, medium, or large. These loans can be used for a variety of purposes, including purchasing equipment, managing cash flow, refinancing debt, and even acquiring property or real estate.

Commercial loans come with varying terms, interest rates, repayment schedules, and eligibility requirements, depending on the lender and the loan product. Typically, these loans are secured, meaning the business will need to offer assets, such as property or equipment, as collateral in case the loan is not repaid.

Types of Commercial Loans

There are various types of commercial loans available, each suited for different business needs. Below are some of the most common types:

Term Loans

Term loans are the most traditional type of commercial loan. They are provided as a lump sum of money upfront and are repaid over a set period, which could range from a few months to several years. Term loans are typically used for long-term investments, such as purchasing equipment or expanding operations. Interest rates on term loans can vary, and businesses may have the option to choose between fixed and variable rates.

Lines of Credit

A business line of credit is a flexible loan option that allows businesses to borrow up to a predetermined limit. Unlike term loans, you only pay interest on the amount of money you use, not the entire credit limit. This makes lines of credit an excellent choice for managing cash flow or covering short-term expenses, such as payroll or inventory purchases. Lines of credit are revolving loans, meaning they can be used repeatedly as long as you repay the balance within the agreed terms.

SBA Loans

Small Business Administration (SBA) loans are a government-backed loan program designed to help small businesses secure funding. SBA loans offer lower interest rates and longer repayment terms compared to traditional commercial loans, making them an attractive option for businesses that may not qualify for conventional bank financing. However, the application process for SBA loans can be lengthy and requires a solid business plan and strong creditworthiness.

Commercial Mortgages

Commercial mortgages are loans used to purchase or refinance commercial real estate, such as office buildings, retail spaces, or industrial properties. These loans typically require a down payment and are secured by the property itself. Commercial mortgages usually come with fixed or adjustable interest rates and repayment terms that range from 10 to 25 years.

Equipment Financing

If your business needs to purchase or lease new equipment, equipment financing may be the ideal solution. With this type of loan, the equipment you purchase serves as collateral, reducing the risk for lenders. Equipment financing can be a great option for businesses in industries such as construction, manufacturing, or transportation that rely heavily on machinery and equipment.

Invoice Financing

Invoice financing, also known as accounts receivable financing, allows businesses to borrow against their outstanding invoices. If your business has a backlog of unpaid invoices, this type of loan provides immediate access to cash while waiting for customers to pay. Invoice financing can help bridge the gap in cash flow and keep operations running smoothly.

How Do Commercial Loans Work?

The way commercial loans work varies depending on the type of loan and the specific terms offered by the lender. However, most commercial loans follow a similar process:

1. Application: The first step in securing a commercial loan is to apply with a financial institution. The lender will ask for details about your business, such as your revenue, credit history, industry, and the purpose of the loan.
2. Loan Assessment: The lender will assess your business’s financial health, including its credit score, income, and assets. They may also require a business plan or financial projections to evaluate how the loan will be repaid.
3. Approval: If your business meets the lender’s criteria, the loan will be approved. The lender will outline the terms, including the loan amount, interest rate, repayment period, and any collateral required.
4. Repayment: Once the loan is disbursed, your business will begin making payments according to the agreed schedule. Repayment terms can vary, but most commercial loans require monthly payments.
5. Collateral and Interest: For secured loans, the lender may hold collateral in case the business fails to repay. Interest rates on commercial loans can vary depending on the type of loan and the lender’s risk assessment.

Factors to Consider Before Applying for a Commercial Loan

Before applying for a commercial loan, there are several factors you should consider:

Your Business’s Financial Health

Lenders will assess your business’s financial health to determine whether you qualify for a loan. A strong credit score, positive cash flow, and healthy profit margins can improve your chances of approval. Be sure to review your financial statements and ensure that your business is in a stable financial position.

Loan Amount and Terms

Consider how much funding you need and the repayment terms that are feasible for your business. The terms of the loan, such as the interest rate, repayment period, and collateral requirements, can significantly affect your business’s financial stability. Be realistic about what you can afford to repay.

Loan Purpose

Be clear about why you need the loan. Whether it’s for expansion, purchasing equipment, or managing cash flow, knowing exactly how you will use the loan funds can help you choose the right type of loan and avoid overborrowing.

Interest Rates

Commercial loans come with varying interest rates depending on the loan type and lender. Pay close attention to the interest rates, as they will affect the total cost of borrowing. Shop around to find the best terms and rates.

Repayment Ability

Assess your business’s ability to repay the loan. Consider how long it will take to generate enough revenue to cover your monthly loan payments. Lenders will look at your cash flow and may request projections to ensure that your business can afford to take on the debt.

Understanding Commercial Loan Structure

Most lenders don’t extend credit in perpetuity or without some very specific purpose for the funds being advanced. This is what bankers often refer to as loan structure (or credit structure).

The following are some examples of questions that a lender should ask themselves when structuring a commercial loan:

• Will the financing be revolving/operating credit or reducing term debt with scheduled repayment intervals?
• What (if any) assets will serve as collateral for the exposure? (Note: if a loan has collateral it is said to be a secured loan)
• What is the maximum loan-to-value (LTV) we’re willing to offer against the asset being financed?
• What is an appropriate amortization period based on the purpose of the commercial loan?
• What should the interest rate be in order to compensate for the borrower’s projected default risk?

Whether it’s a firm’s business banking division or its commercial real estate lending team underwriting the exposure, commercial loan structure is often guided by predetermined credit policies.

Most commercial loans extended by traditional financial institutions are secured by collateral.

Types of Commercial Loans

There are many forms of credit available to support businesses but we’ll look at some of the most common types:

Lines of Credit

An LOC (often referred to as a “revolver”) supports the working capital cycle for firms that sell on credit terms. There is no set repayment schedule; it’s structured to revolve up and down as balances change in the company’s working capital accounts. 

Term Loans

Term loans are used to acquire non-current assets, which include things like equipment, vehicles, and furniture. Term loans are typically amortizing, meaning they reduce with periodic payments (often monthly). At the time of loan advance, both the borrower and the lender will have already agreed upon a repayment schedule. The loan repayment period is generally aligned to the useful life of the underlying asset being financed.

Capital Leases

Capital leases – sometimes referred to as “finance leases” – serve a similar purpose to term loans (meaning they’re used to finance non-current, capital assets like equipment). The main difference between a term loan and a capital lease is that the equipment finance firm funding the lease retains the legal title of the physical asset (as opposed to registering a lien over it).

Commercial Mortgages

Commercial mortgages are another type of term lending but they’re used exclusively to finance (or refinance) commercial real estate. The analysis and underwriting techniques vary depending on whether the property is owner-occupied or if it’s an income-producing investment property; however, both tend to have more flexible terms (longer amortization, more favorable LTVs, very competitive pricing, etc.) than other types of commercial loans. 

Acquisition Loans

Acquisition loans are another category of commercial loan. These are used by businesses that are buying other businesses (or other business divisions) as opposed to physical assets like property or equipment. While not universally true, acquisition loans tend to have shorter amortization periods and lower loan-to-values than other types of commercial loans.

The Commercial Loan Process

At CFI we teach the credit process as having 5 distinct steps. These are:

• Loan origination, where the relationship team goes out and prospects for potential borrowing clients. 
• Client discovery and credit structure is where the team of lenders (including the relationship manager and the credit analyst) seek to understand the health of the business, what its specific borrowing needs are, and how the deal might be structured and priced. 
• Analysis and underwriting occurs once the team has secured the client’s commitment to move forward on a formal credit application. At this stage, the bank’s adjudication team (or credit committee) must provide final approval of the proposed credit structure.
• Documentation and perfecting security begins once the deal has been approved, the loan agreement executed, and any liens against the business and its assets registered correctly by the lender’s counsel. 
• And finally, the loan is advanced and the borrower gets access to the loan proceeds.

What types of Commercial Loans are available?

There are various commercial lending options. Here are some examples of widely used commercial loans.

Business Term Loans: A traditional financing structure where the business receives a lump sum disbursement of cash for various business purposes. A company could use the funds for working capital, one-time purchases, and more. The business repays the term loan, interest, and fees in fixed monthly payments.

Business Line of Credit: Instead of a one-time disbursement, the funds are activated as an available credit limit. Companies can draw funds from the credit line as needed and only pay interest on what they draw. The credit limit replenishes as it’s repaid, like a credit card. Lines of credit are excellent for ongoing projects or covering unexpected costs.

SBA Loans: The US Small Business Administration (SBA) oversees the SBA loan program and partially guarantees up to 85% of the loans. That gives lenders the security to offer higher amounts at lower rates and longer terms, making them the “gold standard” of small business financing.

Equipment Financing: Provides funds for essential business equipment such as medical equipment, heavy equipment in construction, restaurant equipment, and much more. Some equipment financing includes vehicles, such as:

• Commercial vehicle financing.
• Commercial truck financing.
• Commercial fleet financing.

Commercial Real Estate Loan: A business loan explicitly used for real estate purchases or to build or renovate property. The commercial property (storefront, warehouse, factory, etc.) being financed usually serves as collateral for commercial real estate loans. At least 51% of the commercial property must be used for business purposes.

Where do businesses get Commercial Loans?

There are several commercial business loan lender options for your business financing needs. Choosing the right financial institution depends on how much you need, how soon you need it, and your qualifications.

Traditional Lenders

Traditional lenders include banks and credit unions. You can apply to a large commercial bank, or many local community banks also offer business financing.

You’ll typically need at least two years in business, excellent credit, and high annual revenue to qualify for business bank loans. You’ll need similar credentials for a credit union and must also be a credit union member.

Traditional business loans also take a long time to close and fund and require extensive documentation. However, you’ll typically get the lowest interest rates and most favorable loan terms if you qualify.

US Small Business Administration

As mentioned, the SBA oversees the coveted SBA loans. However, you cannot apply directly to the SBA. Business owners must apply to an SBA-approved lender, which could be a bank, credit union, or alternative business financing facilitator like UCS. Small business owners can get lists of SBA-approved and SBA-preferred lenders from the government agency’s website.

Alternative Lenders

There are many alternative business loan lenders available. They’re also called online lenders or fintech lenders since most use financial technology to expedite the underwriting process.

Most alternative lenders provide convenient online applications with minimal documentation requirements. You could potentially receive same-day or next-day credit approval. Several online lenders can fund approved business loans in 1-3 business days, depending on the loan type. Some even provide same-day funding.

In addition, online lenders are more lenient about a low personal credit score or shorter time in business than traditional lenders. The tradeoff is that alternative business loans tend to have higher rates.

Nonprofit Lenders

Other lenders include nonprofit organizations that provide business financing options for companies in economically disadvantaged areas. They usually provide funding to support local businesses in the hopes of stimulating the overall local economy.

What are the benefits & drawbacks of Commercial Loans?

Commercial lending provides the necessary funding to help sustain operations or fuel growth. There are a variety of commercial lenders and loan types available.

You can typically find commercial lenders for most levels of funding needs. Small businesses can get small business loans, while large corporations can get enterprise-level commercial financing.

Most traditional lenders offer high borrowing amounts at low interest rates and longer terms. However, qualifying for a traditional commercial loan is more challenging, and it takes a long time to fund.

Some commercial loan options have exhaustive documentation requirements, and you must have excellent credit. Alternative commercial loans have fewer requirements and are funded much faster but have higher rates.

Commercial Loan Pros & Cons

Pros:

• Provides necessary business funding.
• Multiple loan types & lenders.
• Funding is available for small businesses up to enterprise-level corporations.
• Traditional commercial lenders offer high borrowing amounts at low rates.

Cons:

• Traditional lenders have strict qualifications.
• Some commercial loans require extensive documentation.
• Can be challenging to find the right loan or lender.
• Banks and credit unions take a long time to close and fund a loan.
• Alternative lenders typically charge higher rates.

Also Read : Understanding Business Loans: Key Options and Tips for Entrepreneurs

Conclusion

Commercial loans are a vital tool for business owners seeking to fund operations, growth, and expansion. By understanding the different types of loans, their purposes, and the associated risks, you can make more informed decisions about which financing option is best for your business. Careful planning, assessing your financial position, and selecting the right loan product can set your business on the path to success

FAQs

What is the difference between secured and unsecured commercial loans?

Secured loans require collateral (such as property or equipment) to back the loan, while unsecured loans do not require collateral but typically come with higher interest rates.

What is the minimum credit score needed to qualify for a commercial loan?

The minimum credit score varies by lender and loan type, but a score of 650 or higher is generally considered good for securing a commercial loan.

How long does it take to get approved for a commercial loan?

The approval process can take anywhere from a few days to several weeks, depending on the lender, the loan type, and the complexity of your application.

Can I get a commercial loan with bad credit?

It may be more difficult, but some lenders specialize in working with businesses with less-than-perfect credit. Expect higher interest rates and stricter terms.

Can a business loan be used for personal expenses?

No, business loans are intended for business purposes only. Using the loan for personal expenses could lead to legal and financial issues.

How much of my business’s revenue will I need to use to pay off a loan?

The repayment amount depends on the loan amount, interest rate, and repayment period. Generally, businesses allocate a portion of their revenue to repay the loan based on the agreed-upon terms.

What happens if I can’t repay a commercial loan?

If you fail to repay the loan, the lender can seize any collateral you provided as security. Additionally, your business’s credit score may be impacted.