Term Loan: What is it and How You Can Use it to Grow your Business
A term loan is a type of loan acquired from a bank for a specific amount. These loans also have a specified repayment schedule with either a fixed or floating interest rate. A fixed interest rate is a loan where the interest rate does not fluctuate during the fixed-rate period of the loan. A floating interest rate is an interest rate that moves up and down with the market or index.
A term loan is ideal for businesses that are established with solid financial statements to show the lender. Keep in mind, a term loan may require a considerable down payment to reduce the payment amount and total cost of the loan.
Types of Term Loans
- Short-term loan: This type of loan is generally offered to businesses that don’t qualify for a line of credit. These loans often run for up to a year but some loans can run up to 18 months or so.
- Intermediate-term loan: This type of loan runs for more than one year but less than 3 years. It is paid in monthly installments to aid businesses with cash flow. For businesses that acquire an intermediate loan, it is possible to have a balloon payment for the final installment.
- Long-term loan: This type of loan runs from 3 to 10 years but some can last as long as 30 years. With a long-term loan, the business assets will be used as collateral and will require monthly or quarterly payments from profits or cash flow. Similar to an intermediate-term loan, a shorter long-term loan may have a balloon payment for the final installment.
Advantages of Term Loans
A term loan is one of the most common forms of business financing. Term loans provide businesses with working capital that enables them to operate their business efficiently and helps ensure the business can continue to sustain. With that said, term loans are a great option for businesses who quickly need funds for their operation. Here are 5 advantages of term loans.
One of the more favorable aspects of a term loan is that businesses can expect to snag a relatively lower interest rate. This is because term loans have longer durations that allow for these lower rates.
It’s important to note that your interest rate will depend on the following factors:
- The current index rate
- Perceived credit risk represented by your loan
- The length of the loan term
Flexible Use of Cash Flow
Another benefit of term loans is the ability to use cash flow in multiple areas of your business. For instance, businesses can use the money to make large investments such as for equipment. At the same time, the money can be used to hire and train new employees. Essentially, the flexibility of these loans makes it easier for businesses to meet the various needs of the business.
Flexible Loan Duration and Payments
A term loan is also favorable when it comes to the flexibility of the loan duration, payments, and interest rate. Businesses have the opportunity to negotiate before the loan is granted, allowing them to acquire a loan that they can afford all while helping their business.
Keep in mind, the flexibility of the terms will depend on the credit score of the business and business owner.
Quicker Approval Times
Often times, businesses get in a bind and need cash quickly. This means that waiting for a loan approval might not be much of an option. A term loan can be a great solution to this problem as businesses can get their funds anywhere from 2 days to 2 weeks, depending on the lender.
Preserves Shareholder Equity
One concern that many businesses have when it comes to business funding is shareholder equity. Businesses often need funding but don’t want it at the expense of losing ownership percentage. Since term loans are debt financing, it does not affect the company’s interest in the equity shareholders. In addition, it keeps the company’s equity intact.
Using a Term Loan to Grow Your Business
Term loans certainly have great benefits that make them worthwhile. For owners that are considering getting a term loan for their business, it’s important to consider all the ways you can use the term loan to enable growth.
Refinancing Business Debt
One way that businesses can utilize their term loan is by refinancing business debt. This is a great option for businesses that already have multiple loans at varying interest rates. You can consolidate this debt with the help of your term loan to create a single term loan.
This not only helps businesses manage cash flow better but businesses can streamline monthly payments. In addition, streamlining debt can help businesses save money because it essentially allows them to cut their monthly payments, which improves cash flow.
Purchasing Inventory and Equipment
For a lot of businesses, having inventory and equipment is essential for business growth and sustainability. However, stocking up on inventory and replacing or updating equipment can be costly.
In this case, an intermediate or long term loan can be a viable solution. Businesses can get the inventory and equipment they need while having enough time to pay it back. What’s even better is that businesses can often pay it back in a timely manner through continued business operations.
Hiring and Training New Employees
Your team is a crucial part of meeting customer demands and ultimately providing the best customer experience. For this reason, businesses must focus on hiring quality talent and providing ongoing training to continue to meet the rising demands of the business. This is especially important for businesses that are in a growth period.
For instance, a business might need to hire new employees if the business is growing in order to not lag behind. At the same time, it might be necessary to train your employees on how to use new equipment you’ve just purchased.
Being able to hire new employees and provide training ensures that the business is always prepared to handle operational demands. Along with this, businesses can ensure they are backed by a quality team that represents the business.
Developing New Products
It’s not uncommon for businesses to develop new products as a way to expand their market. In some instances, developing a new product is necessary to keep the business afloat. But, businesses don’t always have the capital to allocate to product development.
With a term loan, business owners can use the funds to cover the initial costs of production or market research. This is a great option for businesses that are already making their dollar stretch as the initial cost of developing a new product isn’t necessarily cheap. At the same time, using a portion of your term loan to fund this new idea ensures that you can properly invest in your idea, improving the likelihood of product success.
4 Tips to Help You Secure a Term Loan for your Business
Have an Idea of the Type of Loan You’d like to Obtain
If you’re interested in a term loan, it’s important to know the type of loan you’d like to obtain. Each loan will have its own guidelines and restrictions that can either increase or decrease the likelihood of your business obtaining the loan. For instance, businesses that are interested in a long-term loan will need business assets to be used as collateral.
Gather Your Documents
Proper documentation is essential, especially when it comes to securing a loan for your business. Gathering all required documents ahead of time is a great way to stay organized and increase the chance of obtaining a loan.
Many lenders will have stringent requirements to help minimize their risk. With that said, get prepared to gather things like your income statements, balance sheets, financial projections, and bank statements.
Assess Your Collateral
Having collateral is key to obtaining a term loan with favorable terms. Start by making a list of everything that can be used as collateral in your business. If you don’t have any business collateral, consider using personal assets. A lender may consider this when determining your loan eligibility.
Stay on Top of Your Credit Score
Your credit score is a key player when it comes to securing a loan. After all, your credit health gives insight into your financial health and financial behavior.
For businesses, it’s important to pay attention to your business and personal credit score. If your business is just starting, you won’t have much credit history. But if your company is registered as a sole proprietorship, lenders might look at your personal credit score.
However, lenders will focus more on your business credit score when you’ve run your business for a while. In either case, it’s always a good idea to know where your credit stands before applying for a loan. This way, you can take any necessary steps to improve your scores and receive the best chance of obtaining a loan.
Term loans are a popular option for business owners who want to grow their companies. These loans have great advantages such as quick approval times, flexible use of cash flow, and flexible loan terms and payment. With that said, there are some disadvantages that businesses should consider such as personal guarantees, loan fees, and credit score qualifications.
If you’re interested in a term loan, be sure to have a solid understanding of your business goals, how much loan you can afford, and the financial obligations of acquiring the loan.
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