March 2023 saw this year’s edition of the Small Business Credit Survey being published. A collaboration between all 12 Federal Reserve banks, the Survey examined some of the traditional financing preferences – particularly loans, lines of credit and cash advances - of a sample of nearly 8,000 small businesses (those with 1 to 499 full- or part-time employees).
With 82% of small business applicants reporting that their funding applications received approval at small banks (those with less than $10 billion in total deposits), and with 68% of applicants similarly receiving approval at large banks (with over $10 billion in deposits), the Survey highlighted the pivotal role that the banking sector continues to play in supporting the financing needs of small American businesses in 2023.
The Survey also revealed that applications for lines of credit (43 percent) and traditional business loans (34 percent) are the most common types of financing being sought after by small businesses. Such statistics amply demonstrate that through various types of loans, business bank lending is hugely popular for American businesses across the country.
And if you are a business owner yourself, you may well be wondering what all the hype is about...
What is a Business Bank Loan?
Business bank loans provide the funding necessary to satisfy a wide range of goals for your business. Whether it is capital to drive a much-needed expansion of your small business, a cash injection to purchase equipment for your mid-sized firm, a strategic addition to your marketing budget, or simply creating a financial buffer to ably weather unexpected future outflows, bank loans can help businesses of almost all sizes (those with at least 2 years in operation) to significantly bolster their growth prospects.
In most instances, a business bank loan will involve borrowing a sum of money from a bank under specific terms and conditions, including:
- the interest rate you agree to pay in return
- the term, or length of time over which you must repay the loan
- the amount and frequency of the repayments
- any collateral required for you to pledge as security on the loan
Banks today offer a wide range of business loans catering to specific business needs and preferences. For example, while most loans require you to make fixed monthly repayments, some banks may prefer semiannually, weekly or even daily payments until the balance of the loan is fully repaid.
As such, it is recommended that you take the necessary time to research the various loan products on offer, both within a particular bank and across various banks in the market. And assuming your business has a sound financial and credit history, an approved business bank loan can help you achieve significant objectives for your business.
Types of Business Bank Loans
There are two broad categories of business bank loan, with some products offering a version of each:
Secured: also known as asset-backed lending, secured business loans are available to you if you can post business assets as security. This can be physical assets such as property and equipment, or liquid assets such as cash.
Should you default on the loan by failing to meet the required payments, the bank can then seize this collateral to repay the loan’s outstanding balance.
Unsecured: banks will offer you such loans without requiring you to post collateral. Such loans are thus purely based on evidence of a strong credit history, with banks sufficiently confident in your ability to repay the outstanding loan balance in full.
Business bank loan products also vary by their specific type and purpose:
Term loan - the standard business bank loan, whereby the bank issues you with an up-front lump sum of cash which you then proceed to repay over an agreed term, usually 48 months or more.
Term loans can be either secured or unsecured, with repayments normally fixed and scheduled every month. Banks will also require your business to have been in operation for at least 2 years, and have a credit score of at least 650 to be eligible for the most expensive (highest rates of interest) term loans.
SBA loans — offered by banks and other lenders, SBA loans are at least partially guaranteed by the US government’s Small Business Administration. With interest rates being among the lowest available, coupled with terms extending up to 25 years, these loans are hugely popular among the small business community, especially:
- 7(a) loans – the most popular SBA loan, 7(a) loans are normally preferred when you want to raise working capital and expand your business. Up to $5 million can be borrowed via this option, with both secured and unsecured 7(a) loans available.
- 504 loans – fixed-rate financing that is designed for you to make specific purchases and thus build assets to expand your business and create jobs.
According to the SBA itself, a 504 loan can be used for a range of assets, including the purchase or construction of existing buildings or land, new facilities, and long-term machinery and equipment. It can also be used to improve or modernize land, streets, utilities, parking lots and landscaping, as well as existing facilities.
You can borrow a maximum of $5 million via a 504 loan (or $5.5 million if you are a small manufacturer), but it cannot be used for working capital. To qualify, your business must also be classed as for-profit, with a net worth under $15 million and an average net income of $5 million for the prior 2 years.
Business Line of Credit – this revolving funding facility is convenient when you need to make large or frequent expenses over a shorter period than, say, a term loan. By being able to access capital as you need it, you can cover costs in a flexible manner from day-to-day.
Banks will grant you a maximum credit limit and a “draw period” in which you can repay the amount owed, as well as continue to borrow more funds up to your credit limit. You will also be charged interest on the amount you have drawn. As such, this funding method draws frequent comparisons with credit cards - the key difference being that the higher credit limits available make the line more suited for costlier, bigger-ticket purchases.
When the draw period closes, however, you will have to pay back the outstanding balance. Nonetheless, there is a strong likelihood of being able to renew the credit line to access more funding.
And while business lines of credit are more flexible than term loans by not requiring you to make fixed, periodic repayments, banks will still require evidence that your business has a strong credit history to be eligible for this funding method.
Equipment Financing – if you are looking to purchase, replace or repair specific equipment required for the operation of your business, an equipment loan could be just the ticket. This can be applied for a broad array of equipment - from machinery and forklift trucks to office furniture and construction equipment, and from printers and photocopiers to computer hardware and payment processing terminals - in each case, equipment financing can help facilitate business growth through specific physical assets.
Given the specificity of equipment financing, banks tend to ease their eligibility requirements for this funding type vis-à-vis a standard term loan. For example, approval of the loan application takes less time, particularly given that the equipment itself can serve as security for the loan.
And with equipment financing aimed more at larger businesses making sizeable equipment purchases, the amount you borrow will most likely cover the entire cost of the equipment, although you may have to submit a down payment in some instances.
As is the case with term loans, banks will require monthly repayment, although other periods are possible such as seasonal and semiannual. And given that collateral is part of the loan deal, interest rates will also be lower than equivalent term loans; nonetheless, they will still depend on the financial strength of your business and credit history.
Equipment financing is also available through SBA 504 loans (as outlined above), which can be obtained for the purchase of long-term machinery and other equipment.
Commercial Real Estate Loan
With commercial property invariably a significant component of business operations, banks also issue loans for you to either purchase or lease a physical brick-and-mortar location. Examples of such real estate include warehouses, office space, restaurant premises and factories.
This makes commercial real estate loans not entirely dissimilar to conventional mortgages, with comparable repayment terms and the arrangement typically secured by liens on the property. And as is the case with equipment financing, interest rates tend to be favorable, again due to the intended purchase – in this case, the property - serving as the collateral.
Depending on your business requirements, banks can issue up to $5 million in commercial real estate financing which can be repaid over a 10-20 year horizon. The terms of such a loan can be stringent, however, with bank approval determined by factors including your business’ credit history, at least 3 years of financial statements, the type of collateral being pledged, your business’ creditworthiness and other financial metrics.
As such, commercial real estate loans are mostly associated with businesses with a strong existing track record of high revenue.
Again, SBA 504 loans are worth investigating in this context, with permissible loans being issued for the purchase or construction of existing buildings, land and new facilities.
How Do Business Bank Loans Work?
As a business owner, the process of applying for the right bank loan requires sound preparation – conduct thorough research to identify all your business loan options and compare terms between banks to select the most suitable loan for your business needs.
Before approving any loan, the bank will assess whether your business meets certain important criteria, namely:
- Age - Banks require that your business has had at least 24 months in operation.
- Credit History - Banks will consider your credit score – that is, a valuation of your creditworthiness as determined by such factors as your payment history and amounts owed in relation to your income – before deciding to approve your business loan application.
A minimum score of 650-700 should be enough to obtain a loan at higher interest rates, while “excellent” scores exceeding 800 will incur much more favorable terms including lower rates and more flexible repayment periods.
- Performance: Banks may also be interested in the earnings history of your business, particularly with respect to revenue, cash flow, debt servicing and profitability figures.
- Collateral – for secured lending arrangements, banks will require you to pledge assets as collateral throughout the term of the loan, such that they can be seized in the event of you defaulting and thus used to repay the remaining balance.
So, it makes sense to check beforehand if you qualify for business bank loans. If you do, then it is worth comparing across banks to identify the most suitable type of business bank loan for your needs. In most cases, banks will also require you to sign a personal guarantee to confirm that you are personally liable for paying the outstanding loan balance should your business default.
Once the bank approves the loan application, and you have also signed it, you should receive your requested funds in your bank account.
Pros of Business Bank Loans
Generous Terms – you can obtain sizeable loan amounts through banks, with lenders often willing to provide more than $1 million if you have an established business, and maximum term lengths stretching even beyond 25 years.
Retain full business ownership – business bank loans require that you repay what borrowed, with interest, and within a certain period. They do not require that you relinquish any share of your business, nor any percentage of your profit or revenue. If you are committed to retaining full ownership of your business, such loans will be vastly preferable to equity financing solutions.
Variety of Loan Options – as outlined above, the business bank loan market has expanded to serve a wide variety of business needs. This means that loans can be allocated for many uses today, including business expansion, working capital, real estate and equipment.
Perks of Relationship Banking – should you repay your business loan on time without problems, banks may offer much-improved terms the next time you are seeking financing. Developing trust and sound relations mean that your proven financial and credit profiles will only improve if you stick with the same bank.
Cons of Business Bank Loans
Not Accessible To All Businesses - Approval of a loan application typically requires a credit score of at least 650 – and at least 700 for competitively priced loan – along with at least 2 years in operation, possible collateral to secure your funding and minimum annual revenue of as much as $100,000. This means business bank loans are not accessible to all businesses – if your business is still in the early start-up phase and/or you have a poor credit history, you will have to consider alternative funding sources.
Lack of Flexibility – aside from business lines of credit, most business bank loans require fixed payments every month. This could mean that repayment during some months might be tougher, especially if your business is exposed to cyclical / seasonal dips or there are uncertain delays in cashflow. It can also mean that you are making interest payments on a lump-sum amount that is sitting idle in your bank account.
Seizure of Collateral – secured loans require collateral in the form of physical assets such as property or equipment, or liquid assets such as cash. And despite interest rates being more attractive for secured loans vis-à-vis unsecured loans, you will have to relinquish potentially valuable assets if you default on your repayment obligations.
Loan Processing Time – there is no guarantee that your loan application will be approved quickly – some banks may take a week or longer. And if you have applied for an SBA loan, the process can be notoriously long, even taking up to 90 days before you can access funds.
