Commercial Loans

Everything You Need to Know About Commercial Loans

This guide will cover commercial loans, which are very important for companies that want to expand their business, operate, or invest in other areas. This differs from personal loans, which are tailored to individual needs. This guide will explain commercial loans, their functions, eligibility requirements, application approval, and different types of businesses.

What Are Commercial Loans?

Commercial loans are credit products that banks, credit unions, and other lenders provide to assist businesses with operational or development-related activities. Businesses receive capital through commercial loans to purchase equipment, expand facilities, manage cash flow, acquire real estate, or refinance debt. Dale Elenteny, a senior mortgage loan originator at GCA Forums Mortgage Group, says the following about commercial loans:

From small startups to large corporations, every business is granted commercial loans tailored to its unique needs and specifics. Businesses are given greater loan amounts with more complex terms than personal consumer loans.

Commercial loans assist operations that generate revenue, profitability, and business growth. These loans may be secured or unsecured, depending on the lender and the borrower’s creditworthiness. Secured loans are backed by collateral such as real estate or equipment, while unsecured loans are based on the borrower’s credit profile and financial stability.

How Do Commercial Loans Work?

Like any loan, Commercial loans operate very similarly; however, they are specifically designed for businesses’ needs. Let’s break down the process step by step.

• Step 1: Application Process of Commercial Loans: Businesses must submit a detailed application covering the company’s basic health, strategies, and plans for using the funds.
• It includes financial statements, tax returns, and business credit reports.
• Step 2: Application Evaluation: The business’s lender evaluates revenue and profitability, anticipating cash flow sufficiency to repay the loan and the business’s credit risk.
• In a secured loan, the collateral provided also undergoes value determination.
• Step 3: Loan Approval and Terms: The lender offers a specific loan with an interest amount and repayment terms outlined upon approval.
• Both interest rates and loan amounts come with a repayment schedule that can be fixed or variable, spanning one to twenty-five years, depending on the loan sought.
• Step 4: Payment: Following the agreement on the specified terms, the loan disbursement is either a lump sum or in payments as specified in the loan agreement.
• Step 5: Repayment: The business repays the loan via regular (monthly, quarterly, or annual) payments of principal and interest.
• Some loans have balloon payments, where a large portion of the principal is due at the end of the term.
• Step 6: Monitoring and Compliance: Lenders may track the business’s financial activities to ensure compliance with loan covenants, such as a certain debt-to-income ratio or revenue-based expectations.

Not being able to pay back a commercial loan could bring penalties, loss of the company’s credit rating, or forfeiture of collateral in the case of secured loans.

Eligibility Criteria for Commercial Loans

Meeting certain thresholds is a requirement for obtaining a commercial loan, and these requirements are different for each lender and type of loan. Some of the common eligibility criteria are as follows:

• Business Credit Score: Most lenders require an established business credit score of 680 or more.
• Lower scores are accepted by some lenders for alternative loan products.
• A business credit score indicates the business’s ability to pay debts on time.
• Time in Business: Most lenders prefer at least one to two years of operation.
• Startups accepting some loans tend to be under more scrutiny and charge higher interest rates.
• Profitability, Revenue, and Cash Flow Evaluation: Every lender checks a business’s annual revenue and profitability to ensure that it can generate enough cash flow to service the loan.
• While some lenders may not have revenue requirements, most expect at least $100,000 for a small business.
• Debt-to-Income (DTI) Ratio: A DTI below 35% is considered low, meaning the income is sufficient to cover the existing debts and monthly loan payments.
• Most lenders underwriting new debt prefer this ratio below 43%.
• Collateral – Secured Loans: For secured loans, the properties offered by the borrower must have sufficient value to cover the loan amount in case of a default on the payment.
• The lender can seize the collateral if the business cannot repay the loan.
• Financial Documents: The balance sheet and income statement provide a snapshot of a business’s financial health at a given time.
• In addition to the business plan, most lenders must review financial documents, assessing the company’s performance over time alongside other indicators of its operational results, such as tax returns.
• Personal Guarantees: For startups and small businesses, owners may have to provide personal guarantees, which make them personally liable for settling the loan obligation if the business fails to do so.
• Analytical Restrictions: Loans are restricted to particular businesses or geographic locations.
• For example, businesses operating in high-risk industries such as gambling or cannabis may not be eligible for specific loans.
• Approval is never guaranteed, as lenders consider the market, the business sector, and the overall economic milleage.

Commercial Loans Availability

All commercial loans are tailored towards a certain need. Below are the most common types of commercial loans:

Term Loans

• Description: A term loan is a set amount of capital given to a business to meet specific needs.
• It is repaid regularly over predetermined time frames.
• These loans can be short-term (1-5 years), Intermediate-term (5-10 years), or Long-term (10-25 years).
• Use Cases: Payment for new equipment, expansion of operations, and refunding pre-existing debt.
• Features: Both fixed and variable interest rates can be secured or unsecured; they must be for registered businesses with good credit history.
• Example: A manufacturing company purchases new machinery worth $500,000 and takes a seven-year term loan to pay it off.

Commercial Real Estate Loans

• Description: Used for purchasing and refurbishing commercial buildings, such as office buildings, retail space, and warehouses.
• Use Cases: Buying or renovating spaces to be used for business purposes.
• Features: Long repayment terms of 10-25 years; the property secures the loan, and a 10-30% down payment is often required.
• Example: Funds $2 million for a retail chain intending to buy a new store.

Commercial Loans: Lines of Credit

• Description: A revolving line of credit lets businesses loan up to a certain limit, withdraw as necessary, repay the loan, and borrow again.
• Only the borrowed amount attracts interest.
• Use Cases: Managing cash flow, unexpected expense coverage, and short-term financing.
• Features: Borrowers are subject to different conditions, such as secured or unsecured lines and flexible funds access.
• Example: A small business utilizes a $50,000 payroll credit line to meet payroll obligations in the off-peak season.

Equipment Financing

• Description: Equipment financing loans help purchase or lease equipment, such as a machine, vehicle, or technology.
• Often, the equipment itself acts as collateral for the loan
• Use Cases: Acquiring, upgrading, or replacing business equipment.
• Features: The loan is repaid within 3-10 years, and the interest rate is lower than average
• Example: A construction company financed a $100,000 excavator with a five-year equipment loan.

Commercial Loans: SBA Loans

• Description: The federal government makes these loans available to small businesses.
• SBA loans mitigate the risks for lenders and make lending easier for small businesses.
• Businesses can obtain an SBA 7(a) loan and an SBA 504 loan.
• Use Cases: Financing general business activities (7a) or purchasing real estate or equipment (504).
• Features: Strict qualifying criteria; low interest rates, lengthy repayment terms (as long as 25 years).
• Example: Whatsa is a startup company that obtained and managed an SBA 7a loan worth $250,000 to open a new office.

Invoice Financing (Factoring)

• Description: Using this procedure, businesses can collect outstanding invoices through a lender who purchases the invoice outright (or at a discount).
• The lender uses the client’s domain to claim the invoice amount.
• Use Cases: Financing for a firm with slow-paying clients.
• Features: No amount is restrained by collecting funds, quick access to finance, no need for security, charges to invoice value, and collection periods.
• Example: Business management consultants get immediate access to 80% of a 50,000 invoice through invoice financing.

Merchant Cash Advances (MCAs)

• Description: An MCA facilitates funds in a lump sum per the merchant’s cash flow.
• A percentage of future credit or debit card sales is kept aside to cover the loan.
• Repayments are deducted.
• Use Cases: Fast Cash for businesses that operate on credit card-based sales.
• Features: Unsecured; poor credit businesses benefited; high fees and effective interest rates.
• Example: A restaurant with a credit card sales average of $20k MCA takes a subsequent draw of $30k. 15% of daily credit card sales are used to pay off the transaction through the MDR transaction.

Bridge Loans

• Description: Short-term loans are made to borrowers to cover expenses until a larger loan or permanent funding is secured.
• Use Cases: Catering expenses as they arise while awaiting a larger loan or sale.
• Features: High interest rate; short 6-month to 3-year terms; Often securitized.
• Example: A Commercial property developer to a borrower who uses a million-dollar bridge loan to finish a development project while awaiting a commercial real estate loan.

Commercial Loans: Microloans

• Description: Small loans are usually less than 50K, given by non-profit lenders for micro-establishing micro-establishment businesses.
• Use Cases: Set up a business, purchase inventory, and cover smaller business-related activities.
• Features: Increased interest rates as loan availabilities reduce for businesses with no credit history.
• Example: A startup bakery operating from her house gets given a commercialist 10k microloan to buy a commercial oven.

Like any other method of financing, commercial loans help businesses achieve strategic goals like expanding operations, purchasing new assets, or managing the cash flow. Knowing the types of commercial loans, their eligibility criteria, and their operations is important for sound borrowing decisions. Firms can identify the most suitable loan product and lender for their growth potential by deeply evaluating their financial needs and credit profile.

Before applying, businesses must evaluate different lenders, analyze the terms of the loans and the APR, and seek the opinion of financial experts to mitigate paying an unfavorable fee for the credit. A business equipped with the most suitable commercial loan can maximize its leverage and succeed in the challenges posed by a competitive market.