Owning a business is another big dream that many people will need a loan to finance. Business is risky and lenders know that. That is why commercial loans are some of the most difficult loans to get. The lender is going to be very critical of all aspects of the business and they are going to require a lot of documentation up front in order to even consider a commercial loan.
The statistics are quite scary when you consider how many small businesses fail each year and how many new businesses of any size fail each year. Business is a tricky thing and it is not easy. However, one thing that a business has going for them is that there is a lot of support out there that works hard to support business and business owners.
Despite many efforts, though, the fact remains that the majority of new businesses fail within the first two years. That is why lenders see commercial loans as a huge risk. There is no guarantee that the business is going to exist for the life of the loan.
Where does all this leave the business owner? Well, this leaves the business owner in a position where they must sell themselves and their business to the lender. They have the major hurdle of convincing the lender to lend them money. The best way to do this is to learn as much as possible about the process of commercial loan lending.
Types Of Commercial Loans
There are three main types of commercial loans and they are very different. These three types of business loans are:
- Business loans
- Real estate loans
- Construction loans
Business loans can be obtained for different reasons. A person may get a business loan to start a business or improve a business. Getting a loan to start a business is the most difficult type of commercial loan to get because it has the most risk.
Generally speaking lenders want to loan money for as little risk as possible. The failure rate of new businesses is quite high and so lenders know they are very risky. Also, a new business has no established credit or character. The lender has no clue if the business can pay back the loan. Usually what happens is the business owner has to get the loan for the business.
With a start up business loan the lender is going to require a complete business plan. They want details and proof that the business owner knows exactly where the business is going and how it will be run.
The business plan details everything from the construction of the company’s management staff to projected sales figures to expenses. It requires a lot of work and research to create an acceptable business plan.
Getting a business loan to improve a business is going to be easier. Lenders will prefer if the business is profitable and if it has been in operation for at least two years with a profit. Also an established business usually has assets which can be used as collateral to secure the loan.
REAL ESTATE LOANS
Real estate loans are loans to purchase real estate. Generally, this will be for a purchase of a storefront or office area. The same ideas apply to a real estate loan as to business loans – lenders will be more likely to lend to an established business then a start up business. However, one thing to note is that with a real estate loan there is the property that can act as collateral. This makes is less difficult, even for the start up business, to secure this type of loan.
A real estate loan is a lot like a home mortgage in almost every aspect. The only difference is that the business is taking out the loan, but an individual. The real estate property can go through the same foreclosure process as happens with a residential mortgage.
A construction loan is a loan to build commercial property. Construction loans are the most variable of all commercial loans. They offer choices that are really unique to just construction loans. For example, a business may be able to borrow a loan, but get only the amount they need for each stage of construction. This helps ensure they do not overspend and stick to the budget. It also puts the lender at ease and can bring down costs of the loan.
Outside Help With A Commercial Loan
In the United States the idea of entrepreneurship is taken seriously. It is part of the American right that every person has the ability to pave their own way. With that in mind, commercial loans are something you can get a lot of help with from the government and other private groups who want to help you succeed in your business dreams. There are several agencies that were crested specifically to help people start and maintain a business.
SCORE is a non-profit organization that is partnered with the Small Business Administration. SCORE offers education and other resources to small business owners to help them build and maintain their business. SCORE has a staff of counselors who are experts in business that offer their knowledge to business owners free of charge. There are chapters of SCORE all across the United States.
SBDC (Small Business Development Center)
Like SCORE, the SBDC is a private organization that works to educate and counsel business owners to success. The SBDC is composed of efforts from private individuals and all levels of the government, including federal, state and local. The SBDC also provides educational services to business owners.
SBA (Small Business Administration)
The SBA is the federal governments department that focuses on small business. The SBA offers a range of services, including offering funding and assistance to groups like SCORE and the SBDC.
Teaming up with one or all of these agencies when you are just getting started in business is one of the best choices you can make. Representatives from the group may even be able to offer assistance in securing a commercial loan.
4 Key Evaluation Factors Lenders Use
Approval for a commercial loan is never an easy process. After all, a lender wants you to give money to them, not the other way around. The reason lenders do loan money is because they have a lot of earning potential off a loan. If a person pays back a loan as agreed then the lender stands to make a pretty payoff in costs and interest. However, lenders are reluctant to loan because if a person does not pay off the loan as agreed there is a lot for them to lose.
Most lenders are going to consider four key factors when they are determining if a business qualifies for a loan or not.
- Business experience
- Ability to repay
It is a simple fact that a person going into business without any experience in the business will likely fail. Business is not easy and having experience greatly increases you chances of success.
The lender wants someone whose business will be successful so they are able to repay the loan. Looking at a person’s business experience may include looking at how well the business has been doing, if it is an established business or looking at the education and past employment history of the individual.
Being a member of the organizations mentioned earlier can be a real plus when it comes to this factor because these organizations all have a main goal of educating a business owner. Plus most of the organizations offer mentorship programs where a successful business person assists the new business owner. Lenders will look favorably on this.
ABILITY TO REPAY
The ability to repay is a large factor of consideration. The lender needs to know you can afford the loan. They want to see either business success, meaning profits or personal creditability.
The bottom line for every lender is that they want to ensure they are going to get paid. If you or your business can not prove to be stable and secure in income then you will likely be turned down for the loan.
As with any loan, having collateral always increases the chances of approval. It lowers the risk to the lender and shows you are serious about not defaulting. As the lender sees it, when a person puts up collateral they are at risk as well, so it puts the lender and the borrower on more even ground.
Collateral is usually going to be something worth an amount close to the loan amount. Many times with a business loan there are no business assets that are going to be enough to use as collateral. In situations like this many business owners will put up their personal assets as collateral.
Collateral is not required for a loan, but someone in a start up business will want to seriously consider having something to put up as collateral because it can increase the chance the lender will approve the loan.
Documentation is one aspect of a commercial loan that is much more involved then with any other type of loan. Documentation is going to include business plans, tax records, accounting paperwork and any other document that tells about the business.
Lenders want complete and accurate documentation so they can see exactly how successful the business is or what potential for success the business has. They need some type of outline or proof that the business is viable and that it will be able to turn a profit.
For the start up business a well researched business will be the proof the lender will look at. For an established business the lender is going to want to see the records of the business and tax returns.
Commercial Loan Options
There are many options in the type of loan you can get. Despite the differences in business, real estate and construction loans, commercial loans still offer a range of options.
In fact, there may be more options in commercial loans then with other types of loans. This is likely due to the fact that a business is completely different then an individual.
A business has operating expenses and other factors to consider that can affect the ability to repay the loan. With that in mind, lenders want to offer as many options as possible so the business can find a loan that suits their situation best.
Some commercial loan options are:
- Credit Lines
- Contract Financing
- Short Term Loans
- Asset Loans
- Term Loans
Credit lines are an alternative to getting an actual commercial loan. Credit lines are basically like credit cards. However, instead of getting a card, the business gets a small amount of money to use due to a short term need. Generally, a credit line is used when there is timing differences in income and expenses.
Contract financing is most often found with construction loans. It is where the lender gives out funds according to a schedule over a period of time. This works best for stages of construction where at the beginning of each stage money is released from the loan.
SHORT TERM LOANS
Short term loans are generally seasonal loans. They can be for any business that has certain needs during a particular season where they need to build inventory or receivables. They are usually for a year or less and require one large pay off instead of monthly payments.
Asset loans are given based upon the equity of a business’s assets. They are generally for a percentage of the equity.
Term loans are the most traditional loan type. When one think of a loan this is what they are thinking of. A term loan involves monthly payments and interest. They are for a longer amount of time then other types of loans and usually offer the most money.
Leasing is a good option for a business that may not need to actually purchase equipment or other asset, but does need it right now. With a lease the process is similar to getting a loan. However, at the end of the lease period the business can either renew the lease, return the leased item or buy it.
Commercial loans are a complex area of the lending industry. Everyone seems to have a lot of risks in commercial dealings, so it is no surprise that the process of getting a commercial loan is not always easy. However, a business that is prepared will be more likely to end up with the loan they need.