Common Types of Business Loans

Banks have many different type of loans to choose from. It pays to have a basic understanding of the most common type of loans to help you pick the one that’s best for you.

Line of Credit
 This is one of the most common type of small business loans. Your lender makes available a fixed sum of money that you can use as the need arises over the term of the loan. Most terms run one year.

Rates for LOCs typically run one to three percentage pointer’s above the lender’s prime rate or cost of funds. You typically pay interest only on the outstanding balance. There may be other fees including a commitment fee or a requirement for a compensating balance (money required to be left on deposit with your lender during the term of the loan.

There are different types of LOCs. The non-binding LOC does not guarantee that the full amount of the loan will be available at all times. Changes in the regulatory environment for lenders, a downturn in the economy, a deterioration in the financial condition of your company can all affect the availability of monies.

For those that are willing and able to pay more for their loan, they may be able to obtain a binding or committed line of credit. This guarantees that your money will be available for the full term of the loan. This is also a terrific means for providing security to a note being held by a Seller.

A revolving LOC is similar to a credit card loan. You have a fixed amount available. When you use a part of that amount, your credit line is reduced. When you pay off the principal your line is restored.

Most LOCs are secured with accounts receivable and inventory. Typical loan amounts are 50 too 75 percent of A/R and 50 percent of inventory.


Factoring
Factoring has been come more popular in recent years as a means to raise cash quickly. Factoring involves a lender buying your accounts receivable as they occur. When you receive an order you submit the details to the lender. If the lender approves you are advanced a discounted amount (typically 80%-90%) for the order. The lender then assumes responsibility for collecting the A/R. This type of financing is obviously more expensive than a LOC because the lender assumes all the risks and costs associated with collecting the A/R.


Term Loans
Business Term Loans are set for a specific amount and time period. Most are set for one to seven years. They can be used for a variety of purposes including:

  • Bridging a working capital gap.
  • Expansion.
  • Purchasing Equipment.
  • Paying off other debt (such as a balloon payment).

Typically lenders will require some type of collateral on a term loan. They can be secured with accounts receivable, inventory or a company’s fixed assets such as heavy equipment, manufacturing machinery, trucks.

Borrower Beware- Loan Covenants

Lenders can and will usually include restrictions or covenants to the loan agreement.

Covenants restrict what you can do with your business’ money. A fairly common approach is to tie the availability of funds in your credit line to the maintenance of specified financial ratios. As an example you may asked to maintain at least a 2:l or 3:l ratio on a quarterly basis.

You may also be asked to limit the amount of salary you take. You may also ask that any monies loaned be subordinated to the business, meaning the lender has first claim on the business and its assets in the event of a default. Your loan may also forbid you from borrowing from the business or switching to another bank until the loan is paid off.

If your business relies heavily on one or two key employees you may be required to obtain key man insurance. You may also be restricted from participating in high risk ventures.

Need help securing financing? We can help. Contact John McGovern, CEO, jmcgovern@mediamergers.com, (917) 881-6563.

 

Grimes, McGovern & Associates provides expert advice during all phases of a transaction. Contact us today for a confidential consultation: John McGovern, CEO, jmcgovern@mediamergers.com, (917) 881-6563 or Julie Bergman, VP, Newspaper Division, jbergman@mediamergers.com, (218) 230-8943.

 

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