It is not enough that you become familiar with the most important aspects of bank loans, it is also important to become familiar with the most prevalent loan types given by banks to startup and emerging small businesses.
By: Phoenix Lee/
Some of the most prevalent loan types given by banks are:
- Working capital lines of credit for the ongoing cash needs of the business
- Credit cards, a form of higher-interest, unsecured revolving credit
- Short-term commercial loans for one to three years
- Longer-term commercial loans generally secured by real estate or other major assets
- Equipment leasing for assets you don’t want to purchase outright
- Letters of credit for businesses engaged in international trade
A line of credit sets a maximum amount of funds available from the bank, to be used when needed, for the ongoing working capital or other cash needs of a business. Consider a line of credit a loan that functions like a revolving credit account. In most cases you’ll receive a cheque book for your line of credit so you can write cheques on the fly without dipping into your own cash. Some may offer debit cards, or you can visit the bank to withdrawal cash. It is, of course, still a form of financing that must be repaid with interest.
Common Terms for Lines of Credit
As you consider a line of credit, you’ll find most fall within these broad categories:
- Lines are typically offered for renewable periods that range from 90 days to several years.
- Extended periods are usually subject to annual reviews by the lender.
- Maximum amounts vary greatly, from $10,000 to several million dollars.
- Interest rates usually float, and you pay interest only on the outstanding balance.
Most small business owners typically use prevalent loan types like lines for daily operations, such as inventory purchases, and to cover periodic or cyclical business fluctuations. Collateral for the loan is often accounts receivable or inventory.
From a lender’s perspective, the adequacy of your cash flow is the most critical consideration. A commitment fee may be assessed by the bank for making a line of credit available to the borrower, even if the full amount is never used. Established businesses with sound credit histories have the best bet of obtaining unsecured revolving lines of credit.
Just be warned that a commercial line of credit can, for better or worse, become an “evergreen” never-ending debt to a small business.
A Cautionary Tale: The “Evergreen Credit” Trap
Frequently, a small business will open a working line of credit of, for example, $40,000. Because of the immediate cash needs of the business, the credit line is quickly topped out. To make matters worse, the borrower’s continuing cash shortage forces it to pay only interest on the loan, and the principal is not reduced.
Commonly, lenders review working capital lines of credit annually, either renewing them or calling them due. While lenders typically want the line of credit to carry a zero balance at some time during the annual period, the competitive banking environment may lead a bank to continually renew a maximized line of credit as long as the institution is receiving timely interest on the loan.
This behavior leads to evergreen lines of credit becoming, in effect, indefinite term loans with a balloon payment of principal that poses risks to both the lender and the borrower.
Prevalent loan types like lines of credit are a wonderful way to help entrepreneurs build their business. But like any form of revolving credit, they must be used wisely.
Financing Through Credit Cards
Although credit cards are not a financing device exclusive to commercial banks, they are often a part of a bank’s lending portfolio. A revolving credit charge card can used by a business as an alternative to a working line of credit.
The competitive banking environment has forced many institutions to seek new sources of income and develop new financial products that meet changing demands. One of the less publicized developments has been the growth of the small business credit card.
The Basics of Small Business Credit Cards
The largest card issuers—VISA International, American Express and MasterCard International—have adopted small business card programs. As a source for working capital, revolving credit cards offer a quick source for limited funds. However, their convenience is costly. Cards typically offer an interest rate slightly less than the rate on individual consumer cards and have lending limits that average just over $15,000.
To make the cards more attractive to prospective users, the lenders generally package credit along with additional features such as:
- Discounts for rental cars, hotels and gas
- Travel insurance
- Warranty extensions on purchases
- Variety of different types of insurance
You should be prepared to present both a personal and business credit history when applying for the cards. And, much like lines of credit, be leery of over-reliance on this form of credit.
If you are searching for the most prevalent loan types, it makes good sense for you to speak with a loan consultant. The loan consultant has close links with most lenders in the market and can connect you in the best loan which serves your most pressing needs.
Always remember that you need to borrow when you don’t need the money and are in the black. This is because when you are in the red and are struggling, no one would lend you any money,