Commercial loans are simply debt funding which is used for a variety of business purposes. This includes the development of real estate, to purchase equipment for business operations or to add to available working capital. These types of loans are available from both banking institutions and specialist lenders that focus on providing financing for businesses while eschewing retail banking entirely.
Lending for business purposes takes on a number of forms. This is partly due to the size of the loans which far exceed that of personal loans for individuals to purchase a car or renovate a kitchen. As such, commercial loans run the gamut in type and size with terms varying for larger deals to suit both the lender and the borrower.
In this article, we run through five of the best types of commercial loans available to clear up the main differences between them.
- Commercial Real Estate Loans
A commercial real estate loan varies in size depending on the project. Loan values can easily reach in the tens of millions, but equally can be just a few hundred thousand too. The loan term is typically lengthy due to the security that the asset represents. Therefore, in the case of shopping center loans, these might be over 20 years and come with an interest rate that’s reasonable at 5-7%. However, for higher risk projects, the rate charged could easily reach double-digits for inexperienced shopping mall developers or operators who represent a more significant risk to the lending capital.
While a loan for a shopping center is often to purchase it, it might also be to fund upgrades and improvements to an older center that’s seen better days. In order to compete with newer, nearby shopping centers, upgrades might be warranted to offer similar facilities and to give the development a much-needed facelift.
The underlying real estate provides ample assurance on the lending amounts in most cases. As long as the center is rented out with low vacancies, rentals from retail tenants are unlikely to decline (often rental contracts stipulate a CPI-hugging price uplift annually). Because of this and the value of the collateral being the center itself, commonly lending substantial sums is warranted and isn’t considered as higher of a risk as other types of commercial loans.
- Merchant Cash Advances
Merchant cash advances are a form of lending for companies that have considerable credit card sales each day but find their available cash balances to be limited. This is often a situation with fast growing businesses where net 30 or net 60-day terms on invoices while provisioning the service or goods upfront create a cash shortage in the business checking account.
This type of funding is instead of another type of loan like a line of credit or a business loan. They’re reasonably expensive at the low end at around 15% rising to over 100% in some cases. Therefore, a business has to consider the true cost of this funding before proceeding.
The advance is made upfront to the business and is then collected back via credit card sales. Because the sales are generated from real customers, the lender knows that the majority of these sales will get paid eventually. They lend on the basis that the payments will arrive and it is due to this anticipated stream of credit card payments (that get validated at the point of sale) that a cash advance is made.
This is a little different to invoice factoring where companies are advanced monies and then repay them when invoices are paid. With a merchant cash advance, it relates to credit card sales.
- Business Line of Credit
A business line of credit is a flexible lending option for established businesses. The idea is that the company can seek funds as needed on a revolving credit line. They get approval for a maximum lending amount and then draw down on that line of credit as needed.
The loan rate runs from 7% up to 20% or even higher for lines of credit. The rate is higher because the credit is flexible and not attached to collateral of the business, such as a piece of real estate. The credit term can be anything from a few months to several years.
In some ways, a credit line is like an open credit card facility, so it must be managed with care. It’s suitable for companies that perhaps have a seasonal trade where cashflow doesn’t keep up with busy periods or growth happens at the same time. In which case, drawing down on a credit line gets the company out of a cash crunch. The line of credit might then be repaid after the busy period when much less cash is required to keep up with business expenses such as extra seasonal staff, renting extra delivery vans, and so forth.
A business line of credit is hard to get accepted for when applying. A straight business loan is easier. A personal credit score over 700 is usually preferred and often necessary with credit lines.
- Equipment Loans
An equipment loan can be up to the value of the equipment cost. It’s typically repaid over a one to 5-year term. The internet rate varies from 7% up through to 30 percent.
When starting a business or expanding one, the need for equipment is often necessary to operate. Without it, it simply cannot get going. However, business equipment can cost hundreds of thousands or millions of dollars to purchase which represents a financial hurdle to overcome.
Rather than borrowing on a business loan to purchase equipment, a more specialized equipment loan is often easier to obtain. This is because the lender that’s used to providing this type of funding is familiar with different equipment costs and the rate of depreciation on each item. As a result, they have greater clarity about the risk they’re accepting because they understand it better.
- Other Loans
There are also traditional business loans over a set lending period, short-term loans covering specific cashflow difficulties and SBA loans that relate to real estate.
Each of these loans have their place in the business landscape. Depending on the loan, the lending limit is usually up to 12% of the annual revenue but could be lower. They’re often more straightforward than other types too. Sometimes a borrower will seek a merchant cash advance if their business cannot qualify for a business loan or a short-term loan. Other times, a business equipment loan is more relevant than a commercial business loan.
Business loans are usually based on annual revenue and earnings. As such, many small businesses won’t qualify for a standard business loan whereas they would qualify for something more specific.
A business needs to consider carefully what options they have for lending. Not every loan or credit facility is suitable for every circumstance. They each have their pros and cons. It’s important to weigh these up carefully to determine what lending facility to apply for.
