– It’s always good news when a company does well enough to expand. For small
business owners who often put in long hours and risk their personal fortunes to
build their enterprise, the key question is how best to finance the expansion.
Often, a term loan – the traditional commercial loan offered by many financial
institutions – is the answer.
you file a loan application, you should carefully review your operating needs.
Term loans are appropriate for long-term financing (i.e., anything over a year)
– not for short-term purchases of, for example, extra inventory or growing
receivables. Ideally, you should make those types of purchases using credit
terms supplied by your suppliers, business income, or a line of credit.
there are as many kinds of expansion objectives as there are businesses;
therefore, it’s helpful for business owners to be clear regarding the motivating
business needs for the term loan before applying. Understanding the purpose of
the financing will help an owner choose the right duration for the loan. As an
example, to finance equipment it typically makes sense to match its useful life
with the duration of the loan, typically between three and seven years;
whereas, appropriate loan terms for real estate are generally anywhere from 10
to 20 years.
considerations are also important in determining whether a fixed or variable
interest rate is best. Here’s a snapshot of each option:
fixed rate offers certainty. A fixed rate on a term loan provides consistency
in payment streams. Knowing exactly how much you’ll pay each month can help you
get a handle on what your regular expenses will be.
variable rate fluctuates with interest rate changes. The benefit of a variable
interest rate loan is that they typically offer the more attractive interest
rates at the beginning of the loan, and the rate could go down during the life
of a loan and save you money in the long run. However, a variable rate offers
less certainty, and interest rates could increase.
choosing between a fixed and variable interest rate, you should appreciate and
understand your risk tolerance as well as consider the predictability or the
patterns and cycles, if any, of your company’s cash flow. You should also bear
in mind that fixed-rate term loans are often advisable in a rising-rate
greatly improve your chances of getting the loan terms you desire if you know
what a lender is seeking from loan applicants. Generally, lenders want
assurance that a business owner will be able to pay back the loan. To do this,
they’ll examine a company’s operations to see whether it generates enough income
to service the debt the loan will add to the business’s balance sheet. A track
record of profitability is helpful.
just as lenders carefully screen their applicants, it’s important for a
borrower to discriminate when choosing a lender. While interest rates on term
loans are a key concern, you should also look closely at fees. In some cases,
an initial low interest rate may mask hidden fees that can dramatically raise
the overall cost of your loan.
addition to reviewing rates and fees, many small business owners seek out a
lender with experience in financial planning and investments. Having this kind
of wide-ranging expertise available to you is like having an advisor on your
management team, and could offer a huge advantage for your business operations.
A financial advisor can help you assess your business needs, as well as draw
upon their wealth of contacts to assist you in determining the best lender and
loan for your unique situation.
(The writer is a Merrill Lynch Senior Financial Advisor. She can be
reached at 410-213-9084.)