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Bank Loan Buffet: Financing Options for SMB Expansion
Published on Oct 22, 2012
Read our article, 'Bank Loan Buffet: Financing Options for SMB Expansion' at 'Time to Start Up,' the small business blog by BizFilings.
No matter the industry, many startups face the same costs: facilities, equipment, inventory, professional fees, insurance. But when it comes to expanding, enterprises often face very specific situations that require tailored financing.
For one company, expansion might mean moving into (or constructing) a new office. For another company, it might mean increasing inventory, and another company might expand by broadening its client base regionally, nationally or overseas. No matter how your business is growing, there’s probably a type of bank loan - maybe one of the five listed below - that is a good fit.
1. Term loan: This is the most conventional type of business loan. The term refers to the length of the loan, and these products can be subdivided into short-term, intermediate and long-term loans.
A short-term loan usually has a repayment period of six months or a year, with payments made on a monthly basis. Some lenders offer alternative payment options, such as small daily payments. Although short-term loans might not provide the sustained funding needed for significant expansion, they can be a good option if there’s an opportunity with a limited time frame. Successful repayment of a short-term loan can help a business qualify for a longer term loan. An intermediate loan lasts one to three years, and a long-term loan can have a repayment schedule lasting 20 years or longer. In general, term loans can be used to fund any type of business expense and have a fixed interest rate.
2. Balloon loan: These loans feature an initial repayment period when only interest, or interest and a small percentage of the principal, is due. After this period, the loan “balloons” to the whole principal amount. The risk involved is obvious: It can be hard to predict what your business finances will look like in the future, and a ballooning loan can place enormous strain on your company. But in certain situations, balloon loans can fit the bill to fund an expansion - for example, if you know without a doubt that on a certain date you will begin receiving payment from a new client or customer.
3. Interim loan: As their name implies, interim loans are short-term products, usually with terms of six months to five years. They are most often used to finance the purchase or construction of new facilities. For example, this financing can cover the “interim” during which expenses are high as a new office is being built and the company must still operate out of its current location. Or you might find a great deal on real estate and want to purchase it right away, even though your current property has not yet sold – an interim loan can be used for this purchase. In cases like these, the interim loan would eventually be paid off by a mortgage on the new property. Interim loans generally have a variable interest rate but are occasionally fixed-rate loans, and can have extendable credit provisions, giving businesses breathing room in the event construction costs exceed estimates.
4. Line-of-credit loan: This type of loan is similar to credit card financing, in that a bank sets a credit limit and the borrower can utilize as much or as little of the available money as needed on a rolling basis, with payments generally due each month. In some cases, a bank will require interest-only payments for a set period of time, although a typical advantage of this type of loan is that you can pay the total balance at any time without penalty. Another advantage is that collateral is not needed in most cases to obtain a business line of credit, and companies can enjoy the flexibility of being able to draw on funds as necessary. But it’s important to understand the term rules, fee structure and interest rate of a line-of-credit product. For example, a line-of-credit loan might be offered with a 10-year term; however, the bank may reserve the right to cancel the loan and require full payment of outstanding balances on an annual basis. There can also be fees associated with drawing on the credit line, and interest on money drawn is often variable, set in relation to the prime rate. Lines of credit are often used to expand a business by bumping up available working capital, which can be used to increase expenditures in areas such as marketing or sales.
5. Equipment loan or lease: This is a popular type of financing for early-stage businesses, but can be utilized by more mature companies, as well. An equipment loan is similar to a term loan, with the loan financing as much as 100 percent of the purchase price of equipment, which then gets paid back, often at a fixed interest rate, over a specified term. The equipment itself - ranging from industrial equipment to vehicles to computer technology - can serve as the collateral securing the loan.
Leasing is another option, and there are a variety of equipment lease options to consider. In many cases, the best type of equipment financing will depend on how much the equipment will depreciate and how long it will last. An operating lease, which may have a term that is shorter than the expected useful life of the equipment, can be a way for a company to utilize equipment for a set period of time before it is given back to the lessor. If an expansion project requires a type of equipment that will not be useful to the business after the project is complete, this type of financing can be ideal. In a finance lease, the term is usually related to the expected useful life of the equipment, and the business takes ownership of the asset once the loan is paid off.
These are only a few of the major types of loans that banks offer to fund SMB expansion, and each lender is likely to have customizable loan options to fit your business profile and needs. Having so many choices when it comes to loan products can be overwhelming, so it’s wise to formulate a big-picture expansion plan that you can share with bankers and other consultants, who can advise you on which types of debt financing make the most sense, given your current situation and ultimate goals.