Understanding Commercial Financing: Finding the Right Loan Option for your Business

Commercial Lending Options for Business Growth

Securing timely business financing helps reduce operational risks. As per Digits, 38% of startups fail because of poor financial management, and commercial financing may help you avoid the same fate. Here are some common commercial financing options to check out:

1. Small Business Administration (SBA) Loans

The U.S. Small Business Administration offers partially guaranteed loans with the help of certified lenders. These lenders can be searched on its official website, or you may reach out to local banks with PLP (Preferred Lenders Program) status. These lenders are designated by SBA to process loans faster and may have the autonomy to make decisions without SBA review. While these lenders process the funds, SBA only provides funds.

A major benefit of Small Business Administration loans may be the lower interest rates. However, you may be required to provide some personal guarantees to secure commercial financing with SBA. Popular SBA loan programs are:

• SBA 7(a) loans: For managing operational expenses, purchasing commercial real estate, inventory, or refinancing eligible debt. The maximum loan amount under these loans is $5 million.

• SBA 504 loans: For purchasing equipment, commercial real estate, and other fixed assets. The maximum loan amount under these loans is $5.5 million.

• SBA microloans: For shorter working capital requirements up to $50,000.

2. Community Development Financial Institution Loans (CDFI)

CDFIs provide commercial financing to support business ventures of underserved communities. From commercial lines of credit to long-term commercial loans, these provide several loan options with convenient repayment schedules. For smaller loan requirements, you may be able to find unsecured business loans at your local CDFIs as well. Usually, these funds are sourced from a community development fund pool. A few examples of such community lending funds are Connecticut Economic Development Fund and NYS CDFI Revolving Loan Fund.

3. Term Loans

Traditional terms loans are still relevant for small businesses. Several commercial lenders offer these loans at both fixed rate and variable rate. Small business owners may get the option to negotiate loan amount, loan tenure, interest rate, downpayment, and more. However, usually lenders prefer owners with high credit score for these loans.

4. Commercial Real Estate Loans

Think of these as commercial mortgages to purchase business property like a store, office space, warehouse, distribution center, and more. These are secured commercial financing where the financed property itself secures the loan and helps owners secure lower interest rates. Usually, these have longer repayment tenures, lasting up to a few decades. Still, business owners may get the option to foreclose the loan by paying a small fee.

5. Equipment Financing

These are asset-based loans where the financed equipment serves as a collateral. Business owners may rely on this type of commercial financing to purchase heavy equipment, industrial machinery and tools, computer hardware, point of sale systems, shelves, racks, cash counters, kiosks, audio-video equipment, furniture and more. In case of default, the lenders may seize the equipment, but all other business assets remain protected in equipment loans.

6. Business Line of Credit

These are based on the principal of revolving line of credit, where you may withdraw as many funds as required and only need to pay interest on that amount. The outstanding balance even moves on to the next month just like a credit card. Business owners may use these loans to manage working capital like payroll, inventory, marketing, and more.

How to Use Commercial Financing?

Owners may use commercial financing in numerous ways. Some of which include:

• Setting up a new store or commercial space
• Renovating existing store
• Purchasing raw materials and inventory in bulk
• Purchasing essential business equipment like cash counters, racks, shelves, furniture, computer hardware, commercial kitchen equipment, and more.
• Hiring and training workforce
• Investing in cutting edge technology, including both software and hardware
• Managing payroll costs and other employee benefits
• Managing marketing costs for paid ad campaigns, influencer marketing, and preparing other marketing collateral
• Acquiring business permits and other licenses
• Refinancing existing debt under a single loan
• Acquiring other businesses
• For market research & development or starting a new product line.

Eligibility Criteria to Secure Commercial Financing

Lending requirements vary for each lender. The following information serves only as a baseline reference for your preparation.

1. Credit score: Traditional institutions may often require a minimum FICO score of 670. Alternative lenders might accept lower scores if your revenue shows strong consistent revenue.

2. Business vintage: Lenders typically look for at least two years of active operations. Startups may find options through specialized programs if they present strong projections.

3. Annual revenue: Your business might need to meet minimum annual sales requirement. Higher revenue opens access to competitive rates and flexible repayment terms.

4. Cash flow: Underwriters evaluate your bank statements to confirm your business generates sufficient monthly surplus. Strong cash flow ensures you handle regular debt payments easily.

5. Collateral value: Securing large amounts often requires tangible assets like property or equipment. Lenders assess these assets to reduce their risk during commercial real estate lending.

Documents Required to Secure Commercial Financing and Loans

Your lender may require the following documents to evaluate your application.

• Business tax returns
• Personal tax returns
• Profit and loss statements
• Balance sheets
• Business bank statements
• Personal credit history
• Detailed business plan
• Commercial property appraisal
• Business licenses

Important Things to Keep in Mind When Opting for Commercial Financing

1. Secured vs Unsecured Loans

Commercial financing includes both secured loans and unsecured loans. While the former requires you to keep a fixed asset like business equity, commercial real estate, equipment as collateral, the latter doesn’t require anything. A potential upside to secured loans is lower risk and interest rate, whereas unsecured loans may provide some business owners with more peace of mind as no collateral is involved.

2. Fixed Rate vs Variable Rates

Usually lenders offer fixed rate, but some lenders may offer you variable rates as well. While fixed rates ensure predictable monthly payments, variable rates bring some uncertainty. Variable rates fluctuate as per the market rate, and it only makes sense to opt for them if your financial advisors expect to see a drop in the market rates during your loan tenure.

3. Soft Credit Pull and Hard Credit Pull

Many times, business owners do the mistake of applying for commercial financing at multiple lenders at once. This leads to multiple hard credit pulls and may harm your credit score. This is because credit bureaus may perceive multiple hard credit pulls as a sign of desperation. On the other hand, soft credit pull is a basic check on your credit score. Confirm with your lender if they’d conduct soft pull or hard pull, or else, opt for pre-qualification first which mostly includes a soft pull.

4. Overall Cost of Borrowing

When applying for commercial financing, you may want to check out the overall cost of borrowing. Apart from the interest rate, there are many other things involved in the costs, such as the origination fee, underwriting fee, legal fee, and more. Annual Percentage Rate (APR) is truly indicative of these costs. While your interest rate might be low, APR can be high. So always check the APR of a financial product.

5. Fines and Penalties

Lenders often charge foreclosure penalties, prepayment penalties, and balloon payments on their commercial loans. Read the loan agreement carefully before signing to avoid or prepare for any such costs.

Conclusion

Commercial financing is available to support business growth, but owners must ensure that they invest the funds carefully to get maximum returns and commercial success. Securing the funds alone may not be enough, owners still need to put in their hard work and efforts. For this purpose, certain institutions like SBA also provide mentorship, guidance, and support network. They also provide additional resources and support for veteran-owned and women-owned businesses. In case you are not able to secure funding from traditional options, you may opt for alternate lenders.