Ravi Chandran
Although short term commercial loans are sometimes used to finance the same type of operating costs as a working capital line of credit, they’re not interchangeable.
By: Phoenix Lee/
Short term commercial loans are usually taken out for a specific expenditure (for example, to purchase a specific piece of equipment or pay a particular debt), and a fixed amount of money is borrowed for a set time with interest paid on the lump sum.
In essence, short term commercial loans are close to the loans you’re most familiar with, like student loans, home loans, etc. For nearly all startup businesses – and most existing businesses – short term commercial loans from a bank must be:
- Secured by adequate collateral
- Supported by a reasonable cash flow and a regular sales history
A fixed interest rate may be available because the duration of the loan, and therefore the risk of rising rates, is limited. While some short-term loans have terms as brief as 90-120 days, the loans may extend one to three years for certain purposes.
As far as what qualifies for adequate collateral, accounts receivable or inventory, as well as fixed assets, usually qualify. For startups and relatively new small businesses, most bank loans will be short-term.
Rarely will a conservative lender like a bank extend short term commercial loans to this type of borrower for more than a one- to five-year maturity. Exceptions may exist for loans collateralised by real estate or for third-party (e.g., Government backed SME loans) guaranteed loans.
Aside from revolving forms of credit, a lender can provide a commercial loan which is similar to what you might have experienced getting a mortgage. Commercial loans, available in short-term and long-term forms, are similar to traditional consumer loans. And, if you’re not interested in purchasing a big-ticket item that would require a loan, you can always consider commercial leasing.
Financing Through Longer-Term Commercial Loans
As the name implies, long-term commercial loans are generally repaid over more than one to three years. Because more time for you to repay a loan equals more risk for the bank extending the loan, long-term commercial loans are typically more difficult for smaller businesses to obtain.
With small businesses, a lender may not be willing to assume the risk that the business will be solvent for, say, 10 years. Consequently, banks will require collateral and limit the term of these loans to about five to seven years. Occasionally, exceptions for a longer term may be negotiated, such as loans secured by real estate.
The purposes for longer commercial loans vary greatly, from purchases of major equipment and plant facilities to business expansion or acquisition costs. These loans are usually secured by the asset being acquired. Additionally, financial loan covenants are regularly required.
Work Smart
Some small business advisers discourage the use of debt financing for fixed assets, particularly long-term assets such as equipment, office space or fixtures. They suggest that the cash-flow problems of small businesses require that borrowed money be directed to generating immediate revenue through expenditures relating to inventory and marketing.
Buying a new expensive piece of machinery may take many years to pay for itself. Instead, you should aim to obtain a high rate of short-term return on every cash investment, and do whatever you can to minimize the costs of fixed assets by leasing, buying used equipment, sharing equipment, etc.
Financing Through Equipment Leasing
From a bank’s perspective, the leasing business can take the form of either:
- A loan that the borrower uses to lease equipment from an independent source
- A direct lease from a bank subsidiary company that owns the equipment
The duration of the loan is tied to the lease term. Assets commonly leased by small businesses include equipment, vehicles, real estate or facilities. Most banks require a solid operating history before engaging in leasing agreements with small businesses.
With myriad varieties of loans and financing options available from banks of all sizes, you’ll need to know the which is option is best for you. 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 common loan types given by banks to startup and emerging small businesses.
Much like trying to pick the right loan for a home mortgage, you’ll likely be overwhelmed by the many types of small business loans and financing options your bank makes available. And, much like a mortgage, one loan option usually floats to the surface as the best fit for you and your situation. Discerning which loan is the right choice isn’t necessarily a matter of one type being better than the other.
Regardless of if you are searching for short term commercial loans or longer term ones, 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,
In choosing between short term loans and long-term ones, SMEs should consider the textbook rule of thumb for prudent financing: ‘finance short-term investments with short-term funds and long-term investments with long-term funds’. Simply, this means use cheap short-term borrowing where it is safe to do so (investments that are short-term in nature and hence renewal risk is not a problem) but use long-term finance for long-lived investments.
