All but the smallest of businesses may use both debt and equity financing in financing their business. Bank loans through commercial banks are the most common way of obtaining debt financing. Businesses have needs for short-term loans, intermediate-term loans, and long-term loans. This article will focus on both long-term business loans and intermediate-term business loans and why small businesses need and use long-term business loans in their businesses. Term loans have different maturities, but different purposes as well.
Long-Term Business Loans
Bank term loans usually carry fixed maturities and interest rates as well as a monthly or quarterly repayment schedule. The long-term loan usually has a maturity of 3-10 years although long-term bank loans can stretch out as far as 20 years depending on its purpose.
Long-term bank loans are always supported by a company's collateral, usually in the form of the company's assets. The loan contracts usually contain restrictive covenants detailing what the company can and cannot do financially during the term of the loan.
For example, the bank may specify that the company cannot take on more debt during the life of the long-term loan. Long-term loans are usually repaid by the company's cash flow over the life of the loan or by a certain percentage of profits that are set aside for this purpose.
The Purpose of Long-Term Loans
Businesses should generally follow the rule of tying the length of their financing to the life of the asset they are financing. So, if a business needs to make a major capital improvement, such as purchasing a piece of equipment for their manufacturing process that will last 10 years, a long-term business loan would be the appropriate type of financing. A short-term business loan would not be appropriate in this case. If a business needs to buy capital equipment, buildings, other businesses, or undertake construction projects, a long-term loan is the way to go.
Obtaining a Long-Term Business Loan
Long-term business loans are difficult for start-up businesses to obtain. Usually, only established businesses with some years of financial success are approved for long-term bank loans. The business has to produce their business plan and several years of historical financial statements in order to secure a long-term loan.
In addition, it has to prepare forecasted financial statements to prove it can repay the loan. Before a small business seeks a long-term loan, they should always compare the cost of the loan with the cost of leasing the asset they are looking to finance. The interest rates on a long-term loan are usually a few points lower than the interest rates on a short-term loan in a normal economy.
If you are aware of the prime rate of interest, you can add a few points to that and come up with something close to the interest rate the bank will charge on your loan. Those few points will reflect how risky they feel your company is. The riskier your company, the more points they will add to the prime rate of interest. In assessing the risk of your company, banks will look at the 5C's of the creditworthiness of your company.
Obtaining a Long-Term Loan
The ease of acquisition of a long-term loan depends on many factors including the bank you have chosen to do business with, the financial strength of your company, and the health of the economy. During the Great Recession, credit has been very tight and loans have not been easy to come by.
How Much You Can Obtain Through a Long-Term Loan
Long-term loans usually start at $25,000 and go up toward $200,000. The more money you need, the more rigorous the approval process becomes.
How an Intermediate Term Loan Differs From a Long-Term Loan
Intermediate-term loans usually have a term to maturity of 1-3 years. They are used to fund assets that aren't long-term in nature such as computer systems that may have an economic life of only around 3 years. Payments are made to the bank monthly or quarterly. The approval process for an intermediate term loan is almost as rigorous as it is for a long-term loan.