What Is Lending and Types of Lenders?
Lending (also known as "financing") in its most general sense is the temporary giving of money or property to another person with the expectation that it will be repaid. In a business and financial context, lending includes many different types of commercial loans.
Lending and borrowing are the same transactions from the two viewpoints.
What Is a Lender?
Lenders are businesses or financial institutions that lend money, with the expectation that it will be paid back. Banks, credit unions, and savings and loans are all potential lenders for a small business.
The lender is paid interest on the loan as a cost of the loan. The higher the risk of not being paid back, the higher the interest rate.
Lending to a business (particularly to a new startup business) is risky, which is why lenders charge higher interest rates and often they don't give small business loans.
Lenders do not participate in your business in the same way as shareholders in a corporation or owners/partners in other business forms. In other words, a lender has no ownership in your business.
Lenders have a different kind of risk from business owners/shareholders. Lenders come before owners in terms of payments if the business can't pay its bills or goes bankrupt. That means that you must pay lenders back before you and other owners receive any money in a bankruptcy.
What Are the Types of Commercial Loans?
The type of lender you will need for a business loan depends on several factors:
- Amount of loan: The amount of money you want to borrow influences the type of lender. For larger loans, you may need a combination of types of commercial loans.
- Assets pledged: If you have business assets you can pledge as collateral for the loan, you can get better terms than if your loan is unsecured.
- Type of assets: A mortgage is typically for land and building, while an equipment loan is for financing capital expenditures like equipment.
- Startup or expansion: A startup loan is typically much more difficult to get than a loan for expansion of an existing business. For a startup, you may have to look at some of the more untraditional types of lenders described below.
- Term of the loan: How long do you need the money? If you need a short-term loan for a business startup, you will be looking for a different lender than for a long-term loan for land and building.
What are Different Types of Lenders?
The most common lenders are banks, credit unions, and other financial institutions.
More recently, the term "lender" has been expended to refer to less traditional sources of funds for small business loans, including:
- Peer-to-peer lenders: Borrowing from individuals, through online organizations like Lenders Club.
- Crowdfunding: Through organizations like Kickstarter, and others. The good thing about these lenders is that they don't require interest payments!
- Borrowing from family and friends: There are organizations that help sort out the tricky financial and personal issues involved with these transactions. If you are considering a loan from someone you know, be sure to create a loan agreement. These agreements are sometimes called private party loans.
- Borrowing from yourself: You can also loan money to your business as an alternative to investing in it, but make sure you have a written contract that specifically spells out your role as a lender, with regular payments and consequences if the business defaults.
Consumer Protection and Business Lenders
Be aware that lenders distinguish between business loans and personal loans, and that some legal protections in place for personal loans are absent for business loans.
The federal government has federal fair lending laws (the Equal Credit Opportunity Act and the Fair Housing Act) in place to prohibit discrimination and protect borrowers. But these laws don't apply to business and commercial loans. For example, the Equal Credit Opportunity Act prohibits discrimination by lenders on race, color, religion, national origin, sex, marital status or age. It isn't generally limited to individuals but it does distinguish between business and consumer credit, based on the borrower's stated purpose. The regulations behind this law are more relaxed, particularly for larger businesses.
SBA Loans and Lenders
You might also consider the Small Business Administration, which works with lenders to provide guarantees for loans to small businesses. Their 7(a) loan program helps small businesses get loans who might not otherwise qualify because of "weaknesses" in their applications.
The SBA doesn't act as a lender; a lender makes the loan and the SBA will guarantee the loan by agreeing to repay up to 85% of the loss in case of default. The SBA's 7(a) Small Loan, for example, allows you to borrow up to $350,000 with up to 85% of up to $150,000 guaranteed by the SBA.
Looking for a Lender?
As you look for a lender, consider the type of loan you need, whether you have any assets to pledge against the loan, and the other factors that will determine your ability to get a business loan and the terms of that loan. Be prepared by creating a personal financial statement, a business plan, and financial statements for your business.
Before you go to a lender for a small business loan, check out this SCORE article on how to write a bank loan request letter.
Small Business Administration. "Become an SBA Lender." 7(a) Loan Program. Accessed Jan. 21, 2020.
Federal Reserve Board. "Federal Fair Lending Regulations and Statutes." Accessed Jan. 21, 2020.
National Association of Federally-Insured Credit Unions. "The Regulations on Business Loans." Accessed Jan. 21, 2020.
Small Business Administration. "Loan Fact Sheet." Accessed Jan. 21, 2020.
Small Business Administration. "Types of 7(a) Loans." 7(a) Small Loan. Accessed Jan. 21, 2020.