Securing adequate funding is essential to get new businesses off the ground. To optimise funding sources, businesses can take advantage of multiple financing options. However, it's essential to understand the terms and conditions to determine whether they are a good fit for your business. This guide explains standard business loan terms to keep in mind for a successful borrowing experience.
In a tech-driven world where clicking the "I agree" button on just about every service's terms of use is the norm, closely reading your business loan agreement may almost seem like a chore. However, a business loan term contains critically important details that are far more likely to impact you and your business directly. Not taking time to understand what you're getting into could very well spell the end of your business or lead to financial ruin.
As a business owner seeking the best financing for your company, you'll need to know common business loan terms. Because loan terms vary by lender—as well as your business’s capacity and needs—it is vital to review and weigh all your options to help you choose the right financing decision.
To help make the loan process a little less daunting, this article breaks down the most common business loan terms often found in small business loan agreements.
WHAT IS A LOAN AGREEMENT?
A loan agreement is an essential part of the borrowing process. This document protects both the lender and the borrower from any fraud-related practices during the loan period. For instance, your lender could make significant changes in your loan amount without a loan term agreement that justifies how much you owe. On the flip side, a loan term protects the lender when a borrower refuses to make a payment. Typical loan terms include the loan amount, the loan’s repayment period, interest rate, penalty fees, and other special conditions that may apply.
Reviewing a loan agreement can take some time, especially for more complex loans, such as business loans. It’s best to sit with an attorney or a financial advisor if you’re having difficulty understanding the more technical aspects of your loan agreement. Likewise, do not hesitate to reach out to your lender and ask questions about your loan.
WHAT'S INCLUDED IN A BUSINESS LOAN AGREEMENT?
Loan agreements vary from one lender to the next. However, some standard terms and conditions feature in most agreements. The following details should be spelt out in the loan term policy, so borrowers understand their legal obligations thoroughly.
Loan Repayment Period
This section stipulates how much time you’ll have to repay the loan. Loan repayment periods range up to 30 years—depending on the size and type of loan, the lender’s terms and conditions, and local regulations. Repayment is often in an amortisation schedule, which allows you to pay the debt off over time. Typically, this schedule specifies how much of each payment goes to the principal loan, interest, additional fees (if any), and so on.
At Kriya, we offer a variety of flexible repayment periods to help borrowers choose an option that best suits their businesses’ needs.
Interest Rate and Other Fees
Beyond the loan repayment period, the interest rate and additional fees are crucial elements to focus on when comparing business loan options. The annual percentage rate (APR) is the annualised interest charged for borrowing, usually expressed as a percentage.
In addition, lenders can charge other miscellaneous fees, including application fees, annual fees and late payment penalties. Some lenders also require an origination fee, which is typically used to pay for the entire cost of processing the loan. In some cases, a prepayment fee is charged to your account if you decide to pay off your debt sooner than expected.
Time to Funding
Time to funding refers to the amount of time it will take borrowers to receive the money. There is no standard time to funding, so it largely depends on the lender's program and processes. The turnaround time can range anywhere from 36 hours to a couple of weeks, if not months.
Eligibility
Another important detail to watch out for is anything that mentions the lender’s additional requirements, such as credit score, collateral and age of business. These factors will determine whether your business qualifies for a specific loan.
COMMON BUSINESS LOAN TERMINOLOGY
To get a thorough understanding of your loan agreement, you need to come armed with a strong knowledge of common business loan terminology. The industry uses jargon which can be confusing for business owners new to the loan process. Below are some of the most common terms and what they mean.
Accounts Payable/Accounts Receivable
Accounts receivable and accounts payable are simply two sides of the same coin. On one side, accounts payable is the money a business owes its vendors or lenders. On the other side, Accounts receivable is the money that is owed to a business, typically by customers, for example, outstanding invoices.
Amortisation
Amortisation is the process of allocating payments within the repayment period. It involves estimating how much money will go to the interest and the principal loan. Typically, early payments are applied to the interest while the balance is applied to the principal loan.
Borrower Default
A loan default occurs when a borrower fails to repay the loan as promised. Some lenders may offer a grace period for late payments. However, if the debt remains unpaid, the lender may make use of debt collection services.
Collateral
Collateral can include business properties like vehicles, real estate, equipment and other investments. Businesses can pledge these assets to a lender as security for the loan. Should you default on the loan, the lender may seize the assets to recover the outstanding debt.
Cosigner
A cosigner is a third party, such as a business partner or an immediate family member, that pledges to repay the loan should you fail to do so. Typically, business owners with a low credit score or no credit report need a cosigner to qualify for a loan. Cosigners are liable for repaying the debt should the borrower miss a payment or default on the loan.
Credit Score
A business credit score is a measure of the company's creditworthiness. Lenders use credit scores as part of their risk assessment. Credit scores are calculated based on a few factors: payment history, your current debt amount and credit history. The higher your credit score is, the more likely you are to qualify for financing.
Grace Period
A grace period extends the payment due date, which gives borrowers enough time to make ends meet. During this period, lenders may not impose interest on late fees and other penalty charges. Likewise, the delay in the payment won't result in default or loan cancellation within a grace period.
Loan Limit
A business loan limit functions in the same way as a credit card limit. Put simply; it is the maximum amount of debt you can take out. Lenders typically set a loan limit based on the borrower's income and creditworthiness.
Secured and Unsecured Loan
A secured business loan has collateral attached to it. Like we’ve discussed, lenders can seize the collateral in the event of a borrower default. Conversely, unsecured business loans do not require collateral. This means that lenders take on more risk by approving unsecured loans.
TYPES OF BUSINESS LOANS
Now that you’re familiar with the basic components of a business loan agreement and the key terms that come with it, it’s time to choose the best type of loan for your business. Here’s a breakdown of common business loan repayment terms to help you compare your options.
Term Loans
A term loan is a traditional type of financing that provides a single lump sum of business funds, which must be returned over an agreed-upon repayment period. This can be short-, medium- or long-term. Short-term business loans typically range between 3 to 24 months. Medium-term business loans can have a repayment period of up to 5 years, while long-term often extends to 10 years and beyond.
Term loans generally start at £1,000 and can exceed £50,000, depending on your lender's program, business's needs and other qualifying factors. The interest rate is typically charged after evaluating the loan amount, the risk level and the loan period.
Microloans
A microloan is a small fund usually lent at lower interest rates to new businesses. This financing option is popular among startups seeking financial assistance to cover their initial working capital and future investment goals. In fact, one statistic shows that thousands of microloans were given out for small business use in the UK alone between 2012 and 2017. The average repayment term for microloans is three years. In some cases, small-value loans can be paid off in less than 12 months.
Flex Loans
A flex loan offers an unsecured line of credit to give businesses easy and flexible access to funds. Like personal loans such as credit cards, flex loans allow you to borrow money, pay back some or all of your balance with no hidden charges and then borrow again up to your available credit limit.
Equipment Financing
Equipment financing is a type of loan specific to purchasing or leasing necessary business equipment. Business equipment is any tangible asset used in daily operations, such as industrial machines, office furniture, computer equipment and even company vehicles.
When it comes to equipment financing, the purchased equipment serves as your collateral for the loan. This means that the lender can take possession of the equipment should you default on making timely payments. Borrowers can take out a loan amount of up to 100% of the equipment’s value. The repayment period for equipment financing doesn’t exceed the average lifespan of the equipment, which could be a few months or years. Although interest rates vary widely, the standard rates can range from 3% to 30%.
Inventory Financing
Inventory financing is another asset-based loan that businesses can use to purchase more inventory and maintain good cash flow despite seasonal fluctuations in sales. This works similarly to equipment financing because the inventory itself acts as collateral for the loan. Businesses can either make fixed monthly payments or pay off the loan in full once the inventory is sold. Since products tend to depreciate over time, loan amounts for inventory financing are often equivalent to a tiny share—particularly between 20% to 65%—of the total purchased inventory. Depending on the lender type, interest rates may be as high as 80%.
Invoice Financing
Invoice financing provides businesses with an advance of funds to maintain cash flow until customers can pay their accounts receivables. With this funding option, unpaid invoices are considered as collateral to obtain cash assistance from a lender. This option may be helpful for B2B and other invoice-based businesses with irregular billing cycles.
Invoice financing usually has a short-term repayment period, which ultimately relies on how long it takes customers to pay the invoice. Borrowers can take out a loan as much as the amount of the outstanding invoices. Should you apply for Kriya invoice financing, you’ll be eligible for a discounted interest to be charged only on your used funds.
THE BOTTOM LINE
Those are the most popular loan terms to consider for your business. When deciding which financing option best suits you, it’s helpful to assess your critical needs, the repayment term that works for your business and the amount of debt, including interest and fees, that you can safely get. Reviewing business loan terms is just one of the many things to do when finding the right loan to facilitate your company’s needs and future growth.
Whether you need quick and flexible cash assistance or a long-term financial solution, Kriya is ready to help you obtain the best financing for your business.
FREQUENTLY ASKED QUESTIONS (FAQS)
What are business loan terms?
Loan terms are the vital loan details that form the basis of your agreement with the lender. These include the loan repayment period, interest rate and fees and other conditions set by the lender.
Can borrowers negotiate a business loan agreement?
Negotiating business loan terms with the lender may be possible, provided that you have a strong credit history and excellent cash flow. According to the Consumer Financial Protection Bureau, borrowers may negotiate repayment periods, monthly instalments, and more.
How can you qualify for a business loan?
To secure a Kriya business loan, you need to meet a few criteria. Your business must be a limited company or LLP registered in the UK and must have at least 12 months of operational experience. In addition, at least half of your company directors must have permanent residence in the UK. Finally, we require a statement demonstrating that your business and its founding team are not subject to any insolvency or bankruptcy procedures.
How can you get funding for a new business?
Besides seeking out personal loans from your family and friends, government-backed loans and grants are two of the best ways to secure funding for your new venture.
What should borrowers look for in a business loan?
When comparing different business loan options, always look for competitive and fair pricing of interest charges. Your loan term agreement should indicate how much you owe the lender. It's also worth choosing services that offer a quick and easy application process and hassle-free payment options.
