Businesses require an adequate amount of capital to fund startup expenses or pay for expansions. As such, companies take out business loans to gain the financial assistance they need. According to the U.S. Small Business Administration, before approaching a lender for a loan, it is imperative for the business owners to understand how loans work and what the lender will want to see from the owner.
Function
Some business owners use business loans to pay for salaries and wages until their new company gets off the ground, while other companies put borrowed funds toward office supplies, inventory or business projects. Lenders want to know how the business intends to use the borrowed monies, so business owners must make sure to have a clear outline for how the money will be spent. It is important to impress the lenders by being professional, or they may decline the loan application.
Types
Businesses have a variety of loan options to choose from. Traditional bank loans are the most popular source of funding. Banks are tightening their lending policies due to the economic downfall, making it more challenging for businesses to receive financial assistance from commercial loans. Businesses can apply for home equity lines of credit if one or more of the company owners are homeowners.
Features
Lenders charge interest on loans as the price paid for borrowing the money. It is important to know whether the interest is fixed or variable. A fixed interest rate means that the interest rate remains the same for the duration of the loan and its payback period. A variable interest rate indicates that the interest rate can fluctuate based on a variety of determinants. Other features of a loan to pay attention to are the payback period and what the lender will use as collateral if the business is unable to pay the loan back timely.
Significance
Business loans allow companies to have a chance at success. As such, loans are in high demand, but not every company that applies for a loan will receive one. When applying for a business loan, lenders evaluate the company’s history. The amount of debt the company has and whether the business seems risky. Risky businesses, such as startup companies, are often not the winning recipients of traditional loans.
Considerations
Businesses that take out loans with high interest rates should make plans to pay the loan back as quickly as possible, so the interest owed does not accrue into an exorbitant amount. High-interest loans are best used for short-term financing needs.