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Term Loans: A Guide for Small Businesses

Term Loans: A Guide for Small Businesses

Getting financing can be challenging for small businesses, especially in the early stages when there is little operating history to demonstrate creditworthiness. Term loans allow small businesses to borrow money that must be repaid over a set period of time, usually with interest. They can provide an influx of capital to fund growth, equipment purchases, or other business needs.

What is a Term Loan?

A term loan is a business loan that gets repaid in regular payments over a set period of time, or term. Term loans usually range from 1-5 years for repayment. The loan amount, interest rate, fees, and repayment schedule are set at the beginning of the term.

Term loans can be secured or unsecured. Secured term loans require collateral like real estate, equipment, or investments to get approved. Unsecured loans are based more on the borrower’s creditworthiness. Secured loans typically have lower interest rates because the lender has recourse if the loan isn’t repaid.

Common Uses for Term Loans

There are many reasons a small business might need a term loan, such as:

  • Buying equipment like vehicles, machinery, or computers
  • Funding a business expansion or renovation
  • Refinancing higher-interest debt
  • Covering operating expenses during a slow sales period
  • Launching marketing campaigns to attract new customers

The flexibility of term loans allows the funds to be used for virtually any business purpose. The key is making sure the investment will lead to increased profitability so you can repay the loan.

Types of Term Loans

Several loan products fall under the umbrella of term loans:

Bank Loans

Banks provide some of the most common types of term loans for small businesses. Options include:

  • Commercial term loans – General purpose installment loans with maturities between 1-5 years.
  • SBA 7(a) loans – Government-guaranteed loans with longer repayment periods of up to 10 years.
  • Equipment financing – Funding for purchasing vehicles, machinery, IT systems, or other equipment.

Alternative Lenders

Online alternative lenders provide term loans using quick application processes and lending decisions. However, interest rates are often higher than traditional bank loans.

Invoice Financing

Rather than borrowing against collateral, invoice financing lenders provide money against unpaid customer invoices. The loans are repaid once customers pay their bills.

401(k) Business Financing

Some lenders allow using a 401(k) or IRA retirement account to invest in your own business. There are strict IRS rules around this type of financing to avoid penalties.

Term Loan Interest Rates

Interest rates on term loans typically range from 5-36%. Several factors determine the rate:

  • The Prime Rate – Rates on variable rate loans fluctuate based on changes to this underlying benchmark rate.
  • Credit score – Borrowers with higher scores get approved for lower rates.
  • Collateral – Secured loans receive better interest rates.
  • Loan length – Shorter repayment periods often have lower rates.

Compare interest rates from multiple lenders to find affordable financing for your business.

Term Loan Qualifications

While each lender has their own approval criteria, most evaluate these key factors:

  • Time in business – Most require at least 1 year of operations.
  • Annual revenue and cash flow – This demonstrates repayment ability.
  • Credit score – A minimum score in the 600s is typical.
  • Collateral – For secured loans to get better rates and terms.

Having organized financial records will help demonstrate your business is a safe lending risk.

Term Loan Providers

Many lenders offer term loans for small businesses:

  • Banks – Traditional banks like Wells Fargo, Chase, and Bank of America.
  • Credit unions – Member-owned nonprofits focused on community lending.
  • SBA lenders – Banks providing loans backed by the Small Business Administration.
  • Alternative lenders – Online loan brokers like LendingClub, OnDeck, and Kabbage.
  • 401(k) rollover lenders – Companies that facilitate 401(k) backed financing.
  • Merchant cash advance – Funding against future credit card sales.

Shopping rates from multiple lenders ensures you get the most competitive term loan for your specific business.

Applying for a Term Loan

The term loan application process involves several key steps:

  1. Check eligibility requirements – Ensure your time in business, credit score, and annual revenue meet the lender’s criteria.
  2. Choose loan type and provider – Select the loan purpose, ideal repayment term, and best lender fit.
  3. Gather documents – Tax returns, bank statements, business plans, and collateral details.
  4. Submit application – Fill out the lender’s term loan application documents.
  5. Get pre-qualified – Most lenders provide initial eligibility decisions within 1-2 days.
  6. Prove repayment ability – Further verification of credit, income sources, and collateral if pre-qualified.
  7. Get final approval – You will receive a term sheet detailing the rate, fees, and repayment schedule.
  8. Accept loan terms – Sign loan closing documents if the offer meets your needs.
  9. Receive funding – Money gets wired to your business bank account.

Following up promptly with any lender requests for documents or clarifying questions can speed up processing time.

Repaying a Term Loan

Term loans get repaid in regular principal and interest payments over a set period of time. Many lenders allow making additional payments toward principal to pay off the balance early.

Setting up automatic monthly payments from your business checking account ensures no missed payments and avoidance of late fees. Careful cash flow planning is vital to ensure adequate income to cover the loan payments.

If the financial projections used to qualify for the loan aren’t panning out, communicate immediately with the lender. They may allow temporarily adjusting payment amounts, extending the repayment term, or restructuring the debt.

The Bottom Line

Term loans allow flexible financing for small businesses to fund investments in growth. Take the time to understand qualification requirements, compare lender rates, and project the impact on cash flow. With the right planning, a term loan can provide working capital to take your small business to the next level.

For more information, check out these additional resources:

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