Whether you’re currently operating a business or are interested in launching a company, you might wonder whether getting a business loan to help financially support your operations is wise. If you’re asking yourself, “What is a business loan, and is one right for my company?” here’s what you need to know.
How Do Business Loans Work?
Business loans are a form of commercial financing that gives companies access to borrowed funds that they can use for operational expenses, expansion, and more. Generally, business loans work one of two ways. First, the lender might provide a lump sum. Second, they may operate as a line of credit. Additionally, either option may be secured or unsecured.
Business loans do come with interest rates, though they’re potentially lower than what people find with personal loans and similar alternatives. For example, the Small Business Administration (SBA) loan program offers rates between base rate plus 2.25% to base rate plus 4.75%. However, rates do vary by lender, so it’s possible to see interest rates far above that mark.
In exchange for receiving the money, your business agrees to repay the principal along with interest and fees. The payment schedule can vary depending on the loan agreement. Some require monthly payments, while others have daily, weekly, or biweekly payment requirements.
Why Do People Get Business Loans?
Generally, people get business loans to financially support operating their company. In some cases, the goal is to make startup costs more manageable. After launching a small business, it’s not uncommon to spend around $40,000 during the initial year, and that’s more than many individuals can cover out of pocket.
A business loan can also support expansion efforts or operational upgrades. For example, a company that initially invested in low-cost equipment to evaluate proof of concept for a new product may want to install higher-quality equipment once they know the product is viable in order to streamline operations. Company owners may also get business loans to consolidate higher-interest debt or simplify debt repayment, though there are other potential uses as well.
What Can You Use a Business Loan For?
In most cases, company owners can use business loans for nearly any purpose as long as the funds are spent on the business itself. Startup costs, cashflow for expenses, debt consolidation, equipment purchases, business expansion, marketing, and business acquisitions are all possible uses. Additionally, it’s possible to use the cash to purchase real estate for the company to use for its operations or a company vehicle.
Primarily, the only restriction involves personal expenses. In general, lenders won’t allow borrowers to use the money for non-business purchases of any kind.
Basic Business Loan Requirements
In most cases, the business loan requirements are simple. Along with meeting the credit score requirements, you’ll need suitable revenue and a reasonable debt-to-income ratio to support debt repayment. At times, how long the company’s been operating plays a role, as some lenders set a minimum number of months or years for a business to become eligible.
For secured loans, businesses need to provide collateral. Finally, some lenders do require a personal guarantee, ensuring that if the company isn’t able to repay the debt, the business owner will do so on their own.
