There are many options when looking to get additional funding for your company. You could get a quick cash option, which gives you cash almost immediately, but has high – and sometimes unfavorable – repayment terms. Another option is to get a business term loan through a bank or broker, which has a fast turnaround and reasonable rates. There are also SBA loans with favorable rates, but more documentation is required, and approving and funding the loan takes much longer.
Time and time again, we see one thing that is the key to success with term loans. What is it? Borrowing the correct amount. Make sure the loan amount is large enough to meet your needs, but not so high that you jeopardize your cash flow. Getting an inadequate amount may mean resorting to less favorable options in the future when financing is still needed. Similarly, taking on additional debt may unnecessarily strain the business’s financial position.
While the loan amount is just a number, it’s not as simple as it may seem. To help determine what that amount should be and win this critical step, work with your financial team and your lending partner and follow these four steps when deciding on a small business term loan.
Step 1: Assess your needs
The first step to success with a loan is assessing your needs. Ask yourself the question, how can I efficiently grow or improve my business? Term loans can be used to clean up your finances, like refinancing merchant cash advance (MCA) loans that have high interest. They can also be used to grow your top-line revenue by investing in marketing resources and opportunities. The loan could be utilized to build up or refresh infrastructure, such as acquiring a new point-of-sale system or updating equipment or processes around the retail operation. For your financing needs, think in terms of this philosophy: Obtain funds for higher up-front costs so you can spread the cost over an extended period. Another lending possibility is taking advantage of a significant discount on a bulk inventory purchase. However, term loans tend to have structures and costs that are not optimal for regular inventory purchases and recurring costs.
Match the duration of the need with the length of the loan. For example, if you want to update anything in the store, remodel, update or change POS software, or any system, you’ll be using those upgrades for a while, and it’s a cost you can spread over a long time. For a term loan, two to five years is the average time range.
Step 2: Know what you are getting into
In addition to understanding your business needs and how you will use financing to grow, it’s essential to understand both your cash flow, and the loan costs and repayment structures. Short-term loans such as MCA loans require daily and weekly repayment schedules. Longer-term loans will be predictable in their payment structures. Understanding factors such as the timing and the amount of your income and other costs can help you to match your finances with the best repayment option.
Step 3: Find the sweet spot for term loans
Unsecured term loans range from about $25,000 to $500,000. For more significant amounts, retailers will typically need to use a traditional bank and put up significant amounts of collateral. Smaller amounts could be financed through lines of credit, MCAs, or even credit cards, among other choices. As with term loans, understand why you need the loan and how you will pay it back. Credit cards and MCAs can have some of the highest rates out there but can be used in a pinch for short-term cash needs if they can be repaid quickly.
Step 4: Determine whether to finance with a bank or a fintech partner/broker
There are multiple avenues to obtain financing. You can go directly to a bank or financial institution. They will have competitive rates and may be able to show different financing options for your business. They will have worked with several companies like yours and have the expertise to guide you.
There are also numerous options with fintech partners. One advantage of fintech partners is that they can draw from multiple banks and lending agencies to offer the best options for your loan. They may have a broader scope of resources for you to draw from. However, because there’s a broader set of potential fintech partners, you’ll need to research and understand with whom you are partnering, their network, and how their contracts are structured.
Regardless of your chosen company, ensure the financing partner has an established background and record of working with small businesses and providing small business loans.
A real-world example of a term loan being used to full advantage
A combination café/retail operation is one excellent example of how to leverage funds to expand the business. The company, located in Texas, had established a solid customer base. The owners felt they could improve revenue by building out a new space that could host events, expand on-site services, and grow retail sales—quadrupling its retail square footage. The company took a $150,000 loan to support its current operations while funding the expansion.
The loan enabled the company to spread the considerable cost of relocating to a bigger place, and management took out enough money to cover the anticipated costs. Since the funding, the business has grown into its new space, increasing in popularity, and achieving the goals of the original loan.
Be sure to avoid the number one mistake made by companies when getting term loans – financing a wrong or unsuitable amount. Then, follow the four additional steps to ensure you successfully get a term loan to grow your business and thrive in the future.
August Wagner is Portfolio Manager, SMB, at TAB Bank.