Small businesses need money for many reasons. Whether to expand the workforce, purchase property, update facilities or even get the company off of the ground, owners rely on capital to bolster growth and expand their reach. There are several ways for entrepreneurs to gain access to necessary capital, with small business loans from banks being the most common. However, this may leave you wondering what your options are. What are the different types of loans? What about the variety of lenders? And what are the different requirements for each loan product?
Conventional loans are a viable source of capital for companies in need of additional funding. These loan options differ from the programs provided by the U.S. Small Business Administration (SBA), which are made by banks and non-bank lenders and guaranteed by the federal government. While commercial banks provide conventional loans, the funds are not guaranteed by any other entity.
Small businesses and franchises of any development stage can apply for conventional loans. However, since these loans are not guaranteed by the federal government, banks prefer to lend to companies that demonstrate a strong ability to service the debt (Debt Service Coverage) and have significant collateral to cover the loan (Loan To Value or LTV) if the company ultimately cannot pay back the loan. In addition, business owners seeking these loans are usually required to have exceptional FICO scores, a reasonable debt to worth ratio, and be able to show lenders a solid business plan, and projections especially for a speedy approval process.
Conventional loan rates and terms
Conventional loans are the most common type of lending for small businesses. They provide short-term, intermediate and long-term funding for companies. Rates differ between each lender and depend on the overall credit risk of the businesses applying for the loan. Conventional loans can carry floating or fixed interest rates, which are determined upon approval and are typically assessed by the overall risk. Fixed or fixed-to-floating rates are the most common for small businesses. A higher perceived risk will generally result in a higher interest rate assessed. The payment of commercial loans will be based off of the term and or the amortization of the loan. Payment schedules, which are normally monthly, can be changed to quarterly and even annual payments if needed and agreed upon by both parties. Some entities looking for start-up, transitional or construction financing can even enjoy interest-only payment structures.
Conventional loans vs. SBA loans
While conventional loans make up a majority of lending for small businesses, the programs provided by the SBA also give entrepreneurs significant access to capital. The most popular products from the agency are the SBA 7(a), 504 and Small Loan Advantage programs. These loan products differ from one another and from conventional loans in many ways. Click here to learn more about SBA loans for small businesses.
Rates and terms can differ significantly between conventional and SBA loans. Conventional loans can be priced based off of several different interest rate indexes or internally by a bank, while SBA loans are typically priced based off of the Prime index plus a spread. SBA loans are limited to only business purposes like real estate, working capital, equipment and inventory, while conventional loans may be used for investment real estate and other passive investments. Banks and lenders will typically determine the loan product during the underwriting or analysis of your loan transaction. They may prefer to make an SBA loan because of the guarantee from the U.S. government. Or, they may choose to use a conventional loan product if your loan request is not eligible for SBA financing.
How conventional loans benefit small businesses and franchises
There can be advantages for small businesses taking out conventional loans.
- With conventional loans, banks will work with owners to develop a package that works best and fits the needs of companies. This may be in relation to the interest rate or term/amortization structure, or prepayment penalties of the loan.
- Conventional loans may be easier to negotiate down the road as the borrower has developed a relationship with the bank or lender.
- In certain situations, conventional loan options can cost less than those provided by the SBA. Conventional loan interest rates and origination fees may be lower.
- Conventional loans can help small businesses finance various operational aspects, including workspace renovation, expanding the workforce and purchasing new equipment, purchase of real estate to name a few.
Which program is right for you? Schedule a free consultation and use the Fundability App to learn if lenders may be interested in you.
Small business lending from non-banks
Small businesses have the option of borrowing from banks and non-bank lenders. These non-bank financial institutions can offer both conventional and or SBA loan products. Businesses may seek out loans from non-bank lenders if they are having difficulty finding access to capital from banks. Non-bank lenders normally extend financing to certain industries and business models, which can range from startups to franchises. Small businesses with less credit histories can work with non-bank institutions to gain access to needed capital. Additionally, loans from non-bank lenders often have more flexible terms regarding collateral and how cash flow is evaluated.
Apply for a conventional loan
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Visit our free Fundability App to see which banks and lenders would be interested in your loan request as well as the strengths and weaknesses of your deal.