Commercial Magazine

Weigh Your Options

Choosing the right business loan requires looking at both the pros and the cons

By Noah Grayson

For commercial brokers helping their clients find the best deal possible, it is often difficult to navigate the plethora of financing options available in the market. An online search will inundate any loan seeker with confusing advertisements, conflicting articles and dozens of choices — but which one is the right product?

The correct loan option, whether it be a Small Business Administration (SBA) 7(a) loan, equipment financing or alternative business financing, will depend on the needs and credit profile of the business. Each loan also offers opportunities and challenges.

The SBA 7(a) loan, for instance, offers many positive aspects, from lower downpayments to competitive interest rates. If borrowers, however, are in need of a loan larger than $500,000 — which doesn’t go as far as it used to — then the paperwork and time requirements increase. Commercial brokers can offer value to their clients by understanding the pros and cons of these popular loan options and being able to explain the findings to their clients.

“There are many financing products available today, and the increased presence of technology in business lending will only make accessing capital easier and more affordable as time goes on.”

Case in point is the SBA 7(a) loan. The SBA guarantees several loan products to assist small businesses with their capital needs. Although it is not a direct lender, the agency offers a backstop to approved lenders to deliver affordable and flexible business capital. The 7(a) loan is one of their most popular options and can provide funds for most purposes.

One aspect of the SBA program is that it offers lower downpayments for qualifying borrowers. Most 7(a) loans require a downpayment of between 5% and 20%, but for those business owners who qualify, the program can offer up to 100% financing for the acquisition of commercial real estate in which the borrower’s business occupies 51% of the building.

This means that in some cases a business owner will not need to put any money down on a purchase. SBA 7(a) loans also offer terms that can last up to 25 years when there is real estate collateral available, and up to 10 years for working capital, inventory loans and equipment. They come with low interest rates and SBA lenders have the flexibility to adjust those rates to meet the needs of the borrowing business. Even though a business owner may be eligible for other prime financing options, a 7(a) loan may still be the most affordable option.

Eligibility requirements

Despite the many good aspects of the 7(a) loan, it may not be right for every borrower. For one, the loan includes strict eligibility requirements. An approved SBA 7(a) lender generally won’t finance a borrower who has a personal credit score below 650, has no hard collateral or has insufficient cash-flow. However, a preferred 7(a) lender, one authorized to approve SBA loans, will be adept at navigating program nuances to best meet a small business’s capital needs.

The loans may also involve a lengthy application process. Working capital financing up to $500,000 can be provided quickly and with limited documentation but accessing financing of more than $500,000 can be lengthy and time consuming. Working with a tech-powered preferred 7(a) lender will make the process faster and smoother. SBA 7(a) loans of $25,000 to $500,000 also will require some collateral. Above that level, borrowers will need to use personal residential and investment real estate as collateral (if available). If a business owner does own hard collateral, it will often be leveraged by the lender regardless of the loan size.

Equipment financing

Financing equipment is a specialized product that is offered by banks and alternative business lenders. Equipment serves as the sole collateral for the financing, the documentation and downpayment requirements are often minimal and financing can occur in hours, depending on the lender. Equipment financing can be provided in a traditional loan format, as a contract of payments or via a leaseback structure.

The positives for such a loan include the preservation of capital, asset-centric financing, a variety of payment options and a fast and easy completion process. Equipment can be considered anything from an office computer to an airplane. Many lenders offer business owners the ability to purchase equipment with no downpayment, and no out-of-pocket fees. Broker fees (which can range up to 10%) and even processing costs can usually be wrapped into the financing amount.

Business owners are rarely required to pledge any collateral other than the equipment that is being financed. Some lenders will purchase the equipment for the business and lease it back to them at a set monthly cost. This can sometimes present tax benefits and cost savings from having to own equipment outright and enable a business to keep up with technology by upgrading their equipment more frequently. Borrowers also may obtain flexible equipment financing repayment terms, such as quarterly, semi-annual, delayed or annual payment options.

Equipment financing is known for its ease, speed, and convenience. To access equipment financing a business owner can expect in most cases to only complete a one- or two-page application, possibly provide bank statements and consent to a few third-party reports. In the same way that a personal vehicle loan can be obtained at a dealership in minutes or hours, a business equipment loan works similarly.

Obsolescence concerns

Equipment loans, however, come with some potential challenges. Most equipment lenders won’t offer financing terms longer than 72 months, which means a business’s financing payment could be significant. The shorter the useful life of the equipment, the shorter the repayment term will be. A lender won’t finance a piece of equipment for a long period if it may be obsolete in 24 months.

Equipment financing is usually strictly for purchasing or refinancing the equipment itself. Most dedicated equipment lenders will not deliver working capital, or finance additional items in their equipment financing package.

This type of financing often comes with a penalty for early repayment. If a business is purchasing used equipment, or equipment that may be obsolete soon, then selling that equipment may be costly. It’s important to match the terms of the equipment financing deal with the length of time a business will need the equipment.

Considering alternatives

Alternative business financing is considered any unconventional financing product and encompasses a wide range of capital options. Business term loans, credit lines, receivable advances and other product types are available to business owners through a streamlined and limited-documentation online borrowing process. Due to heavy competition in the alternative business lending space, there are now many low-rate and low-cost alternative business financing options.

While there are always exceptions, there should be an alternative business financing product available for most small businesses in good standing, regardless of the business owner’s personal credit score, business revenue, business type or its time in operation. Alternative business lenders often can approve a loan very quickly. In some cases, the underwriting process is fully automated and credit decisions can occur in minutes with just basic application information and-or limited documentation. It may be possible to have the funding process completed in one day.

Creditworthy businesses can usually obtain reasonable alternative financing terms. One form of financing gaining in popularity is business credit lines, since there is no set up cost (if eligible), and they usually offer higher credit limits and lower rates than business credit cards.

Costs and risks

For some businesses, the ease of obtaining alternative business financing may come with more expensive loan terms. However, borrowers who have had difficulty qualifying for bank or SBA financing, or that have a time-sensitive need, may find that alternative business financing is the best and only option available.

The commissions that lenders pay to brokers for alternative business financing can be very high. These high commissions can create the temptation to mislead borrowers into products that are not in their best interest, and the regulations policing these activities are still catching up. It’s highly important that brokers and business owners conduct extensive research on lenders they are working with and never pay upfront fees.

Small business owners need to keep in mind that the ease of quickly accessing large amounts of alternative financing can make it possible to accumulate too much expensive capital and end up endangering the business. These types of loans can be difficult to consolidate into a conventional or SBA loan down the road. Any business financing should only be obtained to address a need or solve a problem and, of course, must be repaid.

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There are many financing products available today, and the increased presence of technology in business lending will only make accessing capital easier and more affordable as time goes on. That is why it is so important for brokers to work with their clients to carefully weigh the pros and cons of all financing options that are available before making such crucial choices. Ultimately, the financing selection should come down to the needs of the business, as well as what is the most affordable financing option for which the business owner qualifies. ●


  • Noah Grayson

    Noah Grayson is president of South End Capital, a division of Stearns Bank, N.A. The $2.2 billion financial institution is an SBA preferred lender and a top nationwide business and equipment lender. South End Capital offers an innovative balance-sheet lending and comprehensive marketplace financing delivers a full spectrum of capital solutions for emerging and expanding businesses. South End Capital’s tech-enabled platform and premier customer support offers equal access to industry-leading conventional and alternative funding. Reach Grayson at (320) 202-6106.

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