If you've applied for and gotten approved for a business loan, congratulations! Most of the hard work is behind you. There is, however, one task you have to tackle before putting small business financing to work: evaluating the loan offer.
This requires taking a closer look at the loan terms before signing off on the final paperwork. Doing helps ensure that you fully understand what you're committing to and that the loan is a good fit for your business needs and cash flow.
If you have a business loan offer on the table, here are the most important things to review.
Start With the Repayment Period
The repayment period is simply the length of time that you'll be repaying the loan. With a term loan, this can be anywhere from six months to one year for a short term loan, or up to five years for a long term loan. Knowing how long the repayment period lasts can make it easier to plan your business budget around your monthly loan payments. That level of predictability matters if maintaining a positive cash flow is a priority.
Something else to be mindful of is whether the loan comes with a prepayment penalty. If, for example, you're offered a five-year loan term but your cash flow outperforms your expectations, allowing you to pay it off in three years, you'd want to be sure that the lender isn't going to penalize you for fulfilling your obligation ahead of schedule. Watch this video with Bond Street CEO David Haber for more on small business loan terms and repayment.
Calculate the Interest and Fees
Once you've reviewed the repayment period, the next step is determining how much the loan stands to cost you. There are two specific numbers to focus on: the annual percentage rate (APR) and the origination fee.
The latter is an upfront charge the lender adds on for issuing the loan. The origination fee is generally deducted from the loan proceeds. If, for instance, you borrow $100,000 and the lender charges a three percent origination fee, you'd receive $97,000 to put towards your business.
The other consideration is the loan's APR. The APR is the annualized cost of borrowing money (inclusive of fees and service charges). If you've ever had a credit card, you're probably familiar with this term. The higher the APR, the more the loan will cost. Your lender should be fully transparent in disclosing what your loan's APR is and whether it's fixed or variable. A fixed APR remains the same for the life of the loan, but a variable APR is tied to an underlying index, such as the prime rate, and may fluctuate over time.
With other types of small business financing, pinning down the APR may be more difficult. A merchant cash advance or invoice loan, for example, may assign a factor rate, rather than an APR. This factor rate, expressed as a decimal point, is a fee that determines how much you'll pay for financing. The corresponding APR can potentially reach the triple-digit range. Asking the lender for a detailed breakdown of the factor rate — and how that translates to an APR — beforehand is critical for measuring its true cost.
Ask About Collateral or Security
Term loans and other types of small business financing may require you to have some skin in the game, so to speak. Depending on the type of loan and the lender's preference, that can take the form of collateral, a personal guarantee or a Uniform Commercial Code (UCC) lien against your business assets.
Understanding what's expected of you in terms of collateral or security for a loan puts in perspective what's at stake. If you sign a personal guarantee, for instance, and default on the loan, the lender could attempt to attach your personal assets as repayment.
Consider the Long-Term Outlook
The final piece of the puzzle centers on how the loan will benefit your business in the long run. If you're taking on a loan to expand into a second location, for instance, will your anticipated future profitability justify the cost of borrowing? In other words, what's your return on investment (ROI)?
Taking on debt through a loan can be a strategic move if it allows you to grow your business, but you have to weigh the cost against the potential rewards. When in doubt, be sure to ask your lender any questions you may have about the business loan offer, the loan's structure, the associated fees and the APR to be certain it's the right choice for your business.
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