Making the Most of Your Term Loan

How a term loan can help your business grow

It’s always good news when a company does well enough to expand. For small business owners who often put in long hours and risk their personal fortunes to build their enterprise, the key question is how best to finance the expansion. Often, a term loan—the traditional commercial loan offered by many financial institutions—is the answer

Best for Long-Term Financing
Before you file a loan application, you should carefully review your operating needs. Term loans are appropriate for long-term financing (i.e., anything over a year)—not for short-term purchases of, for example, extra inventory or growing receivables. Ideally, you should make those types of purchases using credit terms supplied by your suppliers, business income, or a line of credit.

Clearly, there are as many kinds of expansion objectives as there are businesses; therefore, it’s very helpful for business owners to be clear regarding the motivating business needs for the term loan before applying. Understanding the purpose of the financing will help an owner choose the right duration for the loan. As an example, to finance equipment it typically makes sense to match its useful life with the duration of the loan, typically between three and seven years; whereas, appropriate loan terms for real estate are generally anywhere from 10 to 20 years.

Evaluating Repayment Options
It’s important to note that these are simply ballpark figures. Determining the right duration for your loan must be analyzed with your financial provider taking into account your particular needs. Longer repayment on the loan means lower monthly payments and potentially more cash to operate the business. On the other hand, it also translates into paying down the debt slower and paying out more for interest costs.

Individual considerations are also important in determining whether a fixed or variable interest rate is best. Here’s a snapshot of each option:

• A fixed rate offers certainty. A fixed rate on a term loan provides consistency in payment streams. Knowing exactly how much you’ll pay each month can help you get a handle on what your regular expenses will be. Typically, a conservative business owner with predictable cash flow will select a fixed-rate loan.
• A variable rate fluctuates with interest rate changes. The benefit of a variable interest rate loan is that they typically offer the more attractive interest rates at the beginning of the loan, and the rate could go down during the life of a loan and save you money in the long run. However, a variable rate offers less certainty, and interest rates could increase.

Before choosing between a fixed and variable interest rate, you should appreciate and understand your risk tolerance as well as consider the predictability or the patterns and cycles, if any, of your company’s cash flow. You should also bear in mind that fixed-rate term loans are often advisable in a rising-rate environment. Locking in a fixed rate can help you manage your cash flow more predictably. There are a variety of tools online that can help you assess which option is better for your business needs, including fixed and variable interest rate calculators.

Know Your Lender
You can greatly improve your chances of getting the loan terms you desire if you know what a lender is seeking from loan applicants. Generally, lenders want assurance that a business owner will be able to pay back the loan. To do this, they’ll examine a company’s operations to see whether it generates enough income to service the debt the loan will add to the business’s balance sheet. A track record of profitability is very helpful. For example, a business that has been in operation for 5 to 10 years and has three plus years of profitability is an attractive loan candidate.

But just as lenders carefully screen their applicants, it’s important for a borrower to discriminate when choosing a lender. While interest rates on term loans are a key concern, you should also look closely at fees. In some cases, an initial low interest rate may mask hidden fees that can dramatically raise the overall cost of your loan.

Seek Out Broad Financial Expertise
In addition to reviewing rates and fees, many small business owners seek out a lender with experience in financial planning and investments. Having this kind of wide-ranging expertise available to you is like having an advisor on your management team, and could offer a huge advantage for your business operations. A financial advisor can help you assess your business needs, as well as draw upon their wealth of contacts to assist you in determining the best lender and loan for your unique situation.

For example, if you’re looking to expand into a larger office building, you might want to consider purchasing rather than leasing the property. If you decide to use your term loan to buy the building, you could benefit twofold. In this scenario, your business pays rent to you as the property owner. This means your business pays down the debt you had initially incurred to purchase the new building while simultaneously building equity in your property as it appreciates in value over time.

The above scenario may only be identified when you have a strong relationship with your lender. A financial advisor can help you explore different possibilities for expanding your business and work with you as you make the right loan decisions for your particular needs.

Commercial financing is generally offered through Merrill Lynch Business Financial Services Inc., 222 North LaSalle Street, 17th Floor, Chicago, IL 60601 – California Loans made pursuant to a Department of Corporations California Finance Lenders License. Programs, options and property types are not available in all states and are subject to change. Certain conditions, restrictions and costs may apply. All loans are subject to credit review and approval. Not all features are available with all programs. Maximum loan amount subject to regulatory restrictions.