A Beginner's Guide to Common Small Business Loan Terms

Collateral. Annual Percentage Rate. Merchant Cash Advance. If you have ever applied for a small business loan, you must have come across these terms. Most entrepreneurs – first-timer applicants particularly – struggle with understanding these finance terms and this may result in opting for a funding option that doesn’t align with your business goals. And then it will spell trouble for you and your business’s financial future.

Every applicant must remember that it is not important to be a financial expert to find the right funding for your business. But it is absolutely necessary that you understand vocabulary terms so that you can decode the terms and conditions of any financial option with ease and select the loan that works best for you.

Let’s check out some common terms and phrases that will make any business owner understand small business loan process better and in likelihood, make the discussion with any financial lender less daunting. More so, no one would be able to confuse you using these terms.

Term Loans

A term loan provides borrowers with a lump sum amount in exchange for a set repayment schedule with a fixed or variable interest rate. It is offered by traditional banks or online lenders. Although the application process tends to be long and tedious, qualified applicants can enjoy some of the lowest interest rates and long duration terms. It requires collateral as security and the approval process is quite strict so that default risk can be reduced for the lender. Some lenders may even require substantial downpayments before advancing the loan amount.

Revenue-Based Financing

Revenue-based financing (RBF) for small business is a form of alternative funding option that provides capital in lieu of a percentage of the business’s monthly revenue on regular basis. It is different from debt financing or equity financing as it does not require a business owner to give up the company’s equity to raise capital. Although the business applying for the funding will need to make regular payments, the interest is not paid on an outstanding balance and there are no fixed payments. It is best suited for businesses with a steady monthly income. Moreover, there are no requirements for collateral or any downpayment.

Commercial Real Estate Loan

Commercial Real Estate (CRE) loans are provided by putting the commercial property itself as collateral. Businesses generally opt for these loans when they need large capital or when they are looking to acquire office spaces, retail locations, or industrial properties. Since the property itself provides significant collateral, it reduces the lender's risk. So, in this way, it is a win-win product for both the lender and the borrower.

SBA Loans

One of the popular small business loans, SBA loan is backed by the U.S. Small Business Administration (SBA) to provide affordable capital to growing businesses. But keep in mind that SBA does not issue these loans directly but instead, the capital is offered through government approved lenders like banks and credit unions. To instill confidence, the SBA guarantees a part of the loan, which in turn reduces the risk for lenders and ensures easy approval for businesses. This type of financial option makes it easier for small businesses to get the funding they need.

Business Line of Credit

A business line of credit allows a borrower to borrow money up to a certain limit and only pay interest for the amount they use. For example, if your line of credit is up to $20000 and you use only $5000 from that, you would have to pay interest for $5000 within the agreed up to term. Unlike traditional loans, a line of credit allows you to borrow as much or as little as you need without the obligation of a fixed term loan.

Merchant Cash Advance (MCA)

A form of alternative lending option, MCA loan offers a large amount of capital up front to a business in exchange for a percentage of future credit or debit card sales. These small business loans are suitable for those enterprises that experience high credit card sales but variable income. But in comparison to traditional business loans, a merchant cash advance is not a loan. It is an advance given on future sales, making it perfect for businesses with poor credit.

Unsecured Loan

It is a type of loan which does not require a borrower to put any collateral to get the loan. The interest charged might be higher than secured loans as the risk will be high for the lender in this type of funding option.

Interest Rate

It is the cost that is paid to the lender for borrowing money to finance a loan, on top of the loan amount or the principal.

Annual Percentage Rate (APR)

Annual Percentage Rate or APR means yearly interest charged to borrowers or paid to investors or lenders. In short, it is the interest rate plus any additional fees charged by the lender. This includes origination charges and other fees charged when the loan is made.

Collateral

It is an asset that a borrower pledges or guarantees as a security for a loan. In the world of small business loans, a business may put a valuable piece of equipment or property owned by the business as collateral to secure a loan. This reduces the risk factor for the lender in case of repayment default as repayment amount can be recouped by selling off the collateral.

Conclusion

Now that you have a little bit of understanding of the terns associated with small business loans, it is very important that you read the documents carefully and if required, consult with a financial advisor to check whether it is suitable for your business.