Term loans: Financing tied to collateral
posted in Financial Literacy, General Finance |Similar to an asset-based loan, a term loan requires physical, or fixed, collateral to be used as a guarantee of repayment. These can include equipment, vehicles, owner-occupied commercial real estate and renovations.
The majority of term loans to small and medium-sized businesses in Canada are provided by chartered banks. Similar to a personal loan, they are administered with a monthly schedule to pay principal and interest; the principal decreasing as it is paid down. Most term loans for small businesses are amortized over five years or less.
In a pinch, a small business can consider a short-term loan with a repayment schedule inside of six months. These short-term loans are also called demand loans because the lender can require the funds to be repaid in full at any time.
Before applying for a term loan, be sure to gather the following business and personal financial documentation:
List of assets — This includes all lien-free assets for the business along with personal assets that can be used as collateral. In some instances, it might be necessary to include personal assets as loan security. It is important to include all possible assets to give the lender means to assess the risk.
Financial history — A new business might not have much of a financial history, so a detailed accounting of past, personal finances will suffice. This demonstrates responsible money management. Be sure to include records for repayment of past loans, prior tax returns, debts and investments.
Cash flow projections — Estimates of the cash flow expected for the business should already be included in the business plan. They should set out all anticipated expenditures and revenues, and show how the finances will be structured and managed. A healthy cash flow projection with earning potential indicates means to repay the loan.
Credit report — While banks have access to personal credit reports, it is always wise to order a credit history to ensure the information is accurate and up-to-date. A report includes instructions to rectify errors or add current information. It’s possible to take measures to repair a poor credit rating before applying for a loan.
Personal credentials — Summarize personal strengths, experience and expertise that are related to the business. This can be put together much like a resumé. Any related work or management experience, education, business resources and connections or specialized training is imperative to mention. A list of references can also be helpful.
Banks use a score sheet to rate an application and determine eligibility. Be sure to ask how the rating process works before making a formal application. If the loan is declined, ask why. Some banks frown on small businesses that have applied at numerous financial institutions and been declined, so the best bet is to find a trustworthy lender that is a good fit and re-apply there once the business can qualify.
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