You may need additional capital for various reasons such as: starting or expanding your business, purchasing or refinancing equipment or restructuring your balance sheet. A business loan provides probably the most flexible solution to meet your financial needs (but not always the cheapest way to get cash. Depending on your situation asset finance/leasing or factoring might present you with a better option.) A loan is an agreement in which a lender (finance company/banks) gives money (principal) to a borrower, and the borrower agrees to repay the money with interest, at some future point(s) in time. Loans are very flexible and can be structured to meet your needs. When arranging a loan, consider its effects on your cash flow and assets. This section will give you a general overview. It does not replace professional advice. You may wish to consult your accounting and tax advisors before finalising a loan to reap the maximum benefit and avoid complications.

How a Commercial Loan Works

Loans may be structured several different ways but the two most important aspects to consider are the interest rate (type and method) and the repayment schedule for the loan.

There are two options to set your interest rate:

• Fixed Rate: With a fixed rate the interest rate (i.e. the percentage) applied to the outstanding principal remains constant through out a predetermined period that may or may not equal the length of your loan. The interest rate is set at the beginning of your loan by examining the risk involved and the current market rates. The advantage of a fixed rate loan is that your interest rate is fixed and the payments constant and they will not rise if the market rate rises. The disadvantage is that you will not benefit from a decline of the market rate.
  
  
• Variable Interest Rate: With a variable interest rate the interest rate applied on the outstanding principal amount fluctuates in line with changes to the Bank Base Rate or LIBOR and, as a result, so will the amount of your payments. The interest rate for each period will be the current market rate plus a predetermined premium that remains constant throughout the life of your loan. The advantage of a variable interest rate loan is that you save money when the market rate decreases. The disadvantage is that you are not protected from an increase in the market rate and the interest you pay will increase with the market rate.

When deciding on your repayment schedule you should always remember the longer you take to payback the principal the higher your total interest payment will become:

• "Equal" Payments: This type of loan requires you to pay the same amount each period (monthly or quarterly) for a specified number of periods. Part of each payment goes toward interest and the rest goes toward principal. After the specified number of periods you will have paid back the entire loan plus all interest.
  
  
• "Equal" Payment and a Final Balloon Payment: This type of loan requires you to make equal monthly payments of principal and interest for a relatively short period of time. After you make the last instalment payment, you must pay the balance in one payment, called a balloon payment. Some lenders will give you the option to refinance the loan to help you stretch out the final balloon payment. This type of loan offers definite benefits to you. Because of the lower monthly payments during the course of the loan, you can keep more cash available for other needs. Of course, when you are thinking about those nice low payments, don't forget the big balloon payment waiting around the corner.
  
  
• Interest-Only Payments and a Final Balloon Payment: With this type of loan, your regular payments cover only interest. The principal stays the same. At the end of the loan term, you must make a balloon payment to cover the entire principal and any remaining interest. The obvious advantages of this arrangement are the low periodic payments. But over the long term, you will pay more interest because you are borrowing the principal for a longer time.
  
  
• Single Payment of Principal and Interest: If your lender agrees, you can promise to pay off the loan all at once at a specified date. This payment includes the entire principal amount and the accrued interest. Borrowing money on these terms is best for a short-term loan.
  
  
• Equal Principal Payments: This type of loan requires you to pay the same amount of principal each period for a specified number of periods. The total payment for each period will be variable (and should decline) as you pay interest only on the outstanding principal at the beginning of the period. Borrowing money on these terms requires larger payments in the beginning of the loan.

Advantages

• Retain Ownership. Instead of raising funds by selling an interest in your company to an investor, you retain the current ownership of your company. The lender is only entitled to an interest return on its loan, not a percentage of the profits or a share in the company that an investor would expect.
  
  
• Financial Flexibility. The proceeds from the loan can be used for almost any purpose including paying off current debt to avoid higher interest rates, short repayment term, or pending balloon payment. A loan also allows you to preserve your cash and working capital.
  
  
• Better Cash Flow. A loan gives you access to capital with minimal up-front payments and the flexibility to design a loan schedule that suits your needs. You can organize your loan schedule to match your payments with the projected cash flows from the proceeds of the funds this will help you minimise the drain on your working capital.
  
  
• Borrower is legal owner of equipment. If you decided to take a loan against your equipment, unlike some other forms of financing you remain the legal owner of the equipment.
  
  
• Maximize Financial Leverage. Normally you can use your refinance most of your assets, real estate, commercial equipment and vehicles, to arrange for a loan and may free up cash flow for other pressing needs.
  
  
• Simplified cash flow management. Loan schedules are preset, making cash management more predictable.
  
  
• Tax advantage. Interest payments on your loan are tax deductible and are made with pre-tax money. Purchases financed with profits, in contrast, are made with after-tax money.

Disadvantages

• Additional guarantees. Depending on the credit rating of your company, the lender might require additional guarantees. These may be provided by you, your partners or your bank and could affect your personal credit rating or your standing with your bank.
  
  
• Collateral. The lender may insist on a pledge of some asset to secure the loan. Under a security agreement (for personal property), if you default on the loan, the lender is able to foreclose upon the asset and sell it to repay the money owed to the lender. If you are required to provide security, try to limit the amount you have to give to secure the loan. And make sure that when the loan is repaid, the lender is obligated to release its mortgage or security interest and is required to make any government filings acknowledging this release.
  
  
• Defaults. The lender may define a variety of events that will constitute a default on the loan, including failure to make any payment on time, bankruptcy, insolvency and breaches of any obligations in the loan documents. Try to negotiate advance written notice of any alleged default, with a reasonable amount of time to cure the default.

Glossary

• Asset - Any item of economic value owned by you or your corporation, especially that which could be converted to cash.
  
  
• Bank Base Rate - The minimum interest rate that the bank will charge you for your loan.
  
  
• Fixed Rate - The interest rate (i.e. the percentage) applied to the outstanding principal remains constant through out the life of the loan.
  
  
• Lender - A financial entity that makes funds available to others to borrow.
  
  
• Loan Commitment - A formal offer by a lender making explicit the terms under which it agrees to lend the money to a borrower over a certain period of time.
  
  
• Loan Schedule - A listing of the amount of principal and interest, due dates and balance after payment for a given loan.
  
  
• LIBOR - London Inter-Bank Offer Rate is the interest rate that the largest international banks charge each other for loans.
  
  
• Outstanding Principal - The amount borrowed from the lender which, at a point in time, remains unpaid (this excludes interest outstanding).
  
  
• Principal - The amount borrowed from the lender.
  
  
• Secured - A loan that is backed by the offering of an asset to the lender.
  
  
• Terms - The specific condition and details of an agreement or contract.
  
  
• Unsecured - A loan in which has no assets backing the loan.
  
  
• Variable Rate - The interest rate (i.e. the percentage) applied on the outstanding principal amount fluctuates from period to period.
  
  
• Working Capital - The amount of funds in the business required to finance the day-to-day operations of the business.

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Commercial Loans