BUSINESS TERM LOAN GUIDE

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What is a Business Term Loan?

Business Term Loans are useful for financing longer duration projects and assets. The Term Loan is relatively inflexible and often has high early repayment penalties if the financing is no longer needed. Business owners therefore want to be careful in selecting the duration of the Term Loan. Term Loans are best used as core debt in the business and can play an important part of the capital structure for generating higher returns to equity holders.

How Do Business Term Loans Work?

A business term loan can be either amortising over the term of the loan or interest only. It is more common for term loans to be amortising. In the case of a fully amortising term loan the principle is fully repaid over the duration of the loan. So for example, if the term of the loan is for 5 years then the repayment schedule will be set to have the principal fully repaid over the 5 year term. For amortising term loans, because the loan principle reduces over time the interest portion of the payment on the loan is higher at the start of the loan than at the end of the loan.

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In the case of a fully amortising term loan the principle
is fully repaid over the duration of the loan.

When Should Business Term Loans Be Used?

Business Term Loans are best used for financing longer term capital purchases. This could include equipment, land and or buildings or another business. One of the basic principles of finance is to match funding of assets with their cash flows. Or rather to ensure that the life of the asset is equal to or longer than the term of the financing. On this basis a 5 to 10 year term loan may be a good facility to use to purchase a building for example. A 5 year loan is however not a good way to finance the purchase of an asset with a 3 year life (for example a laptop) as the business will be paying financing costs well past the useful life of the asset.

Where does the Business Term Loan fit into a Businesses’ Overall Financing Strategy?

Business Term Loans are best used for financing longer term capital purchases. This could include equipment, land and or buildings or another business. One of the basic principles of finance is to match funding of assets with their cash flows. Or rather to ensure that the life of the asset is equal to or longer than the term of the financing. On this basis a 5 to 10 year term loan may be a good facility to use to purchase a building for example. A 5 year loan is however not a good way to finance the purchase of an asset with a 3 year life (for example a laptop) as the business will be paying financing costs well past the useful life of the asset.

What Are the Alternatives to Term Loans?

Equipment Finance can be an alternative where it is equipment that is being financed. Equipment Finance will typically provide a good match to the duration or life of the asset. The choice between a term loan and equipment finance will come down to a comparison of financing cost and tax treatment between the two options. The tax aspects of Equipment Finance are discussed in a separate guide.

A Business Overdraft is typically not a good alternative to a Term Loan for reasons described in the Business Overdraft guide.

Business Term Loan Fees

Because Business Terms Loans are typically secured by property the interest rates and fees can be some of the most competitive business financing rates around. There are however often large early repayment penalties on term loans (and in the case of fixed rate term loans there is also interest rate risk and costs in breaking the loan early). The probability of the business owner wanting to break the loan early should therefore be considered and business owners should fully understand the early break fees before considering term loans.

Who Offers Business Term Loans?

Most major banks that serve small businesses offer term loans
All lenders will usually only consider “established” businesses that are at least 2 years old and have a positive track record with strong cash flows. In addition, Banks will typically require property security.