Types of business loans
When considering finance options for your business, it’s important to know what’s available to you, and what will optimise what you’re trying to do. That might be developing a property or buying a new vehicle which have vastly different finance requirements.
It’s also vital to have a strong understanding of the level and type of lending your business can support, both from a P&L and balance sheet stand point. Be sure to leverage your business and finance advisors on this point.
Below we run through the main business loans available in the market. These facilities may come from your existing bank, or in cases need to come from a more specialised lender, though each can help businesses execute on their commercial opportunities.
Lenders call the different loans a myriad of things, however the below will give you a general understanding and we’re here to help with the rest.
Commercial property loan
Commercial property loans are used to fund commercial property such as warehouse, industrial and office spaces. This may be to purchase existing property as an investment or owner occupied, or to undertake property development, inclusive of residential developments greater than 4 residences.
Secured by commercial mortgage and generally directors guarantees and General Security Agreement over the business, and depending on equity position may tie in residential mortgage
Interest rates are generally 2 - 4% above home loan rates, and may also have an application fee or other ongoing fees, though a level of risk pricing is generally applied so this so can vary greatly
Loan terms can be up to 30 years depending on borrowing purpose and property type, with 15 years being a more common mark when commercial property secured
Additional features such as interest only period, fixed and variable rates and more sophisticated features such as interest rate hedging are common
Business loan
Whilst very similar to a commercial property loan in structure, a general business loan may give you more flexibility around what you can do with the money. You’ll likely still need property security or a very strong balance sheet to get approval, though funds may be used for example to run a marketing campaign or hire staff.
Secured by commercial mortgage and generally directors guarantees and General Security Agreement (GSA) over the business. Tangible equity in the balance sheet, such as unencumbered vehicles or a large debtor book may be considered
Interest rates generally 2-4% above home loan rates, with other costs similar to those of a commercial property loan
Loan terms will generally be shorter than commercial property, and often tied to the investment timeframe, such as 5 years for a regional expansion project
Additional features such as interest only period, fixed and variable rates and more sophisticated features such as interest rate hedging are common
Asset Finance
Asset finance is used to fund equipment such as vehicles. There are a number of different loan structures used for different needs and tax situations that are explained in this blog post however the general pretence is that the equipment is used as collateral, or ownership is retained by the lender, with repayments made monthly. The most common structures are an equipment loan, lease or hire purchase which is a combination of the two.
Equipment covered includes vehicles as well as machinery for most industries such as mining or agriculture, and including plant & manufacturing equipment.
Asset finance may also be used for shorter term working capital needs, utilising existing unencumbered assets to secure a loan for indirect costs.
Rates vary based on the type of equipment and loan structure, though can range from 4 - 8%
Terms generally start around 3 years and up to 15 years for machinery with an extremely long useful working life, with residual or balloons common to provide greater flexibility and affordability
Overdraft
An overdraft is generally tied to a businesses transactional account, and is used to provide a business with a working capital facility to support their cash flow cycles. You may have $50,000 overdraft, meaning at any time you can go that amount into credit. For example a construction company needs to pay for materials to complete work they’re paid for 60 days later. An overdraft shouldn’t be used for capital expenditure with spending from the overdraft repaid on an ongoing basis on completion of work, despite generally being an interest only loan.
Generally an overdraft will be secured, though some lenders will provide quality clients with unsecured overdrafts. Anything sizeable will likely need to be property secured.
Cost depends greatly on security, with a secured overdraft starting a few percent above home loan rates, whilst unsecured variations can be reasonably expensive
Single year terms with an annual review
Line of credit
A line of credit (LOC) works similarly to an overdraft in that it gives the business access to a pool of funds up to a pre-approved limit, also on an interest only basis. An LOC is generally a secured product and is used for working capital and also ongoing operating or capital cost coverage. Common usage is that a builder uses their LOC to drawdown a portion to complete a particular project, with that portion repaid on completion or sale of that project.
Rates sit between home loan and a secured overdraft, with additional costs such as drawdown fees
Single year terms with annual review
Invoice finance
Invoice finance utilises the ‘asset’ of funds owed to a business in the form of invoices, that act as security for a working capital loan. Generally it’s a revolving facility with funds repaid as invoices are paid, and new funds made available when new invoices are issued. The facility therefore provides working capital to allow for trading and growth.
Two main variants exist being Factoring, where the lender will buy the invoices outright and generally take on collection efforts, and Discounting, where the lender lends against the security value of the invoices and the business retains ownership of the invoices. With discounting, the business’ client generally won’t know about the funding arrangement, whilst with factoring they will.
The business may be able to borrow anywhere from 50% to 80% of the invoice value and may be able to borrow against a single or a group of invoices
Costs vary between providers though you can expect to pay an interest or ‘discount’ rate and fees at each drawdown
Trade finance
Trade finance is primarily used to facilitate international trade between importers and exporters, though it is sometimes used in similar domestic circumstances.Trade finance encompasses a few different financial instruments and lending products, with the aim to reduce either the payment risk or supply risk associated with international trade. It is in essence the suite of tools available to importers and exporters that make trade easier and possible.
The most common products are a bank guarantee (see below) or a Letter of credit (LOC), with variations depending on the particular transaction. An LOC is a guarantee from the buyers bank that they will pay the seller should the conditions of the LOC be met, which relate to production and shipping per any trade agreement. Payment is often made from the buyers bank to the seller once goods have been shipped.
Unsecured loan
Mostly the domain of alternate lenders and fintech companies, ‘unsecured’ business loans are more accessible now than years gone by. That said banks are vying to regain market share in the SME market and many have launched similar products. The pitch with unsecured business loans is that it is the domain of specialised lenders who are tech driven and focus on speed and ease.
Funds can be used for pretty much anything business related and you can get them in as little as 24 hours.
‘Unsecured’ in that most require a GSA over the business and directors guarantees as a minimum
Terms generally 3 months to 3 years though can be longer
Rates can range from reasonable to ridiculous, and care is needed in analysing your options
Bank guarantee
A bank guarantee is when your bank provides a guarantee to another party, generally a supplier or vendor. The supplier or vendor can make a claim against that guarantee should agreement terms be breached.
The lender will generally take security via cash (term deposit) or equity in property for collateral should the guarantee be claimed
Rates and terms vary depending on circumstances
Often used in trade finance and for commercial property leases
