If you’ve only ever taken out a consumer loan such as for a home or auto, you may not be aware of the differences between consumer and commercial loans. Furthermore, if your business is comprised of intangible assets, there are a few more differences to consider. We’ll explain the differences and answer a few of the most common questions here.
Similar to consumer lenders, commercial lenders are looking for indicators that the borrower will be able to repay the loan. The most qualified applicants for a business loan have the strongest indicators that they will be able to repay the lender. Most lenders are looking at the past performance of the business to predict the likelihood that the business will continue to perform well in the future.
But there is more to consider than just past financials. What are the future plans for the business? If the loan is for an expansion or acquisition, what is the financial outlook after the transaction? Can the borrower demonstrate how the transaction will benefit the business? If the business owner/borrower takes out a 10-year loan, but plans to retire in five years, is there a succession plan in place? Lenders may be hesitant to lend to a business if the owner is leaving before the end of the term because the possibility of the business defaulting on the loan is considerably higher. A succession plan and a strong leadership team can give lenders greater confidence in the business.
Collateral is required for most secured loans and typically, lenders require an amount of collateral greater than the loan amount. For example, if you want to borrow $1MM dollars, you’ll need to offer somewhere between 50%-80% more than the loan amount in collateral. This ensures the lender will recoup their money if the borrower defaults on the loan even if the value of the assets depreciates over time.
For businesses that do not have traditional forms of collateral to pledge to support their loans, it is important to partner with a lender that realizes the value of future revenue streams as loan collateral. Specialty lenders like Oak Street Funding® lend based on the book of business and its expected recurring revenue. If your collateral is based on intangible assets, a niche lender who deeply understands the nature of your business is often a better choice than a traditional bank that usually handles physical collateral like real estate and buildings.
There are four main types of documents you can expect most lenders to require for a business loan. These are typically submitted with an application form that asks for business information such as address, organizational structure, and contact information for the owner and other stakeholders in the business. Having these documents well drafted helps protect you and shows the lender you are prepared and organized:
Most commercial lenders require the borrower to put 10%-20% down on the total purchase price. However, there are many factors to consider when seeking a business loan besides the amount the borrower must contribute to the purchase. If the loan is for an acquisition, merger, or partner buy-out, financing for the deal often includes third-party equity, seller earnouts, and equity. Each deal is different and the borrower down payment amount will vary based on the amount of 3rd party financing used for the deal.
Another option is a revolving line of credit which does not require a down payment. Instead of taking a loan for a large amount at one time, a line of credit will allow you access to cash when you need it. For example, if your business is seasonal, a revolving line of credit will help cover dips in cash flow to make payroll or cover other expenses.
While many consumer lenders provide pre-approval letters, not all commercial lenders do. Approval for the loan occurs after you apply, submit all required documents, and an underwriter or team of underwriters evaluates the credit worthiness and risk level of your business. Factors that improve the likelihood of loan approval include an excellent credit score, solid financials that demonstrate sound business management, good EBITDA ratio, and a strong cash flow. All these metrics help the underwriters determine if the loan will overleverage the borrower and cause them to default on the loan in the future.
In addition to assessing financials, the underwriting team will also evaluate the character of the organization. The overall integrity of the leadership team influences the lender’s confidence that the loan will be repaid. If the employees are unhappy with the leadership team, they may leave and take their client relationships with them. Strong leadership and employee engagement will help you get approved for your business loan.
If you have additional questions about what is required for a loan from Oak Street Funding, please reach out! Our team of experts is available to answer your questions and help you find the solution that works the best for your business.