If you're just starting your hunt for business financing, you're likely knee-deep in unfamiliar phrases and financing jargon. And it is enough to make even the most excited entrepreneur feel helpless. Do not continue your search without even reviewing a few of the vital terms you need to know to make an informed choice about financing your business. We have broken down eight must-know conditions under.
1. Term loan.
Term loans are a lump sum of cash you pay back, and interest, over a fixed period of time. Classic term loans usually offer longer payment terms and lower monthly payments than short-term loans and other kinds of emergency funding.
Securing a term loan, however, requires a high degree of creditworthiness on the section of your small business. If your business is very young, has poor credit, or presents any other sort of risk to your lender, you can find it difficult to procure a term loan from a conventional lender.
2. SBA loan.
Small Business Administration loans provide even longer terms and lower costs than traditional term loans, as they come partially guaranteed by the U.S. government. SBA loans are specifically designed to provide small business owners the most affordable financing potential as they grow their own businesses. (Brace yourself, however, for a long and aggressive approval process and a great deal of paperwork)
3. Line of credit.
Another popular loan product your lender may provide is a business line of credit. This kind of funding provides a borrower with revolving credit, allowing you to borrow and pay back that borrowed amount over and over while staying within a maximum, as you would using a credit card. Unlike a loan, a line of credit offers you funds as needed, and you'll only pay interest on what you withdraw.
4. Annual percentage rate.
An annual percentage rate, or APR, is essentially the annual price of your loan. It is quoted as a percentage, such as your interest rate, but provides a more precise perspective of what your loan will cost you. In addition to interest , your APR will also include some origination fees, closing fees, documentation fees, etc.. The APR offer you receive will vary from lender to lender, based on the loan product you're looking for and your history as a borrower.
If you have been eyeing a loan, make sure you consider its APR before moving forward. The loan's total yearly cost might be greater than you anticipated.
5. Income statement.
An income statement details your business's net income, revenue and expenditures for a specific period, such as quarterly or yearly. You will come across this period when filling out your loan application. It is among the most significant elements of your program. You may also see it called a"profit and loss statement"
This document illustrates your business's financial health and the strength of its bottom line to your lender. You are able to prepare your statement yourself with the help of an accountant. Income statements come with their very own set of jargon, so it will help to familiarize yourself with their terminology prior to diving on your own.
Collateral describes any asset you pledge to a creditor to help secure financing. This could include real estate, equipment, accounts receivable, inventory -- whatever a creditor could liquidate if you default. Collateral minimizes the danger to your creditor should you don't maintain your end of the bargain.
If you're considering a secured loan, then expect to put up security when you employ. Unsecured loans won't require security and typically arrive with less stringent credit requirements, but also higher prices.
7. Personal guarantee.
If you agree to a personal guarantee when taking out a loan, you commit to being personally responsible for your debt in case of default. Unlike security, this type of security allows a creditor to capture personal assets in the event that you can't pay off your loan -- assets like your retirement fund, your car, or your property. Limited personal guarantees put a cap on how much can be collected, while unlimited personal guarantees permit a lender to pursue you until your debt is repaid.
Personal warranties can be confusingly worded, so it is best to consult a legal practitioner before accepting financing with a personal assurance.
8. Debt-service coverage ratio.
Your debt-service coverage ratio, also called the debt coverage ratio, is the ratio of money a company has available for servicing its debt, which includes making payments on principal, interest and rentals. It's computed by dividing a business's cash flow (more especially, net operating income) from the debt service obligations (loan and lease payments). If your business owes more than it earns, you will have a DSCR of less than 1. If you are at the top of your debt, then you are going to see a DSCR of greater. Most lenders want to see a DSCR of 1.25 or over. They need borrowers who is able to take on new debt, together with some additional cushion.
This is not an exhaustive list by any means. But we expect it will help point you in the ideal direction. The more you know that the lexicon of small business loans before you begin your search, the better you'll be able to guarantee the right loan for you.