How business loans work – Learn how commercial or business credits work and how you can obtain one. In addition, we show you the factors that the different institutions measure to approve this type of credit.
A commercial loan is basically any credit that made in the name of a business, and that destined for its expenses. The three key concepts that distinguish this class of loans are money to make money, financing equals trust, and interest equals risk.
MONEY TO MAKE MONEY
All money a business requests through a loan must be multiplied and not spent. It can be used in marketing, purchasing tools, and hiring more workers, all those activities that will generate more income for the business.
FINANCING EQUALS TRUST
The more trustworthy the business and business owner presents themselves to the lender, the lower the interest or cost of the loan. Trust factors include credit history, cash flow, time of business and the industry in which it operates.
INTEREST EQUALS RISK
The cost of the loan is associated with how risky the operation is. The more complex the trade is for a lender, the higher return he or she will want. You cannot pretend that with a difficult process, with a client with a low credit history and with a recent business, you have a low-interest rate.
WHO LENDS MONEY TO BUSINESSES IN THE UNITED STATES?
In the United States, the business loan system or the commercial financing ecosystem is not exclusive to banks or accredited financial institutions, as is the case in most Latin American countries, but is much more open and accessible to different actors.
Five broad categories of entities lend money to businesses: Institutional lenders, big banks, small banks, credit unions, and alternative lenders.
They are, basically, the Government through MBA and SBA or entities that work supported by state funds. These institutions are the ones that lend the most money in the United States for businesses, covering 75% of the market.
JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley, among others, make up the so-called “big banks” that have a presence throughout the United States. They cover 55% of the market.
Also known as “local” banks. This group comprises institutions such as Bank of Southside Virginia, Clear Mountain Bank, New York Community Bank, Community Bank Oregon, Blue Harbor Bank, Austin Capital Bank, Beneficial State Bank, Community Bank NA, and Cross River Bank, among others. They cover 50% of the market.
In Spanish Credit unions. The fundamental concept of this figure is that of a group of people with specific capital who come together and lend money under an institutional structure. They cover 40% of the market.
They are actors who have appeared in the last ten years. Financial companies dedicated to specific products, such as billing and online loans, are grouped here. All figures not in the institutional or banking categories are considered alternative lenders. They cover 30% of the small business market.
IN WHICH SEGMENT DO SMALL BUSINESSES LEND?
Looking at the drawing above, we can infer that the market for alternative lenders is small, but it is a misleading number. Most of the market is indeed covered by institutional lenders and big banks. However, there is a catch since the table is given based on millions of dollars placed and not by several small businesses that benefited.
Most of the users with whom institutional lenders and big banks work are large companies, and the loans they grant are generally five million dollars or more.
On the other hand, the majority of small businesses in the United States are served by small banks, credit unions and alternative lenders, generating an exciting business niche.
Each lender has different credit products to offer to small businesses. They have other lines of loans. This generates that the universe of options is quite large and promising.
WHAT FACTORS DO LENDERS ANALYZE TO LEND MONEY TO A BUSINESS?
Lenders analyse four significant factors before approving a small business loan: Business stability, financial metrics, credit history, and cash flow & debt.
The stability of the business analyzes how old the company is (a company that is three years old is much less risky than one that is one year old), the cyclicality (a company that has an intermittent sales volume has a risky cyclicality), the seasonality (if the company has very high or very low seasons), and customer concentration (a company that has many customers is less risky than one that has few, even if it invoices less).
One of the metrics that are measured to give a loan is the income of a business. Then there is profitability (if a company wins, it is much less risky than the one that loses). Then follows growth (if the company constantly increases its turnover, it is less risky). Finally, there are profit margins (the higher the profit margin of a company, the less complicated it is).
It is basically the credit history of a business or its owner. The owner’s credit history will analysed if the company has not had commercial credit.
What analyzed in this category? How the business and the owner have paid their debts. A company that has never had debt is much riskier.
Cash flow & debt
It is the cash flow of your business and its debt levels. The first indicator that looked at the “debt to income”, which the burden of debt on income, that , how much of what the business enters per month used to pay the debt.
Then the “income to debt payments” reviewed, that is, how much the business allocates to pay debts. Then there is the “amount of debt”, which is the amount of the obligations, and, finally, the type of debt (short, medium or long term) that a business has.
REVIEW DEPENDS ON EACH LENDER
Not all lenders review all the factors we have exposed in this article. Some lenders only pay attention, for example, to cash flow & debt and credit history since they only lend in the short term.