Term Loans: The Pros, The Cons, and Everything in Between

By Samantha Novick

Managing cash flow is a critical part of running a small business. As your business thrives, you’ll likely come across opportunities to generate more revenue, which will almost always require an upfront investment or payment. You may need to hire additional staff to cover new breakfast hours at your diner or purchase inventory in bulk to stock for the holiday season. To cover these expenses, you’ll need cash on hand, and term loans can help you bridge this gap.

Term Loan Basics

A term loan works very similarly to a mortgage or student loan. You borrow a lump sum of cash upfront and pay it back in fixed installments (weeky, bi-weekly or monthly) over a set period of time (hence the name “term loan”).

What Can You Use a Term Loan For?

Term loans are best suited for business projects that will generate a steady stream of income. Here are just a few examples of how you might put a term loan to use for your business:

  • Remodel your existing premises or open an additional location
  • Boost cash flow
  • Cover daily operational expenses
  • Purchase inventory (in bulk) or invest in new equipment
  • Grow your team or hire seasonal staff
  • Refinance or consolidate business debt

Advantages and Disadvantages of Term Loans

There are a few primary advantages of term loans:

  • Speed of processing: Time is money and some opportunities won’t be around for long. For businesses that need cash quickly, an online term loan can be approved within a few days. Waiting on a decision from a traditional bank or the Small Business Administration (SBA) may take as long as several weeks (or months).
  • Lower interest rates: Term loans are often offered at lower interest rates and annual percentage rates (APRs) compared to other shorter-term financing options, such as a business credit card or merchant cash advance.
  • Straightforward budgeting: Term loans are paid back in fixed installments on a set schedule, so it’s simple to project the required budget for the duration of the loan period.
  • Higher loan limits: Term loans are available for as little as $25,000 (purchasing a piece of equipment) or as much as $1,000,000 (acquiring real estate and developing a new store).
  • Preserves ownership: Term loans fall under debt financing rather than equity financing, meaning that it does not involve selling a portion of your business in order to secure funds. This allows you to keep 100% of your ownership and run your business the way that see you see fit.

Term loans have a few different requirements that may not be the right fit for all business owners, including:

  • Requires a guarantee: Extending capital to small businesses can be considered a risky endeavor, so most lenders require a personal guarantee to offset this risk. When you sign a personal guarantee for a term loan contract, you agree to be personally liable with your assets for a portion of the business debt. While default is an unlikely case for most business owners, it’s still important to understand the fine print of your contract.
  • Requires higher credit: Lenders will likely check both your personal and business credit, as well as your financial history when you apply for business funding. Know your personal credit score and review your credit report. Make sure that your credit history is up-to-date and that your score meets the minimum requirement of the lender. It may be worthwhile to improve your score before submitting a loan application, which can increase your chances of getting approved (at a more favorable rate).
  • Requires demonstrated profitability: Lenders will also require a demonstrated history of profitability in order to assess your qualifications for a loan—usually around two years worth of financial history.
  • Fees: Just like any other form of small business financing, lenders may charge fees, including origination fees, prepayment penalties, late payment penalties, and monthly or annual loan fees. Be sure to read closely through your loan offer to determine which (if any) of these fees may be tacked onto your cost of borrowing.

Samantha Novick is a content marketing writer covering business and finance for Funding Circle.

Term Loans stock photo by William Potter/Shutterstock