Both debt and equity financing have a rightful place in all but the smallest of businesses. If we focus on debt financing, most small businesses have traditionally gotten most of their business loans from commercial banks in the form of term loans. Those term loans may have short, intermediate, or long maturities. The different lengths of maturities signify not only different time periods in which the firm can repay the loans, but different purposes for the loans as well.
What are Short-Term Business Loans?
Small businesses most often need short-term loans instead of long-term debt financing. Most term loans, classified as short-term, usually have a maturity of one year or less. They must be repaid to the lender within one year. Most short-term loans are often repaid much more quickly than that, often within 90-120 days. Term loans with short maturities can help you meet an immediate need for financing without requiring you to make a long term commitment.
Purposes of Short-Term Business Loans
Short-term loans are helpful to businesses that are seasonal in nature such as retail businesses who have to build up inventory for the holiday season. Such a business might need a short term loan to buy inventory well in advance of the holidays and not be able to repay the loan until after the holidays. That is the perfect use for the short-term business loan.
Other uses for short-term business loans are to raise working capital to cover temporary deficiencies in funds so you can meet payrolls and other expenses. You may be waiting on credit customers to pay their bills, for example. You may also need short-term business loans to pay your own bills; i.e. to meet your own accounts payable (what you owe your supplier's) obligations. You may just need a short-term loan to even out your cash flow, particularly if your company is a cyclical business.
Qualifying for a Short-Term Loan
In order to qualify for a short-term loan, you will have to present comprehensive documentation to your lender, whether it is a bank, a credit union, a mutual bank, or some other type of lender. The lender will want, at least, a record of your payment history for other loans you may have had, including payment histories to your suppliers (accounts payable) and your company's cash flow history for perhaps the last 3-5 years. You might also be prepared to hand over your income statement for the same amount of time if the lender requests it. All documentation should be in a professional format.
Your qualifications for a short-term loan will help determine whether or not the loan will be secured by collateral or whether it will be an unsecured, or signature, loan.
In a normal economy, interest rates on short-term loans are higher than interest rates on long-term loans. In a recessionary economy, however, interest rates may be low and short-term loan rates may be lower than long-term loan rates. Short-term loan rates are usually based on the prime interest rate plus some premium. The bank or other lender determines the premium by determining what risk your company is to them. They do this by looking at the documentation you provide them in order to qualify for a short-term loan.
Short-term loan interest rates can be calculated in a number of ways. You want to get your lender to calculate the interest rate in the way most affordable to you. Take a look at the different ways short-term interest rates can be calculated and use this as your guide when talking to a bank loan officer. Also, be sure that you are knowledgeable about the current prime interest rate so you can talk intelligently to the bank loan officer as you negotiate the interest rate on your short-term loan.
Short-term Loans and Start-up Businesses
It is possible for a start-up company to secure a short-term loan. This is because short-term loans are less risky than long-term financing simply due to the fact of their maturity. Start-up firms have to present extensive documentation to the lender, such as projected cash flow statements for the next 3-5 years along with projected financial statements for the same time period. They have to explain where their revenue will be coming from and how it is expected to be paid.
Most start-up companies will only qualify for secured loans from a lender. In other words, the start-up firm would have to offer some sort of collateral to secure the loan with the lender.
Short-term Loans and Small Business
The availability of short-term loans to small businesses is absolutely essential in order for our economy to operate smoothly. Without short-term financing, small businesses literally cannot operate. They can't buy their inventory, cover working capital shortages, expand their customer base or operations, or grow. When commercial banks tightened up their lending policies during the Great Recession and afterward, small businesses and the economy suffered because of these very issues.