Private manufacturers and distributors can select from a wide menu of loan options from financial institutions. Popular choices include lines of credit, term loans, leases, mortgages and Small Business Association (SBA) loans. Which is right for your business in today’s low-interest, tight lending environment?
Lines of credit
You may need a line of credit to fund working capital shortages that arise as you grow or ramp up inventory during seasonal or cyclical peaks. These loans are usually based on the prime interest rate and collateralized by the company’s working capital.
Credit lines give borrowers open-ended access to cash, with flexible repayment terms and without the need to reapply every time there’s a working capital shortage. However, banks reserve the right to review a borrower’s financial statements and periodically readjust credit terms or call the line.
Term loans and leases
You may need equipment and vehicles to make goods or deliver them to customers. These fixed assets can either be purchased with cash and loan proceeds or be leased.
Purchasing fixed assets with term loans makes sense when you expect the items to last for a long time without becoming obsolete. Creditworthy businesses can usually borrow up to 80% of an asset’s purchase price at a fixed interest rate over five to seven years.
Leasing may be a smart alternative when assets will need upgrades or you have limited capital for a down payment. Lease payments are typically lower than term loan payments, but the company doesn’t own the equipment at the end of the lease term. Some banks offer hybrid products that combine the best elements of leasing and owning, however.
Banks also finance real estate purchases and construction projects. Commercial property mortgages typically require a loan-to-value ratio of 80% over a 10- to 15-year term.
Property ownership gives manufacturers more control over making improvements. Plus manufacturers that build up equity in property can pledge it as additional collateral.
Commercial banks are the intermediary for loans that are guaranteed by the SBA. One popular option is the 7(a) program, which offers general purpose loans to small businesses (as defined by the SBA based on industry classification codes).
There are a few use restrictions. For example, proceeds can’t be used to buy an asset to hold for its potential increased value or to reimburse owners for money they previously put into their business.
Ready, set, apply
Contact your CPA advisor for more information on these financing options or for help compiling financial data to apply for a loan with confidence.