SUMMARY
Before you take out a business loan, you’ll be asked to read its terms and conditions. These terms contain key information about the nature of the loan, so it’s essential that you understand how they could impact you and your business. This article breaks down the most common business loan terms out there, so you can become an expert in reading the fine print. It also helps you identify which terms to prioritise to help you choose the best funding option possible for your SME. Finally, we offer our final thoughts and answer some frequently asked questions.
INTRODUCTION
Financing can provide a lifeline for small-to-medium-sized enterprises (SMEs). But before business owners anchor down a loan, they need to read its Ts & Cs first. For first-time borrowers and business finance veterans alike, reading through fine print can be a tedious process. What’s more, even if loan terms have been read, understanding them can be a different matter entirely.
Despite their banality, however, business terms are important. They outline the conditions of the loan and explain key information regarding how the funds should be paid back. Depending on which financing solution you pick, loan terms are likely to vary. So, if borrowers don’t understand how to compare these terms, they could risk picking the wrong funding option for their business.
This article defines some common loan terms and helps you weigh up their significance so you can move forward with a business loan with confidence. But before we explain how to compare terms, what exactly are business loan terms, and why are they so important?
BUSINESS LOAN TERMS EXPLAINED
When businesses take out loans, they need to agree to certain terms and conditions. Loan terms simply refer to the terms and conditions that are involved in a loan agreement.
While terms differ between lenders and funding types, common examples include:
- The loan’s repayment period
- The amount of interest being charged
- The type of collateral required
- Restrictions on its use
- The grace period before late fees are incurred
- Late payment penalty fees
In other words, business loan terms outline what’s expected of the borrower. So, if you want to manage your loan correctly and remain in your lender's good books, it’s important that you understand and abide by these terms fully.
What’s more, loan agreements and the terms they include are legally binding. This means that if business owners break the agreement or fail to fulfil its terms, they also risk legal action against them.
Now that you understand the basics, let’s break these loan terms down a little more.
MAIN LOAN TERMS TO LOOK OUT FOR
Repayment terms
Business loans vary in length. Repayment terms mark the period of time from the beginning to the end of the loan. In other words, they refer to the amount of time borrowers have before they need to repay their debt in full. Depending on the unique circumstances of your business, different repayment terms may be preferable.
For instance, if you’re looking to pay off your debts as quickly as possible, it’s best to look for options with shorter repayment terms. This could include short-term loans, lines of credit or invoice financing solutions. Conversely, if you’re looking to split your repayments up over a longer period of time, then longer-term private loans or traditional bank loans may be more appropriate.
Interest rates
When business owners borrow money, they are expected to pay back the original sum with additional interest. An interest rate refers to the percentage of the loan that's charged on top of the basic credit. It represents how high the cost of borrowing will be, so it's always worth choosing loans with reasonable rates.
Business loan interest rates vary dramatically. The main factors that affect interest rates include a business’s credit history, the length of time it's been trading, the type of loan being accessed, the security of the finance and the lender that’s offering the loan. Due to these influences, the best interest rates are typically offered to established businesses with strong credit histories. Alternatively, startups, new businesses and businesses with poor finances are often required to pay higher interest rates.
Security
The terms of a business loan will also touch on how a loan is secured. When a borrower takes out a loan, it will either come in a secured or unsecured form. Secured business finance represents any type of loan that’s been backed up by assets like property, vehicles or machinery. Conversely, unsecured business loans are sums of borrowed money that aren’t backed up by any type of asset.
For small businesses and first-time borrowers, unsecured loans tend to be the most popular option. This is because they're generally more flexible, and if business owners default on their payments, they won't risk losing any assets as collateral. However, since unsecured offer less security to the lenders, businesses are often charged higher interest rates to mitigate these risks.
Restrictions
With most business loans, you're free to use them as you wish. However, certain lenders place restrictions on their loans which limit where borrowers are able to spend their money. These restrictions are also known as loan covenants, and they come in two main types, affirmative and negative.
An affirmative loan covenant is a clause in the contract which directs borrowers where they should spend their loan. Typically, these restrictions encourage businesses to make sensible investments that are likely to benefit their financial health in the long term. Alternatively, negative loan covenants limit business owners from making financial decisions. This lowers the borrowers risk of defaulting but also reduces their financial autonomy.
If business owners break these clauses, they risk defaulting on their loans. In this case, lenders have the right to demand full loan repayment. To avoid this scenario, it's important that borrowers always check for restrictions before they select a business loan.
Grace periods
When businesses miss a payment date, there is normally an agreed-upon amount of time where a payment can be made without a penalty. This is called a grace period. Throughout the grace period, no late fees are charged, and the delay in payment can not lead to loan default or termination of the contract. Furthermore, when payments are made during this time, the credit profile of businesses aren't affected.
If your business has a history of late payments, it may be worth seeking financing options with generous grace periods. However, because the nature of this may vary from lender to lender, it’s important to carefully examine the loan terms before moving forward with a solution.
Penalty fees
If you fail to make a loan repayment by the deadline and miss the grace period, you may be subject to a penalty fee. This penalty fee is normally based on a percentage of your monthly repayments, and it can increase each day it remains unpaid. In some cases, lenders also charge administrative costs for having to notify you about the charge.
While penalties aren't likely to break the bank, if the borrower fails to pay back the loan for an extended period of time, costs can escalate quickly. Also, if the debt is left outstanding for several months, business owners run the risk of default on their loan. If this happens, it could ruin your chances of accessing business financing in the future.
In rare cases, lenders might also charge if a business attempts to repay its debts early. If you’re looking to clear your debt as quickly as possible, it’s recommended that you look for providers that don’t charge for early repayments.
WEIGHING IT UP: WHICH TERMS SHOULD YOUR BUSINESS PRIORITISE?
When it comes to reading the terms of a loan agreement, every detail is important. However, depending on your situation, some terms may be more relevant to your business than others. When working out which conditions to prioritise, you should factor in your business’s immediate needs and future financial projections. This way, you can determine which loan terms are worth paying more attention to.
For instance, if your business requires a lot of capital and would rather pay it off over a long period of time, you should favour loans with longer repayment terms. Alternatively, if your cash flow projections look tight and you aren’t able to guarantee consistent future earnings, you should opt for solutions with affordable interest rates, generous grace periods and reasonable penalty fees.
It’s also important to consider how much financial freedom you’re after and if your business can offer any collateral. By identifying these key requirements early on, it’ll be much easier to know what to look out for when scanning the fine print. Ultimately, this will help you to settle on a funding option that’s the best possible fit for your SME.
FINAL THOUGHTS
Securing small business funding can be a headache, but it doesn’t need to be. By accounting for the needs of your business and knowing which terms to look out for, you can compare options with ease. Not only does this take the fuss away from finance hunting, but it also can save you precious time. This allows you to focus on things that really matter, like your SMEs next steps.
Whether you’re nurturing a startup or looking to take your small business to the next level, Kriya offers generous terms on all its financial solutions. We offer affordable interest rates to keep the cost of borrowing low, flexible repayment terms that adjust to your business’s needs, and we don’t charge for early repayment.
If you want to learn more about our cash flow solutions and about what we do here at Kriya, you can visit us here.
FREQUENTLY ASKED QUESTIONS (FAQS)
What business loan terms should I look out for? When it comes to reading the loan agreement, every term is important. However, some key loan terms to look out for are the repayment terms, the interest rates and whether or not there is a covenant placed on the funding. If you breach any of these terms, you could face serious financial and legal repercussions down the line. Therefore, it’s always worth paying attention to these terms before signing an agreement.
How do I compare business loan terms? Depending on your situation, some terms may be more relevant to your business than others. When working out which conditions to prioritise, you should factor in your business’s immediate needs as well as its future financial projections. This way, you can determine which loan terms are worth paying more attention to.
What does a repayment term refer to on a business loan? Repayment terms mark the period of time from the beginning to the end of the loan. In other words, they refer to the amount of time borrowers have before they need to repay their debt in full. Depending on the unique circumstances of your business, different repayment terms may be preferable.
What are some common business loan terms? While terms differ between lenders and funding types, common examples include the loan’s repayment period, the amount of interest being charged, the type of collateral required, restrictions of its use, the grace period before late fees are incurred and late payment penalty fees.
What’s the difference between an affirmative and a negative loan covenant? An affirmative loan covenant is a clause in the contract which directs borrowers where they should spend their loan. These restrictions encourage businesses to make sensible investments that are likely to benefit their financial health in the long term. Negative loan covenants limit business owners from making financial decisions. This lowers the borrowers risk of defaulting but also reduces their financial autonomy.
What is a business loan grace period? When businesses miss a payment date, there is normally an agreed-upon amount of time where a payment can be made without a penalty. This is called a grace period. Throughout the grace period, no late fees are charged, and the delay in payment can not lead to loan default or termination of the contract.
