The first task for a new entrepreneur is to accrue enough startup capital to launch their business. While there are many ways to acquire that essential funding, the easiest and most popular is inarguably business loans. Yet, before an entrepreneur applies for any type of business financing, they should take the time to understand more about key terminology involved in business debt, to include some of the most important words below:
Banks are the typical traditional lenders that business leaders turn to for loans, but there are many different alternative lenders that can offer different options. Online lenders, peer-to-peer lenders and even family and friends fall under this category.
Many business loans are amortized, meaning businesses pay small amounts of principal and interest over time. Still, some loans involve a balloon payment, or a large lump-sum payment, due at the end of the payment term. Balloon payments are most common for short-term loans.
Long-term financing can take time to acquire, and in the meantime, businesses often need cash to continue operations. Bridge loans are short-term loans that help leaders attain the money they need before they can access larger loans.
Business Loan Terms
Business loans are only valid for as long as their loan terms, which is the amount of time between when a business receives a loan and when that loan must be repaid in full. Loan terms depend on the type and amount of the loan as well as the business borrowing it.
The cognovit note is a stipulation on a loan that allows the lender to take legal action against the borrower if they default. Generally, cognovit notes are used only when borrowers have poor credit or are for another reason considered to be high-risk.
Some business loans require the borrower to provide collateral, which is an asset that secures the loan. If the business defaults on the loan, the asset is seized to repay the debt.
A debt instrument is another way of describing the vast array financial tools businesses can use to access capital. Business loans, lines of credit, credit cards and more are considered debt instruments.
A common type of business loan, equipment financing helps organizations acquire the equipment they need to do business. Typically, these loans are secured against the equipment they help purchase, which makes them especially important to pay off.
Fair Market Value
Banks and other lenders use a variety of factors to determine a fair value they can offer to business borrowers. Some factors that go into calculating fair market value include the business’s credit standing, similar transactions for cash, prevailing interest rates, secondary market values of similar financial instruments, tax consequences and more.
Another typical debt instrument, invoice financing involves receiving the money owed to a business through invoices before the invoices come due. Businesses pay back the loans using the money earned from their invoices, which gives this loan a remarkably short term.
Loan to Value
Loan to value (LTV) is a ratio used by lenders to determine the risk of lending money to a business. The LTV compares the value of the loan amount to the value of assets that are being used as collateral.
Merchant Cash Advance
An alternative financing option, a merchant cash advance (MCA) provides businesses with a certain amount of cash that can be used to cover short-term expenses. Often, MCAs are used to cover cash-flow shortages. MCAs are then repaid through a portion of credit and debit card sales.
Many lenders will charge an origination fee when a business first takes out a loan. Paid upfront, the origination fee tends to be a small percentage of the loan amount.
Most business loans are repaid by businesses themselves, but sometimes, lenders require business owners to personally guarantee their responsibility for loan repayment. Then, if a business folds, the lender will still receive repayment from the owner’s personal wealth.
Some lenders will impose financial penalties on prepayment of loans. This helps to offset the income lenders will lose from a business borrower avoiding paying interest.
The world of business lending can feel like a foreign one. In addition to learning about the terminology associated with business loans, new entrepreneurs should build relationships with lenders to better understand the realm of financing options available to their new organization.