When you started a small business, chances are your dream wasn’t to stay small forever. After several years in operation, you may be ready to take the leap into the medium-sphere, one of the most important sectors of the U.S. economy. If you’re going to take your business to this new level, you’ll need the resources to get there and small business loans may only get you halfway. In this guide, we cover one of the most effective types of financing for medium-sized businesses: commercial loans.
What Is a Commercial Loan?
The official definition of a commercial loan is a loan made to a business, rather than a loan made to an individual for personal use. While the term “commercial loan” can technically apply to any loan made to a business, lenders also use this term to describe larger loans made to medium and large companies. Small business loans are typically for lower amounts.
The National Center for the Middle Market defines a medium-sized business as one with revenues between $10 million and $1 billion a year. These businesses employ roughly 44.5 million people across the U.S. and represent about a third of the entire economy. Each lender may define a medium-sized business differently, though, so don’t worry if your business doesn’t fit into this standard definition.
What Separates a Commercial Loan From Other Loans?
As you can guess from the names, one key way commercial loans are different from other loans is the amount of money you can borrow. While each lender will have their own standards, small business loans commonly max out at around $100,000. A commercial loan can go up to $500,000 and higher.
The larger size of a commercial loan means that lenders may be willing to consider more flexible payment terms and conditions. For example, a lender may offer a balloon payment plan where you pay less per month in exchange for making a large lump sum payment at the end.
Finally, qualifying for a commercial loan can be more difficult, since the lender will be giving out more money and the stakes are higher. The process depends on the type of lender. A traditional lender will have a more formal, lengthier application process whereas an online lender may have a quicker process, where they just need to verify your income. In any case, to qualify for a commercial loan, expect that your business will need higher revenues, a longer track record and/or greater collateral than you would need to take out a small business loan.
Types of Commercial Loans
Lenders break down commercial loans into different categories, depending on the goal of the loan and how it will be repaid. Some of the more common options on the market today include:
Term loans — These are your standard loans with fixed monthly payments. When you apply, you pick how much money your business needs and how long you’d like to repay the commercial loan. This could be anywhere from two years to 25 years or longer. The lender will set an interest rate for your loan and then set your total monthly payments, which will be a combination of interest and paying down your balance.
Short-term loans — Short-term business loans are for smaller amounts of money that you typically pay back within 18 months or less. In exchange, these loans have a simpler, faster approval process than a term commercial loan. Some even have one-day approval. Short-term loans are useful for restocking inventory, meeting payroll, handling an emergency repair, and a variety of other daily operating costs.
Equipment loans — You can use these loans to buy an expensive piece of equipment or other assets for your business. With equipment loans, you may be able to secure the loan just using the asset itself so your business will not need to put up any other forms of collateral.
Commercial real estate loans — These loans will help your business buy a new piece of property, like a new or second office, warehouse or manufacturing facility. Commercial real estate loans are for the largest amounts of money and have the longest length. They are also secured by the property your business is buying.
Line of credit — With a commercial line of credit, the lender approves your business for a maximum borrowing amount, like $100,000. You then can borrow up to this amount whenever you want. After you repay the funds, you can borrow again. It’s not a one-time loan but rather an option to borrow at your convenience.
SBA commercial loans — SBA commercial loans are part of a government program run by the Small Business Administration. They offer similar commercial loan options, like term, real estate and lines of credit. The SBA doesn’t lend money itself but instead partially guarantees repayment of a business loan. You get a loan from a bank or private lender, and if your business doesn’t pay everything back, the SBA covers some of the loss.
Even though the SBA has small business in their name, their loan programs are extensive enough that they can be useful for medium-sized businesses looking for commercial loans. For example, their 7(a) fixed term loans go up to $5 million. However, when you apply for an SBA loan, you will pay some additional fees to the government. This is how they finance their guarantee. In exchange, you may be able to qualify through the SBA loan program even if your business would be rejected for a regular commercial loan.
Advantages of a Commercial Loan
The immediate benefit of a commercial loan is your business gets the money it needs to expand right away. You don’t need to wait until you’ve saved up from your existing revenues, which can take years. Since commercial loans divide the repayment schedule over a lengthy amount of time, often 10 years or more, your monthly payments are more manageable even for large amounts.
The lender could be willing to set a more flexible payment schedule, that matches when you think you’ll best be able to repay, an option that might not be available for a smaller loan. While the lender will charge interest on your loan, whatever you end up paying in interest will be tax deductible.
Finally, with a commercial loan, you’ll get a large amount of money for your business without giving up any ownership. It’s not like bringing on an investor who will take a percentage of your company in exchange for the money.
Potential Downsides of a Commercial Loan
You will need to qualify for a commercial loan and this application takes some work. Different lenders have different standards, but you can usually expect them to consider your credit score, business history, current revenues and assets.
Depending on their decision, they may ask for collateral, which means you need to secure the commercial loan with other assets like equipment or real estate that your business owns. So long as you repay your loan, that won’t be an issue, but if you fail to pay back your commercial loan, you could lose the collateral.
When you borrow, there is always a cost. The lender is going to charge interest to make up for the risk that you might not pay the money back. While the interest will be spread over time and is tax deductible, it’s still another expense. That’s why you need a clear plan for using the money effectively when you borrow; your growth should be more than the cost of the loan.
Lenders could charge other fees for establishing your commercial loan, like an origination fee to get things started or a fee to process your application. Once again, you need to weigh these costs against the potential benefits of borrowing.
What Are Ideal Business Uses for a Commercial Loan?
If your business needs money to grow and expand, a commercial loan could be the solution. Some of the more common uses of a commercial loan include:
- Purchasing new equipment — Remember, you could secure the loan with the asset itself so you may not have to put up collateral.
- Renovating or upgrading your existing facilities — Improve the safety, size and efficiency of your current workplace. Your customers will tell the difference.
- Securing working capital spending — When your business needs more cash to make payroll, restock inventory or handle bills, you can use a commercial loan to keep up until your customers catch up on payments.
- Buying a new property —Do you have your eye on a new piece of real estate for your business? A commercial loan can close the deal.
- Expanding your sales — Whether you want to launch a new marketing campaign, hire additional staff or target a new territory, a commercial loan gives you the money to do so. By generating new business, the loan can pay for itself.
What Type of Company Should Consider a Commercial Loan?
As mentioned earlier, a commercial loan is best suited for mid-sized companies, those with $10 million a year in revenue or more. These are the companies where it makes sense to take out larger amounts through a commercial loan. If your business is looking for less money, focus on small business loans instead.
Some common industries that use commercial loans include (but aren’t limited to): agriculture, construction, beauty and wellness, restaurants, trucking, medical business and retail. As you can see, it’s a broad range that includes many different types of businesses.
If you can demonstrate that your company will grow because of the loan and you’ll be able to pay the money back in a reasonable amount of time, you should be a good candidate for a commercial loan.
Where Can You Get a Commercial Loan?
Traditional lenders like banks and credit unions are a common source of commercial loans and your chance of qualifying are better today than a few years ago. Forbes reported that business loan approval rates from large banks were the highest they’ve been in about a decade, since the last recession. But even though traditional lenders are approving more loans, they still may have the toughest standards and application process.
If you’re worried about qualifying for a regular commercial loan, another option is to try applying through the SBA program. They list lenders in your area who are approved to handle SBA loans. You will still be dealing with a bank or other lender, but the standards will be a little easier. In exchange, you’ll owe the extra SBA fee.
Finally, there are online lenders specializing in commercial loans. These lenders use a simpler process so you are more likely to be approved and with a faster turnaround.
Applying for a Commercial Loan
When you apply for a commercial loan, lenders will consider several factors to decide whether you qualify like:
- Your credit score
- Your business revenue over the past several years
- The collateral you could put up for the loan
- How your company will use the loan proceeds as well as your overall business plan
- Your business financial statements showing your current business assets, liabilities, profits and losses
What you’ll need to be approved depends on the type of lender, the amount you want to borrow and type of commercial loan. Traditional lenders and the SBA have tougher standards and will expect to see a full range of documents including your financial statements, tax returns and business plan. With an online lender, you may be able to qualify by proving you meet their minimum revenue requirement.
Don’t let a lack of cash stop your business from expanding. Remember, one of the most costly mistakes a business owner can make is not borrowing when they need to: the cost of doing nothing. We hope we’ve answered your question of “What is a commercial loan?” and more. By following the information in this guide, you can decide how this type of financing fits into your vision of business growth.