What is a business loan?
A business might require funds to expand, acquire additional operational machinery or to simply start-up operations. When the owner cannot raise the necessary funds, they take up a loan to specifically cater for their enterprises needs.
A business loan is debt that the enterprise will pay up using a schedule given by the issuing institution or the lender. The loan is paid up together with interest and associated costs, often referred to as the cost of the loan.
What differentiates a business loan from other forms of debt is that this kind of debt is only meant to finance business operations unlike a personal loan that is not restrictive in nature. For instance, with a personal loan, one can use the funds to buy whatever they desire may it be a vehicle, land or even investing in their startup.
To guarantee that the business or business owner will pay up the loan, different institutions require different documents and eligibility requirements before issuing a loan.
- Common requirements
- National Identity card of business owners if a sole proprietorship and those of directors in the case of a company.
- Kenya Revenue Authority PIN for business owners or company directors
- Business records to gauge business performance
- Business licenses including permits or business and company registration certificates
- Business or owner bank statements ranging anywhere from six months to years.
- Company-specific requirements
- A certificate of incorporation
- Memorandum and articles of association
- Passport-sized photos of each signatory and directors
- Board resolution on the company’s letter head sealed with the company seal
- Address confirmation, that is, estate name, road and house number of all directors and signatories
- Company physical address
- Annual returns
- Revenue stamp of Sh100
Business loan features
- Secured business loans: These kinds of loans require collateral as condition for accessing borrowed funds. A collateral is an asset that a lender accepts as security for a business loan. It could be a title deed, cash or shares in a listed company
- Unsecured business loans: This type of loan is given to customers who do not have tangible security. Instead of relying on security, a bank assesses the borrower’s creditworthiness before disbursing borrowed funds.
- Interest structure
- Fixed vs variable interest rates: A fixed interest rate is a loan where the interest rate remains the same throughout the life of the loan whilst a variable interest rate is where the interest charged on the balance at hand fluctuates based on the benchmark rate, in this case, the Central Bank of Kenya borrowing benchmark rate which changes periodically.
- Flat rate vs reducing balance: When one repays a loan under a flat rate regime, it means the interest paid is fixed. The amount of interest is calculated on the original amount and remains constant even as the premium reduces over time. In a reducing balance regime, however, the interest to be paid is revised every month on the outstanding debt amount. Since the premium one pays reduces over time, the amount of interest paid also shrinks.
- Repayment Frequency
- Fixed repayment- A fixed repayment period dictates that the loan premiums and interest should be repaid in fixed intervals, that is, weekly or monthly depending on the lender.
- Balloon/bullet - This is a large payment which is due at the end of a loan term following small repayments. Balloon payments are usually short-term. The borrower only pays a small premium each month, for instance, and makes one big payment at the end.
- Flexible - Typically offered by very few lenders, this mode of repayment allows the borrower to negotiate repayment that suits one’s business needs. This allows the borrower to pay in whatever amount they have at hand but within the loan repayment period.
What can a business loan be used for?
A business loan can be used to
- Raise working capital
- Fund business growth
- Buy stock and equipment
- Fulfil a contract
- Cover a one-off cost
- Expand operations
How Large of a Business Loan Can You Get?
The business loan amount that a business can access depends with a number of variables, including perceived creditworthiness, type and value of collateral, past business performance, and the size of the business.
How Do Lenders Determine Loan Amounts?
After submitting the loan amount that the business requires, the lender will assess the necessary documents including business records and collateral given, in the case of a secured loan, to determine the loan risk. If the business is perceived low risk, the lender will offer the amount the borrower asked for or give a higher amount. However, if the risk is greater, the lender can reduce the amount it will issue or deny the business access to the loan all together.
Pros of Business Loans
- Cash flow boost: A business loan can help an enterprise access the cash it needs and that might not be at its disposal to expand operations, invest in new equipment, meet payroll or pay other business expenses.
- Maintain business ownership: Unlike selling shares in one’s company to raise money, business loans give one direct access to cash without giving up control and equity in their firm.
- Large sums of money: For a startup, access to equity markets is often limited. The entrepreneur might not have contacts that can land him venture capitalist. A business loan in this instance gives a start-up access to cash that the owner might have otherwise been unable to raise.
Cons of Business Loans
- Loan application process and paperwork: To access a loan, a bank has to be confident that one can pay. In this instance, they mayrequire paperwork to prove that indeed, one can be able to meet their loan obligation. In addition to paperwork, the application process can be tedious depending on the loan type applied for.
- Default risk: Before taking out a business loan, it is important to assess risk of default. If one’s loan is secured, default in payments could mean loss of the assets. There are also legal ramifications if one defaults on an unsecured loan such as being blacklisted in a credit reference bureau.
When in need of additional capital to expand one’s business, a business is a worthy consideration. It is, however, important to ascertain beforehand what kind of loan works for you, whether a short or a long -term loan.
Remember to carefully weigh the needs of your business, growth needs and risk tolerance before applying for a business loan. Additionally, comparing business loans from different institutions is of outmost importance to select the right one for one’s business needs.