What is a Conventional Bank Loan?
Whether starting or expanding a small business, entrepreneurs are likely going to need access to capital. While some can finance their business with personal funds or credit cards, oftentimes, they need outside funds. There are a number of sources to get small business financing, and conventional loans from banks are the most common source. Not to be confused with SBA loans, conventional business loans are provided by banks, many of which are likely in your community. Like getting a loan for the purchase of a home, many banks have small business loan programs. Typically smaller banks will have more local decision-making authority than larger banks as they tend to have centralized approval, but smaller banks tend to have lower loan limits.
There are many ways to structure a business loan, and with so many options, it is a bit confusing to know what is available and make the best choice for your business. Any business can get a conventional bank loan, but since these loans are not guaranteed by anything other than the owner’s personal assets and the assets purchased by the business, banks are more likely to lend to businesses that demonstrate the ability to make the payments in addition to the equity and collateral to cover the loan should the business not be able to repay the loan. Especially for startup businesses, banks are going to charge a greater interest rate on the owners’ credit and outstanding debt. It would be a good idea to check your personal credit before going to the bank. Also, be aware, regardless of whether your business is a corporation or LLC, you will likely have a personal guarantee and be responsible for paying back the loan should the business not succeed.
Commercial business loans can provide short, intermediate, and long-term funding for companies, depending on what the loan will be used for. You will typically want to match the loan term to what is being borrowed. For example, inventory should be a shorter term than a building since you don’t really want to be paying on inventory for a long time since it should be sold quickly. Provided the amounts are low, banks will typically wrap up a loan into one term for simplicity, but if not, they would look to multiple loans.
As a startup, expect to put down between 20%-30% of the total project amount while expansion projects can be 10%-25%. There is a lot of variability amount down depending on credit scores, equity, collateral, and the industry of the business.
Interest rates will be different depending on the borrower’s credit score, length of term, quality of the collateral, risk of the business, etc. Loans can be fixed or variable, with fixed being most common for real estate and equipment, while inventory or working capital is more likely to be variable.
Loan Application Process from a Commercial Bank
The process of getting a business loan basically has the small business owner preparing a business plan and making an appointment with the commercial loan officer (at many smaller banks, it will be the bank president). The loan officer spends a little time talking with the entrepreneur and looking over the plan to get an idea of the scope of the project, provide some initial feedback and see whether the project fits within their lending parameters.
Many banks will have a list of industries they won’t lend to, like startups, restaurants, trucking, etc., so we recommend setting up appointments with three banks at a time. If you talk to one bank at a time, there is a good chance your plan sits on their desk for several weeks to months before any review, losing valuable time. By talking with three banks and say all three say no, you now have feedback that you can use to improve the plan for the next round of three banks. Also, by going to multiple banks, there may be multiple offers, which provides the opportunity to select the best deal and get a lower interest rate, longer repayment terms, or lower loan fees.
After the meeting, the loan officer will further review the plan and financial statements to see if there are areas that need further development. The loan officer will have a good indication at this first meeting whether the bank will fund the project internally or need a loan guarantee from the SBA. With some projects, the bank is going to want additional security, and the loan guarantee takes a lot of risk from the lender.
Contrary to popular belief, the SBA does not make the loan to the business. Instead, the SBA provides a loan guarantee to the bank for a percentage of the loan amount. That guarantee varies depending on the program and amount borrowed.
Even with the lower risk a lender has by using an SBA loan guarantee, borrowers with bad credit may need to look for other funding options, such as microloan programs.
Once the business plan is completed it will also need to be reviewed by the underwriter. The underwriting process evaluates the borrower’s credit, capacity to borrow, collateral, and projected cash flow to quantify the risk to the bank. After going through underwriting, the project goes in front of a loan committee to provide final approval or denial.
How long does it take to get a business loan?
Depending on the bank, you could be looking at 2 weeks to 3 months for a loan funded in-house, but it will be faster than getting an SBA guarantee which will add an additional 2 weeks to 6 months, as the bank has additional paperwork to prepare in addition to the SBA’s processing time.