Finding the Right Type of Loan

Despite the intimidating procedures involved in negotiating a loan, your banker wants to lend you money. That’s the institution’s business. He has to be certain, however, to keep the bank’s money under control. One way to impress your banker is to speak his language; structure your loan proposal so that it fits neatly into one of the many loan categories that the bank uses.

There is plenty of room for maneuvering within these categories, but to keep the bank comfortable, your loan request should fit into one of the following groups:
Short-term loans: Short-term credit is the backbone of commerce. Businesspeople use short-term loans (defined as loans maturing in one year or less) to finance everything from inventory to emergencies. Here are a few of the most common short-term loan classifications:

● Time loans. For companies with good credit ratings, the time or commercial loan is the chief source of financing. It keeps bookkeeping to a minimum and can be used for any purpose, including inventory and accounts receivable. Time loans usually mature in three to six months but can be refinanced for longer maturities.

● Accounts receivable. In this type of loan, the bank lends you 70–80 percent of the value of eligible receivables. As checks in payment for receivables come in, you forward them to the bank, which deducts its portion and deposits the rest in your account. Interest is paid only on the amount of the loan outstanding. To be eligible for financing, receivables usually must be less than 60 days old, and your customers must be creditworthy.

● Line of credit. A line of credit is by far the simplest and most flexible short-term financing available for a business, especially a small one. There’s a catch, though: Credit lines are usu¬ally granted only to the most creditworthy customers.

Medium-term loans: The principal difference between a short-term and medium-term loan is the importance of collateral. Medium-term loans are for up to five years and are normally used to finance equipment purchases or plant expansion. In granting such loans, the bank will usually expect you to pledge an asset that will generate the revenues needed to repay the loan.

A banker regards collateral as a safety valve. Although your ability to repay the loan out of your cash flow is the key factor in getting the loan approved, your bank will also request that the loan be supported by collateral, just in case something goes wrong. Here is a rundown on some of the most common asset types and how your bank is likely to regard them as collateral:
● Liquid assets. Money market accounts, savings deposits and bank certificates of deposit (CDs) can be taken at face value, as can short-term U.S. government securities such as Treasury bills. However, longer-term Treasury or municipal bonds are taken at market value. Listed stocks and bonds are usually discounted from market value, with the discount running as much as 25 percent.
● Accounts receivable can bring as much as 60–80 percent of face value, provided they are “eligible.” This means weeding out older accounts, doubtful accounts and slow payers.
● Inventories are less valuable as collateral, primarily because they are more difficult to sell. Figure on an average of approximately 30 percent of the cost of raw materials and finished goods.
● Machinery and equipment are measured by auction value. You can usually use 50–70 percent of the auction value of machinery and equipment as collateral.

Term loans: Most term loans are written to cover the life of an asset or for a five-year period with a refinancing clause. They are written for 80–90 percent of an asset’s total cost. Payments are made quarterly and consist of equal amounts of principal with interest computed on the outstanding loan balance.

Because small companies often find quarterly payments burdensome, many banks will work out a schedule of monthly payments. Most banks also will tailor payments to meet the company’s needs, such as accepting lower payments in the early years of the loan and higher payments later. Long-term loans: Long-term loans (over five years) have been virtually nonexistent for the past several years. From a businessperson’s standpoint, the interest rate is too high, and the bank is hesitant to commit its capital for a long term when inflation might erode the value of the asset
to be financed. When long-term loans are used, they almost always involve real property.

● Business property mortgages. In more stable times, commercial and industrial mortgages were not unlike residential mortgages. They ran for as long as 25 years and were paid off in monthly installments.

Nowadays, you may not be able to get a mortgage for more than five to 10 years. These mortgages usually involve equal monthly installments, with a balloon payment at the end. Only rarely is refinancing guaranteed, although most companies can negotiate a new deal when the balloon payment is due.

● Real estate loans. If you have substantial equity in your building, it may still be possible to arrange a second mortgage. Interest costs could be very high in some areas, however. A whole
new refinancing package might also satisfy your cash needs, but you’ll probably be swapping a low-cost mortgage for a higher one. In short, unless you are certain that the return on your proposed new investment will be very high, you would be better off leaving the equity in your plant untapped.