Business Loan Breakdown

September 22, 2020

Overview

A business loan is an agreement with another party, typically a bank, to borrow money for a specific purpose with an agreement to repay the amount of the loan with interest over a specified period. Loans are necessary when the costs required to start, maintain, or grow a business are higher than the cash currently available to the business owner. For example, a Domino’s franchisee looking to open a Domino’s pizza store will either need to purchase a preexisting store or build a new one at a DFA approved location. Purchasing or building a Domino’s store costs an average of $350,000, depending on location and store volume. Most new and even existing business owners do not have this amount of capital saved up, therefore, they will need to turn to a lender, such as a bank. There are several options when looking for a lender:

Conventional Sources – Major banking institutions such as the place at which you maintain your business banking relationship.

  • Wells Fargo
  • Regions
  • Bank of America

Qualified Service Representative (QSR) – An entity besides your bank that acts as your agent in helping place you with a lender that fits your capital needs at the most advantageous rate.

  • IRH Capital
  • TCF Bank
  • CIT Direct Capital

Small Business Administration (SBA) – a United States government agency that provides loans to entrepreneurs and small businesses. The SBA loan process is generally longer and more extensive than the other methods described above, however, it may provide the capital you require when other avenues are not open.

 

Parts of a Loan

It is important when meeting with a lender to understand at least the basics regarding a loan. Specifically, we believe all business owners should be familiar with the principal, interest rate, term, good faith estimate (GFE), and loan covenants of a loan.

Principal

The original sum of money borrowed in a loan.

Interest Rate

The proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding.

Fixed Interest Rate

  • An unchanging interest rate over the term of the loan.

Variable Interest Rate

  • Interest rate fluctuates over the term of the loan based on an underlying benchmark interest rate or index that changes periodically.

Term

The loan term is the period of time over which a loan is repaid, typically five years.

Good Faith Estimate (GFE)

A GFE is a document that includes the breakdown of approximate payments due upon the closing of a loan. A GFE helps borrowers shop and compare costs of loans with lenders. Please note, the borrower is not obligated to accept the loan just because they received a GFE.

Loan Covenant

A promise in a commercial loan that certain activities will or will not be carried out or that certain thresholds will be met.

  • Disallowed Business Activity Example - As part of a loan, a Domino's franchisee may be restricted from acquiring additional stores until they are able to pay back their existing loans. Once the loan is paid off, the Domino's franchisee may acquire additional stores.
  • Threshold Example - A borrower may need to maintain a debt-to-equity ratio under 2:1. If the borrower exceeds the ratio, they may violate their loan covenant and be subject to a higher interest rate or the bank may call the entire loan due.

Summary

Whether you are starting a business, maintaining it, or growing it, you may need a business loan. A great place to start is at the bank where your business’s operating account is held. In addition, we recommend that you also shop around at several other lenders and compare interest rates and GFEs. The goals as always is to secure the required money at the lowest possible interest rate and closing costs. Once you find the best loan for your business needs and close on it, you will have a lot on your peel, let us at D& S Management Services help with all your accounting needs.

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