Question

In: Finance

Under what circumstances would a business secure its financing through a commercial finance company?

Under what circumstances would a business secure its financing through a commercial finance company?

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Expert Solution

Commercial finance companies are good options for entrepreneurs seeking small business loans. Commercial financing institutions generally charge higher interest rates than banks and credit unions, but they are also more likely to approve a loan request. Most loans obtained through finance companies are secured and the assets used as collateral can be seized if the entrepreneur defaults on the loan. Commercial finance companies provide small businesses with loans for inventory and equipment purchases and are a good resource of capital for manufacturing enterprises.

Commercial finance companies have also grown because they are more flexible in arranging loan repayment schedules than are banks. Whereas banks typically require a seven-year repayment schedule on term loans and 15-year schedules for loans on commercial property, finance companies may extend payment schedules up to 10 years for term loans and up to 25 years for loans on commercial real estate.

Finance companies have experienced sustained growth throughout the 1990s. By the end of the decade, finance companies had become America's second largest source of business credit, behind banking institutions. Larger commercial finance companies often offer small business owners a variety of lending options from which to choose. These include factoring, working capital loans, equipment financing and leasing, working capital loans, specialized equity investments, collateral-based financing, and cash-flow financing.

  • Commercial loans offer the lowest interest rates of all loan options, enabling business owners to access critical funding while maintaining lower overhead costs.
  • The loans are long-term, often between 3 and 10 years, allowing you to pay the money back slowly as you work to increase business profits.
  • Lower interest rates and extended payment plans decrease the potential for default, which reduces your investment’s risk.
  • Commercial loans can be used for very large sums, allowing you to cover the bulk of startup costs with a single loan.
  • Commercial loans are often unsecured, meaning you don’t need to provide any collateral to obtain the loan.
  • You retain complete ownership of your company. Venture capital investments typically require signing over a fraction of your company to the investor, whereas commercial bank loans enable you to retain total ownership of the business.
  • Funding can be very challenging to qualify for and require excellent business credit. First-time business owners are unlikely to be eligible and will have to build credit prior to applying.
  • The application process is exhaustive, often requiring a detailed financial report of the business, an accurate assessment of projected revenues, and detailed information of all associated business risks. Basically, you need to provide a highly compelling proposal that will assure bankers there is a relatively low risk of business failure.
  • You must also provide your personal financial history including your credit score, annual income, and unpaid debts. Even minor problems with your financial history could render you ineligible for the loan.
  • Commercial loans provide less personal autonomy than with some loan options. Larger loans often require detailed accounts of how the money will be spent.
  • In the event you fail to qualify for an unsecured loan, you may have to secure the loan with your home or car as collateral. If you default on a secured loan, the bank retains the right to seize any property used as collateral.

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