Business loans provide companies with financial resources to make investments. Here, you'll find the key aspects.
Whether it’s a startup, a corporation, or a medium-sized company: business loans are suitable for various companies and provide external capital. In this article, you'll discover all the crucial aspects of business loans.
What is a business loan?
With a business loan, a company or self-employed individuals obtain debt capital from a bank for business purposes. Repayment occurs over a specified period in installments, accompanied by interest.
Business loans fulfill various financial needs, such as making investments, securing working capital, financing expansions, or bridging short-term gaps. Depending on the relationship with the bank, companies can achieve favorable conditions and avoid high interest rates.
Business loans represent the most widely used form of external capital acquisition. In 2022, banks granted €1.8 trillion in loans to companies and self-employed individuals in Germany. The majority of these are small business loans.
Components of a business loan
A business loan is an agreement between a company and a bank. The key components may vary depending on the lender and the type of loan. Here are some commonalities:
- Loan amount
- Loan term
- Interest rates
- Amount of repayment installments
- Consequences of default or payment failure
- Collateral for the bank
The suitability of a business loan for a company depends on its capital requirements and investment projects. Companies must review the contract conditions thoroughly before finalizing a loan agreement.
Types of business loans
Various types of loans fall under the category of business loans. Usually, banks offer business loans. However, there are other institutions providing debt financing for companies.
Loan for starting a business
A startup can access a wide range of financing instruments, both debt and equity. Besides venture capital, bootstrapping, or angel investors, they can get specific startup loans from traditional banks.
Such a loan is suitable for:
- Startups with a classic business model that banks can reflect and understand with their risk model.
- Startups with an innovative business model that already generates revenue and is preferably profitable.
- Startups that can take debt and repay it, including interest and installment payments.
- Startups that don’t want to dilute their shares and stay independent.
However, access to credit is difficult for many startups, especially those in the tech and SaaS industries. They can hardly offer any collateral, such as real estate or machinery. They also have a business model outside the scope of a bank's risk analysis.
Companies can use an investment loan to finance long-term growth measures or projects. Usually, this includes traditional tangible assets such as production facilities, infrastructure projects, machinery, or real estate.
In contrast to an overdraft facility (working capital), which primarily covers ongoing costs, the credit line of an investment loan is intended to advance a company over the long term. Therefore, the duration is up to ten years in some cases.
Investment loans are tied to a specific purpose. A clear definition of the intended use enables a bank to better assess its risk.
Earmarked lending does not only include infrastructure projects for manufacturing companies, though. It also covers project financing for service providers such as agencies, consultancies, or other professional services. They use loans, for example, to finance large individual expenses (hardware or events).
Here's an example of Dutch company Stories, who has used the credit line from re:cap to refinance it's operational expenses for further growth.
A bank guarantee is not a traditional business loan where a company receives debt from a financial institute. The bank guarantees a company to a third party and receives a commission. Interest or repayment installments are not included.
Suppliers and service providers, for example, often ask for a bank guarantee before they provide their services. It secures their risk in the event payment defaults. The bank guarantees that the company is financially able to meet the claim.
With goods financing, a company receives a loan to purchase goods or raw materials, which are resold at a profit. This type of business loan is also known as goods pre-financing or purchase financing.
Goods financing is particularly relevant for companies active in retail or e-commerce and regularly require large quantities of goods to run their business.
Commodity financing instruments include:
- Letter of Credit, which is issued by a bank and guarantees payment to the seller once certain conditions are met.
- Documentary Collection: This is a payment arrangement where the buyer's bank processes the payment once the required trade documents are presented.
- Supplier credit: suppliers grant buyers a temporary loan to pay for goods.
Goods financing is an important instrument for bridging financial bottlenecks in terms of liquidity. This is especially true when companies need to purchase large quantities of goods, but payment is only made after a certain period.
The overdraft facility is also known as a working capital or operating loan. It provides companies with short-term liquidity to finance ongoing expenses. This type of business loan enables companies to react to fluctuations in their capital requirements and to bridge short-term financial bottlenecks.
The most important aspects of an overdraft facility are
- Flexibility in obtaining liquidity: an overdraft facility is a flexible form of financing that allows companies to withdraw money from their bank account up to a pre-agreed maximum amount.
- Short-term financing: Overdraft facilities are designed for short terms, often for one year or less.
- Risk management: Companies should practice effective risk management to prevent short-term debts from turning into long-term financial burdens.
Alternatives to business loans
Traditional bank loans may not be ideal for all companies. Some startups, especially in the tech and SaaS sectors, face challenges with traditional business loans from banks. Such alternative instruments include:
- Convertible loans
- Venture debt
- Alternative debt funding
- Revenue-based financing
- Recurring revenue financing
These alternatives, often offered by fintechs, online lenders, or funds, allow companies to diversify their capital structure beyond traditional routes. They leverage automation and risk assessment based on real-time financial data and specific SaaS- and Tech-KPIs, providing more accurate capital solutions with flexible terms.
The advantages of alternative financing:
- Companies have more freedom as the capital is not tied to a specific purpose.
- Companies gain a high degree of flexibility as there are no rigid repayment models, and debt can be taken more easily.
- Companies have access to real-time data on their financial performance. This allows them to react to problems at an early stage.
Conclusion: understanding business loans is crucial
Business loans are crucial for the growth and stability of companies, providing debt capital for advancing investments. Understanding the type of business loan suitable for specific investments is essential.
Apart from traditional loans, there are alternative financing options that consider different parameters, providing automated services with a specific focus on data.