If you have never borrowed money for your business before, you may be in for a surprise. Whether you want to borrow working capital to expand your business or leverage equity in a commercial real estate venture, you will soon find out the commercial loan process is very different from the more common home mortgage process. Commercial loans, unlike the vast majority of residential mortgages, are not ultimately backed by a governmental entity such as Fannie Mae. Consequently, most commercial lenders are risk-averse; they charge higher interests rate than on a comparable home loan. Some lenders go a step further, scrutinizing the borrower's business as well as the commercial property that will serve as collateral for the loan. This means that the business borrower should have different expectations when applying for a loan against his commercial property than he would have for a loan secured by his or her primary residence.
Following is a list of questions the borrower should ask himself and the lender before applying for a commercial loan.
1. How am I going to meet the loan repayment terms?Typically, bank loans require the borrower to repay his or her entire business loan much earlier than its stated due date. Banks do this by requiring most of their loans to include a balloon repayment. This means the borrower will pay interest and principal on his 30-year mortgage at the stated interest rate for the first few years (generally 3, 5 or 10 years) and then repay the entire balance in one balloon payment.
Many borrowers do not save enough in such a short time frame, so they must either re-qualify for their loan or refinance the loan at the end of the balloon term. If the business happens to have any cash-flow problems in the years immediately preceding the balloon term, the lender may require a higher interest rate, or the borrower may not qualify for a loan at all. If this happens, the borrower runs the risk of being turned down for financing altogether and the property may be in jeopardy of foreclosure.
A balloon loan has other risks as well. If the borrower's business is in a "risky" industry at the time the balloon is due (think of the oil and gas bust in the 1980s or the telecom implosion of the 2000s), the lender may back out of all refinancing for the enterprise. Alternatively, a lender simply may decide its loan portfolio has too many loans in a given industry, so he will deny future refinancing within that trade.
Non-bank lenders generally offer less stringent credit requirements for commercial loans. Some non-bank lenders will make long-term commercial loans without requiring the early balloon repayment. These loans, which may carry a slightly higher interest rate, work like a typical home loan. They allow a steady repayment over twenty or thirty years. It is often worth paying a one- or two-point higher interest rate for a fixed-term loan in order to ensure the security of a long-term loan commitment.
2. How much can or should I borrow?Most bank loans prohibit second mortgages, so the borrower should go into the loan process intending to borrow enough to meet current business needs, or enough to sufficiently leverage real estate investments. For a traditional acquisition loan in which the borrower is buying a new property, banks usually require a down payment of 20-25%. So for a $600,000 acquisition, the borrower will need to come up with $120,000-$150,000 for the down payment.
Some non-traditional loans will allow the borrower to make a smaller down payment, maximizing the loan-to-value (LTV) at 85-90%. Such loans are generally not bank loans, but are offered by direct commercial lenders or pools of commercial investors. If the customer wants to borrow the maximum amount possible, the interest rate on such loans may be a point or two higher than typical bank loans. Before deciding how much to borrow, potential borrowers should:
The amount of the loan requested has an effect on which commercial lenders will fund the loan. Small businesses borrowing less than $2,000,000 will visit a different pool of potential lenders than those seeking loans of over $5 million. Small business loans are generally made by direct commercial lenders (easily located by internet searches) or by small local banks. Larger loans are generally made by regional banks, and very large loans are made by mega-banks or Wall Street lenders.
3. How long will it take to get a commercial loan?Borrowers generally start the loan process by contacting their bank. Unfortunately, it is difficult to secure business loans from most banks. Besides, bank loans:
Generally it takes several weeks before the borrower can get a verbal or written commitment letter from a bank. Even after the loan commitment, the bank's credit committee may veto the loan. The business will then have to start the process over with a new lender. If a firm has very good credit rating, a good relationship with its bank, a solid and confirmable history of earnings and profits, and is not in a hurry, a local bank will probably give them the lowest stated interest rate on the loan.
If you need to be pre-qualified quickly, you should shop for credit over the Internet or look at non-bank sources of funds first. Once you secure a commitment from a direct lender, then you may start a parallel process with your bank. Some direct non-bank lenders can give you a verbal commitment in a few days, but keep in mind that you are only searching for "commercial" loans-offers from Internet companies may often be for residential property, so you will need to screen your searches.
Keep in mind the parameters of the terms you will accept: Will you take a balloon loan? What about a covenant or condition on the loan?
If you know that your profit and loss statements are not provable and solid, or you do not have a high credit score, applying at banks is generally a waste of time. Instead, go directly to non-bank commercial lenders.
4. What kind of covenants and conditions are required?Many borrowers are not aware that much more may be required than simply making regular monthly payments on time. Many loans ask you to provide quarterly or annual income statements, balance sheets and tax returns. Some loans will require covenants-promises that your business will meet certain tests in the future. They may require a certain positive cash flow, or a certain debt-to-cash-flow ratio, or other financial criteria. During a downturn in your industry or the economy, your business may face temporary cash flow or profit shortages.
If your business falls short of the terms and conditions contained in the loan covenants, your bank may deem that your loan has entered into default. Default triggers numerous penalties. It may require that you pay back the loan immediately. This can cause you to have to find another lender very quickly, or face foreclosure on the property.
Different lenders require different conditions, so ask the lender up front what conditions or covenants apply. Some non-bank loans charge a slightly higher interest rate but will waive all covenants and conditions except for timely repayment of the loan. If you feel that your business cash flow is uncertain, you might want to consider these non-bank loans first.
If your business does not have its financial statements certified regularly by one of the larger CPA firms, you may opt for a slightly higher interest rate loan. This may relax the reporting process or not require future covenants. Likewise, if losing your business or property to the bank is likely because of the financial test requirements, then find another lender. Ask any real estatedeveloper who has managed to stay in the business for 20-30 years about the risks inherent with traditional bank commercial property loans; he will name many other developers who lost all their assets during lean times in the industry.
5. What kind of documentation will be required?Traditional lenders require 3-5 years of financial statements, income tax returns, and other documentation. This may include:
6. What if I want to sell the property?If your business booms, you may want to repay the loan early or sell the property and move to a larger space. Commercial mortgages, unlike residential loans, usually have pre-payment penalties. However, some lenders will allow the purchaser of the property to assume the mortgage by taking over the seller's payments. An assumable loan is an excellent selling point, because it provides built-in financing for the buyer.
7. What are the "hidden" or total costs of the loan?The stated interest rate is often artificially low when one considers all the costs of a loan. Points, for example, are direct percentages of the loan that the lender deducts from your loan. If your interest rate is 9% with two points that means your real cost of the loan is 11%. The extra 2% comes right off the top into the lender's pockets. Other costs may include:
Other questions to ask:
Keep in mind how you expect your business to perform in the future and how you plan to repay the loan. Do not ignore worst-case scenarios. You do not want to be so optimistic about the possibilities that you lose sight of the fact that the lender may take away your business or livelihood if you do not meet all the terms. Sometimes the lowest interest rates represent the riskiest loans.
The Best Lender
When considering a commercial mortgage, borrowers should seek out lenders who are willing to fund the loan under acceptable time constraints, keeping in mind their general creditworthiness. Borrowers should look at both bank and non-bank funding in order to get their needs met in a timely manner. Asking questions and obtaining unbiased evaluations will reduce delay and frustration. Fortunately, new lenders have emerged to challenge banks on their traditional terms, so borrowers have more leverage now than ever before when seeking commercial loans.
Recommended Commercial Real Estate Lending
Here are some top tips to make you stand above the crowd and ensure that your business is well placed to grow and prosper.
Socially savvy entrepreneurs know that it’s all about engaging the right audiences with valuable content. The online community has little tolerance for self-promoters who view social media as a means to free advertising. Given this, small-business owners face a challenge when it comes to striking a balance in using social media to engage and promote.
Promotion and engagement are really two sides of the same coin. Engagement is rooted in consistently sharing insight and providing value every time you connect with a customer. This establishes credibility while building trust and inspiring customers to tell their friends about you. Promotion extends your engagement efforts by presenting a valuable offer that’s based on your customers’ interests and needs. Social media amplifies your efforts so you can be found and engage a wider audience to grow your business.
To put it all together, here are some best practices for successfully engaging customers and promoting your small business through social media.
Follow the one-in-seven rule. This rule is where only one of every seven posts overtly promotes your business. The remaining six should be focused on sharing valuable content, including posts from the community. This doesn’t mean you can’t promote your business in those other posts; just be sure you pair it with great content.
Ask conversation-starter questions. Most people enjoy sharing their opinions, so ask Facebook fans to weigh in on topics that are relevant to your business and interesting to them. For example, a fitness center may ask fans to vote on their favorite summer sports in order to be entered into a drawing to win private lessons for them and a friend who joins the club. The questions should engage fans and inspire them to refer business while giving the business owner great insight.
Share your expertise. Post little-known, fun facts in the form of questions with a special offer presented to the first person to answer correctly.
Provide value. While including fun posts that reflect your personality is a must, it’s important to create content that benefits your followers. That can mean posting tips on best practices, providing access to white papers, or offering special deals on products or services.
Enhance the rewards for virtual check-ins. For a specific period of time, double the points each time a customer checks in on Foursquare and triple the points each time he or she brings a friend. Their friends on social networks will see when they’ve checked in while you expand your reach exponentially.
Create a Pinterest board. Make sure the board has eye-catching visuals and run a contest through it that will inspire and reward customers for their participation. Be sure to encourage them to re-pin and create their own boards that reflect the initial contest for additional social amplification of your campaign.
Avoid syndicated messages. While you can use tools that allow you to write one message and have it appear on a variety of social media outlets, you risk losing the sincerity behind the message. You can use similar language as you promote your offer on different sites; just be sure to change up the words while reflecting the tone of each network.
If you find that your customers are scattered across a variety of networks, focus your efforts where they’re most active. Not sure? Ask. Otherwise, you may waste a lot of time skimming the surface of multiple networks with little results.
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