Business Banking 101

Business banking doesn’t have to be complicated, but you wouldn’t know that if you’ve ever opened a commercial checking account or tried to get an equipment loan. There is often a menu of business services available: checking and savings accounts, credit cards (for making purchases), merchant services (for accepting credit card payments) and many types of loans for equipment, vehicles and buildings, even funds for working capital (a line of credit to cover short-term cash shortages). It’s enough to make your head spin. To make the best decisions, you need to be informed and to shop around. Yes, shop for the best place to put your money and for future loan needs.

Your first thought might be to go to your local bank, perhaps where you have your personal accounts, but you may want to consider a local credit union as another useful source for small business services. Although membership is required to join a credit union, there are many opportunities for small business owners to join, including past military service, affiliation with certain groups, schools or places of worship, or simple geographical location.

Like any other big decision, it is important to take a bit of time to think about what services you want now and what you may need in the future, and then compare your options between banks and credit unions. Developing a good relationship with your banker will help you now and later as you grow.

It goes without saying that all bankers want your business deposits, and they use those funds to make loans. It’s a super-simple formula: They take money in, paying a low interest rate to the depositor (depending on type of deposit account), and, in return, they lend it back out at a higher interest rate to the borrower. It is a bit like “buying low/selling high” or adding a “markup” to your inventory cost to get a sales price that gives you a margin or profit.

It may surprise you to learn, however, that not all bankers will give you a business loan. Depositing your money is easy, but qualifying for a loan takes some work. In addition to banks and credit unions, there are other lending sources available, such as online lenders or microlenders. Regardless of which type you consider, you’ll need some basic information to get started:

• Purpose of loan.
• Amount to borrow.
• Expected repayment period.

Then, you’ll need to show that your business has the ability to repay, which will require additional information that will likely include:

• Business and personal tax returns.
• Business and personal financial statements.
• Bank statements.
• Work-in-progress and/or accounts receivable.
• Business legal documents.
• Personal credit report (the banker will order this with your permission).

The banker will use a process called a “Financial Analysis” to determine if you qualify for a loan. This is a series of calculations to determine the likelihood that your business can repay the loan amount in full over the designated time frame for the type of loan you request (more on that below). Small business owners are nearly always required to personally guarantee a business loan, which is why your personal tax returns will be requested. A personal guarantee means that if the company is unable to repay the loan, you, as the business owner, are personally responsible to pay it back and that your personal assets, even if not provided as collateral to the bank, could be vulnerable if the company defaults on the loan.

A good relationship with your banker is a two-way street that depends on the “Five C’s of Credit + One”:

• Cash flow (also called capacity).
• Collateral (what is pledged to secure the loan).
• Capital (also called equity).
• Conditions (often related to industry or the economy).
• Character (industry experience, years in business, credit history).
• Communication (when things are going well and when they are not).

There are three basic types of loans, with several variations, but we’ll focus on Term, Mortgage and Line of Credit.

A Term Loan is for a fixed amount of time, usually with a fixed monthly payment, typically used to purchase equipment or vehicles that are used as collateral.

For example: A truck loan of $30,000 at a 6% fixed rate payable for 60 months. At the end of the term, the vehicle is paid off, the loan is closed, and the lien on the truck is released.

A Commercial Mortgage is usually structured as a five-year loan with a fixed or variable rate, but is amortized over a much longer period in order to make the monthly payments reasonable with the real estate and improvements pledged as collateral. At the end of the five-year terms, the loan must be paid off with a balloon payment or potentially refinanced for another period of time.

For example: A commercial mortgage to purchase land with an existing building to house your office, equipment and inventory. On a purchase price of $300,000, the mortgage may be $240,000 (you provide the 20% down payment) at a 5% fixed rate amortized over 20 years, secured by the real estate and improvements. At the end of the term of 5 years, you will owe approximately $200,000 to repay the mortgage.

A Line of Credit, also known as a working capital line of credit, is used to help cover the costs of doing business when there are timing differences between payables (such as fixed monthly expenses) and receivables (such as irregular income due to weather, unexpected cost overruns, etc.). These loans are typically priced at a variable rate, but are interest-only, secured by collateral and annually renewable if all conditions are met, such as maintaining a zero balance (called a rest period) for a minimum of one month each 12-month cycle.

For example: A business line of credit of $25,000 at a rate of prime-plus 1%, payable monthly on the amount of principal drawn (if no balance on the line, no payments are due that month), secured by business equipment collateral or real estate, with a one-month required rest period.

Any of these types of loans may have associated costs, such as points (for mortgages) or other fees, and usually require all of the assets to be insured as well. The better your financial condition, both personally and professionally, the better term, rates, fees and other requirements you are likely to be offered for your loan requests. For that reason, it is important to keep all your finances in order and up to date, and to review your personal credit report annually. The best time to request any type of loan is when you know that your business and personal financials are in order.

In addition to loans, there are other types of credit available to businesses such as credit cards and merchant services.

A Commercial Credit Card makes buying supplies, small equipment and even inventory easier by not having to write a check or have cash on hand for your purchases. You typically have at least 30 days to pay it off, or you can carry a balance at a certain interest rate as set by the card provider. Please note that interest rates on credit card balances are substantially higher than other credit options that may be available to you.

A Merchant Services Account is a fancy way of saying that you can accept credit card payments from your clients. This is an important consideration as it has been long noted that customers will spend more and feel better about doing so if they can “charge it” versus having to write a check or take out a loan for a large purchase, like a roof. The service provider will charge a fee, usually a small percentage of the amount charged, but the funds are available in your account within a few days rather than the few weeks it may take to receive a check.

Choosing a business bank or credit union, understanding the types of business loans and credit card services, and getting your business and personal finances in order are important steps in managing your business. Loans, lines of credit and credit cards are useful ways to help manage your monthly cash flow, cover unanticipated shortfalls and purchase needed equipment, vehicles or property for your growing business. Once you understand the basics as outlined here, working with a competent business banker to establish a long-term business relationship will be one of the best business decisions you can make.