Applying for small business financing can be confusing for many reasons, and one of them is the terminology lenders use. Understanding these commonly used business financing terms and how they affect your applications can help you apply with greater confidence.
Here are 17 terms your business lender may use:
APR: Annual Percentage Rate is the cost of the loan over a year, expressed as an annualized interest rate. It includes interest, but depending on the type of loan, it may or may not include fees. Lenders are generally not required to disclose an APR in conjunction with business loans.
Business Credit Report: A business credit report contains historic information about how a business pays loans and meets other financial obligations, and may include public record information about the business such as tax liens, judgments or UCC filings. A number of agencies compile and sell business credit reports. Dun & Bradstreet, Equifax and Experian are considered major commercial credit reporting agencies in the U.S. There is no requirement that business owners be given free copies of their business credit reports.
Credit Score: Business lenders may check personal credit scores of business owners, business credit scores of the business, or both. The FICO SBSS score is a credit score specifically for small business lending, and it may be calculated using personal credit data of the owners and/or business credit data for the business.
Collateral: Collateral is something of value pledged to secure the loan should a borrower default. The SBA describes collateral as “a secondary means of repaying the loan.” It may include property, equipment or even accounts receivable or inventory, and lenders may require the borrower to state the market value for assets such as equipment or real estate. Lenders may sometimes require the borrower to pledge personal assets such as home equity as collateral.
Debt Service Coverage Ratio: The DSCR is a measure of your company’s free cash flow available to meet current debt obligations. DSCR = net operating income divided by debt service, where net operating income (NOI) is net income plus taxes and interest payments.
EIN: You can think of your Employer Identification Number as a Social Security Number for your business. Also known as a Federal Tax Identification Number, an EIN is used to identify a business entity. Although not required for all types of businesses, it is recommended you get one if you are applying for business financing. You can request an EIN for free from the IRS.
Equity: In a business loan context this may refer to funds owners have injected into the business. Many lenders want to see that owners have used some of their own money to fund their business. In other words, value over and above the loan amount. This is informally referred to as “skin in the game.”
Factor Rate: Used in some types of financing— primarily for merchant cash advances— it describes the cost of a loan in relation to the amount borrowed. Multiply the loan amount by the factor rate to understand the total cost that must be repaid. For example, with a factor rate of 1.2, a borrower will be obligated to repay 1.2 times the amount borrowed (plus any fees charged.) The factor rate is not expressed as an annual rate, and should not be confused with an interest rate or APR.
Interest Rate: An interest rate is used to describe the portion of the loan that is charged to the borrower as interest. It may or may not be the same as the APR which expresses interest on an annual basis. Some loans carry fixed interest rates, which stay the same for the life of the loan. Others carry variable interest rates, which may fluctuate. Variable rates are tied to an index, such as the LIBOR or prime rate, and will change accordingly.
Line of Credit: This type of financing allows the borrower to borrow as much money as needed up to the approved credit limit. Payments are based on the outstanding balance.
Liability: A debt or financial obligation. Some lenders will require borrowers to disclose all liabilities, whether or not they appear on a business credit report.
Owner: Many lenders will require owners with at least 20% ownership in the business to sign the loan agreement. Lenders may also check personal credit of owners and so every owner should be prepared for a possible credit check.
Personal guarantee: When signing a personal guarantee, the borrower agrees to be personally liable for the loan if the business defaults.
Prepayment penalty: A fee charged if you pay all or part of a loan off early.
Revenues: Some lenders will evaluate current and past revenue for the business to determine eligibility and/or loan amount. Other lenders may require month-by-month revenue projections for a future period of time (often the next twelve months.)
UCC Filing: A legal filing used to give notice that the creditor has interest in the property of a business. UCC filings are commonly used in conjunction with business financing where something is pledged as collateral.
Working Capital Loan: A loan that can be used to meet the day to day obligations of a business.
About the Author:
Gerri’s been guiding individuals through the confusing world of finance and credit for 20+ years. She is the author or coauthor of five books, including her most recent, Finance Your Own Business: Get on the Financing Fast Track. Today, Gerri serves as the Education Director for Nav, an online platform that matches small business owners to their best financing options and gives free access to personal and business credit scores.