Breadcrumb

How Does Commercial Finance Work?

Written by

The GoCardless content team comprises a group of subject-matter experts in multiple fields from across GoCardless. The authors and reviewers work in the sales, marketing, legal, and finance departments. All have in-depth knowledge and experience in various aspects of payment scheme technology and the operating rules applicable to each. The team holds expertise in the well-established payment schemes such as UK Direct Debit, the European SEPA scheme, and the US ACH scheme, as well as in schemes operating in Scandinavia, Australia, and New Zealand. See full bio

Last editedJun 20213 min read

There are many reasons why your business might be interested in commercial finance, whether you’re looking for start-up capital or a loan to help with marketing and growth. Commercial lending may sound technical, but it’s just a term used to describe business loans. We’ll cover how commercial finance works below, along with the different types of commercial loans available.

How do commercial loans work?

Commercial finance is a blanket term used to describe financing options available to businesses. Commercial loans are the most common options, and many of these work the same way as personal loans. You’ll agree to borrow a certain amount of money and pay it back under set terms and conditions, with a fixed repayment plan and interest rates based on your business’s credit worthiness.

However, there’s a wider variety of entities offering commercial loans than you might find as an individual. Commercial lenders can include traditional options like banks and credit unions. Independent investors and online lenders also offer commercial financing, as do government agencies like the Small Business Administration (SBA). The application process, payment schedule, and required collateral all depend on the lender and type of financing you choose.

Types of commercial loans

Some loans are designed simply to give your business’s working capital a boost, while others will be for specific purposes like equipment purchase or real estate investment. Here’s a look at some of the main types of commercial loans you might be eligible for.

1. SBA loans

Backed by the Small Business Administration, SBA loans are designed for small businesses operating within the USA. They’re backed by the government but administered through traditional lenders like banks and credit unions. One of the most popular SBA loans is the SBA 7(a), which can be used to purchase equipment or land, consolidate debt, or manage operational expenses. SBA 504/CDC loans are another example of commercial finance for small businesses, though these have stricter guidelines and are designed for real estate and development purposes.

2. Revolving line of credit

While traditional commercial loans give your business a one-time lump sum, a line of credit works a bit differently. Your business is approved by the lender for a line of credit up to a certain amount. You’re only charged interest for the amount you use and can make monthly payments on the balance during the draw period. A business credit card also comes with a maximum amount and flexible payment terms. However, when the draw period ends on a line of credit, you’ll need to close it down and reapply for a new credit line. This type of commercial loan is often used to cover off-season periods when cash flow slows, or to purchase inventory.

3. Vendor credits

Although this isn’t strictly a commercial loan, a vendor-specific line of credit also falls under the umbrella of commercial finance. With this type of system, your business can purchase goods or services from a vendor with predefined credit terms. For example, you might have net-90 payment terms which gives you a grace period of 90 days to pay for your supplies. This frees up cash flow and working capital, giving your business time to transform goods into profits before repayment.

4. Real estate commercial loans

When looking at how commercial loans work, you’ll also note that many are designed specifically for real estate. Commercial mortgage loans let you purchase property for your business, requiring a deposit or down payment in addition to monthly repayments and interest. For short-term alternatives to a commercial mortgage, some private investors offer “hard money” loans with eligibility based on the property’s value. Hard money loans are repaid after you renovate or flip a property and resell it for profit.

5. Construction commercial loans

If you need to renovate your business property, construction loans are designed to pay for land, materials, and labor costs. These are usually released in stages rather than a single payment. This reflects the nature of construction. You’ll agree to a draw schedule that releases money according to specific milestones being reached with your construction project.

Is commercial lending right for you?

Whether or not commercial finance makes sense for your business depends on your eligibility and financial situation. Loan rates can vary widely, from the low interest rates of SBA loans to the higher-rate construction and short-term property loans. When looking at the loan terms and conditions, be sure that you factor rates into the repayment plan.

Rates will also depend on your business credit profile. New businesses might not have built up much of a credit score just yet, which makes you a greater credit risk to lenders if you’re just starting out. It might be better to borrow small amounts of money on a credit card to build your credit rating before sourcing a larger loan.

We can help

GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.