If you're applying for a small-business loan, it's easy to get confused by some of the jargon and acronyms that are unique to this process. Understanding a few key terms before you do your research can help you make a more informed decision about your loan. Here a seven important definitions to know before you jump into the world of small-business lending.
- 5 C’s of Credit
This phrase refers to the five criteria that banks use to make credit decisions regarding potential borrowers. The five C’ are: character, collateral, capital, conditions, and capacity. Examining these characteristics allows the bank to gauge the risk of default.
- 504 Loan
This type of loan allows small-business borrowers to acquire fixed assets such as commercial property. The intent behind 504 loans is to small businesses invest in fixed assets at a cost lower than conventional loans. These loans are financed partially by conventional lenders and partly by Certified Development Companies, which are nonprofit entities set up to encourage local economic growth.
The Small Business Association (SBA) is a government agency dedicated to supporting the economy by assisting small businesses. The agency offers counseling and support to small businesses; it also partners with banks and other lenders to provide SBA loans.
- 7(a) Loan
This is the most common type of loan administered by the Small Business Administration. A 7(a) loan allows both new and existing small businesses to obtain financing for a variety of purposes.
- Equity Financing
With this type of financing, a company receives money in return for issuing shares of its stock. By providing investors with equity in the firm, a small business can avoid taking on debt. Venture capital is a popular form of equity financing for start-up companies.
- Prime Rate
This is the rate against which SBA loans are quoted. The prime rate is determined by the federal funds rate, which is the short-term rate used among banks for overnight loans.
A Small Business Investment Company (SBIC) is a private company licensed by the SBA that provides financing to small businesses. Some small start-ups use SBICs to gain funding as an alternative to venture capital.
Securing a small-business loan is a critical investment in your business. Doing your homework before committing to a loan is essential. With these definitions in mind, it will be easier to wade through the complex aspects of small-business lending to obtain the loan that's right for you.