Area of Law: Business Law
Answer # 232
Business loansRegion: Ontario Answer # 232
Setting up and growing a business can often require a great deal of money. Businesses may finance their operations in a number of ways. One of the most common ways to obtain financing is through business loans, commonly referred to as commercial loans. Business loans can be used to:
- start a business
- buy new equipment or other assets for an existing business
- develop a new product
- finance a growing business
- consolidate business debt
Although considered a business loan, the borrower is normally an individual or a small number of individuals who are ultimately responsible for the debt should the company become bankrupt.
Business loan guarantees
Before loaning money to a business, Canadian banks will, in almost all cases, require a great deal of information and guarantees, such as:
- Financial statements of the business for at least one fiscal year;
- Credit checks of the Directors and Managing Officers;
- Personal guarantees from the Directors and / or shareholders;
- Security interest in the assets of the business;
- Requirement that the business give quarterly reports and financial statements; and
- Requirement that the bank approves any sale of business assets (not including inventory).
If the business is unable to repay the loan, the bank will usually seek payment from the guarantors.
If the guarantors do not pay the loan, the bank can seize and sell the assets of the business and take the money it is owed from the proceeds. Any money remaining after the sale of the assets must be returned to the business. If the business assets are not sufficient to repay the bank loan, the bank can take legal action against the guarantors.
What are the terms of a business loan?
Most business loans carry the following rules:
- a specified period for repayment, (usually between 3 to 5 years)
- a fixed interest rate
- a predetermined schedule for repayment of the principal plus interest
In most cases, collateral will be required to secure the loan. Collateral is a property or other asset that the lender can seize and sell if the borrower stops making the loan payments.
If the loan is for the purchase of an asset, such as machinery or computers, the assets are often used as collateral.
If the loan is to finance working capital or a business expansion loan, then the collateral will be assets that are currently owned, such as equipment and real property (e.g. a building).
Types of business loans
Banks, credit unions, and other financing institutions offer many types of business loans, including:
Lines of Credit
Similar to credit cards, a line of credit allows someone to borrow only what they need, and make payments on the amount they actually use. A line of credit is most often used to pay operational expenses, when there is not enough money in the business bank account. The advantage in taking a line of credit is that you only have to borrow money as you need it, which reduces interest payments.
A short-term loan is one where the entire amount is paid in full on a specific date, rather than in monthly payments. The term of the loan is usually less than one year. Businesses may choose a short-term loan for things like a specific project, or to build inventory.
To get a long-term loan, a business will need a good credit and will likely need to prove that it is an established business. Long-term loans are most often used for refinancing a business, to purchase major assets like buildings, land or machinery, and business expansion. Long-term loans usually have a term of more than one year.
Canada Small Business Financing Program (CSBFP) loans
The CSBFP is a Government of Canada loan program designed to help individuals start new small businesses or help them grow an existing business.
Offered through financial lending institutions, such as a banks, a Canada Small Business Financing (CSBF) loan can provide a Canadian business with up-to $1,000,000 in financing for the purchase of land or business premises (of which no more than $350,000 can be used for leasehold improvements and equipment).
Eligible businesses include:
- Start-ups and existing for-profit small businesses in Canada with gross revenues of $10 million or less
- Businesses that are corporations, sole proprietors, partnerships or cooperatives
Loans can be used to finance:
- The purchase or improvement of land or buildings used for commercial purposes
- The purchase or improvement of new or used equipment
- The purchase of new or existing leasehold improvements (i.e. renovations to a leased property by a tenant)
For more information on the CSBFP, visit Innovation, Science and Economic Development Canada.
The government also offers a number of other small business financing options. Visit the federal government Business and Industry page for more info.
Other types of business credit
Individuals may also choose to finance their businesses using methods other than a commercial bank loan.
Credit cards – while this is a fast and easy way for a business to get money, it is also one of the most expensive as interest rates are usually very high.
Supplier financing – a business may be able to get financing from a supplier when purchasing machinery or equipment. The supplier will set specific repayment terms and interest rates. In such cases, the supplier will take the equipment as collateral and be able to re-posses it should the business fail to make its payments.
Commercial mortgages – available for businesses buying real estate from commercial mortgage companies, trust companies, chartered banks and insurance companies.
While some debt is necessary when starting and growing a business, it is easy for a small business to accumulate too much debt and find they having trouble repaying it, putting the success of their business at risk, and their own credit history in jeopardy.
There are tools a business owner can use to help manage the debt they accumulate:
- list the types and amounts of debt
- determine which debts have highest interest rates and need to be paid off first
- create a plan to repay the debt:
- increase profits
- choose a debt consolidation loan
- use a debt or credit counselling professional
- build a new budget
- reduce unnecessary spending
Borrowing money for a business can be complicated and has serious ramifications if the loan is not repaid. Before signing any agreements with the bank, you should seek legal assistance from a lawyer.
For more information about operating a business in Ontario, visit the Government of Ontario, Business and Economy website.
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