The Reasons Why to Borrow Money for a Small Business - There are three major reasons why businesses borrow; the first and most common reason is to purchase assets. A loan to acquire assets could be for buying short-term, or current, assets such as inventory and would be repaid once the new inventory is converted into cash as it is sold to customers. Or, the funds could be for the addition of long-term, or fixed, assets, such as equipment.

The second reason is to replace other types of credit. For example, if your business is already up and running, it may be time to take out a bank loan to repay the money you borrowed from a relative. Or, you may wish to use the funds to pay suppliers more promptly to get a discount on the price of the merchandise.

The third reason is to replace equity. If you wish to buy a partner's share in your business but you don't have the cash to do it, you may consider borrowing.

Types of Small Business Loans - The purpose of your loan is critical in determining the type of loan you request. You also should make sure that the timing of the repayment schedule on your loan matches the incoming cash flow you will use to make the payments.

There are a number of loan types available to commercial borrowers, including lines of credit, seasonal commercial loans, installment loans, collateralized loans (which are secured with assets), credit card advances, and term loans. Regardless of the type, most loans have the following features.

Common Loan Features

• Loans are long term or short term.
• Interest rates vary depending on the term, type, size, risk of the loan.
• Repayment may be a lump sum or on a monthly or quarterly schedule.
• Payments may be delayed until the funds help your business generate cash flow.
• The loan may be committed, meaning the bank agrees to lend to you under certain terms as you need funds without requiring you to re-apply each time.
• Some loans require that you maintain compensating balance levels in a deposit account.

Types of Small Business Loan Agreements - You should be aware that the lender will expect you to agree to certain performance standards and restrictions in order to ensure that your business can repay the loan. These restrictions, known as covenants, representations, and warranties, commonly include the following.

Common Loan Restrictions

• Maintenance of accurate records and financial statements
• Limits on total debt
• Limits on total debt
• Restrictions on dividends or other payments to owners and/or investors
• Restrictions on additional capital expenditures
• Restrictions on sale of fixed assets
• Performance standards on financial ratios
• Current tax and insurance payments