Tech startups are often focused on a variety of high-profile funding options to help get their small businesses off the ground.
Angel investors, incubators, and accelerators are sought-after sources of seed money for very early-stage companies. Raising a Series A round from venture capital investors is often seen as the next goal after those, with little consideration as to whether that funding structure is the most advantageous.
While entrepreneurs know there are other financing solutions, such as from banks and online lenders, they often don’t consider them promising options. However, a term loan can be an excellent way to get your small business off the ground, whether you’re the hottest new tech startup or a mom-and-pop corner store.
What is a term loan?
A term loan in business terms is a loan that is repaid in regular payments over a predetermined timeframe. Upon securing a term loan, a business receives a set amount of money that is borrowed and that must be paid back over the predetermined amount of time at a set level of interest. Typically, the payments will consist of a fixed monthly principal amount, plus all interest that was earned on the loan balance during the prior month.
Furthermore, with a forward commitment, businesses will know it will be able to draw additional capital and have the assurance that there’s more in the future, without paying interest until the money is needed and drawn.
What is a forward commitment?
A forward commitment is a contractual agreement in which the lender agrees to fund up to a specific additional amount of principal after the initial funding commences through one or more draws within a defined time horizon.
The forward commitment terms are agreed upon at the time of initial funding and outlined in the initial loan documents. There may be specific criteria, typically financial thresholds, necessary to take the additional draws.
This varies from the typical follow-on structure where there is no guarantee of a future loan and any pricing or amount are not specified. It also varies in that it doesn’t require an updated underwriting approval to have the funds issued, assuming no material adverse condition occurred.
The advantage of term loans
Term loans have the advantage of being predictable. Borrowers don’t have to hit a certain growth trajectory to manage the loan; instead, they just need to make sure they can comfortably handle the monthly payment at the time they borrow. The straightforward nature of term loans is also easy for borrowers to understand and feel comfortable with, unlike more complex lending methods such as equity financing.
This type of borrowing is good for businesses with predictable monthly revenue, since a standard monthly payment is due each month. Those with highly variable income may find other types of funding for small businesses, such as revenue-based financing, to be more advantageous.
Who provides short term business loans?
Banks are the traditional purveyors of short term business loans, including term loans backed by the Small Business Administration (SBA) that can be particularly accessible to startups and other small businesses. In recent years, the term loan space has also become increasingly crowded with online lenders who often provide extremely fast and accessible lending but tend to charge higher rates for the service.
Despite the competitive nature of the lending field, banks and online lenders often don’t make a good fit for SaaS businesses. In fact, Lighter Capital CEO, BJ Lackland, has gone so far as to say that