Long-Term Business Loan—Pros and Cons

Financial misfortunes in businesses come uninvited. In such distressing times, exhausting personal resources may not be wise. Rather than contemplating, a good alternative to claw the way out of the storm is to take a business loan.

Business loans offered by banks and NBFCs can be both for short and long term. It is the repayment tenure of a business loan that is one of the several factors that distinguishes a short-term from a long-term business loan. The term of the business loan, in turn, is important as it impacts the equated monthly installments (EMI) which the borrowers pay over a period of time.

Long-Term Business Loans

Long-term loans are mainly preferred by borrowers as compared to short-term business loans because of higher loan amounts and longer repayment tenure that can go up to more than 10 years, depending on the business needs and the lender's discretionary powers.

The interest rate charged by financial institutions for these loans can be both fixed and floating but it is comparatively lower than short-term loan interest, meaning less EMI. In addition to the interest, business entities also have to bear processing fees and other additional charges which vary from bank to bank.

The question is whether taking a long-term business loan is beneficial for a business in the long run. Before we delve into the question, let's analyse the pros and cons of long-term business loans.

Terms and Conditions of a Typical Long-Term Business Loan

Anyone in India can apply for a business loan. But before applying, you must be careful about three aspects of the loan terms and conditions- eligibility criteria, required documents list and the business loan clauses. Here’s a brief description to help you understand the most common eligibility criteria, documentation requirements by lenders, and loan clauses:

1. Eligibility Criteria:

• You must be an Indian citizen.
• You must be at least 18 years old.
• Your business should be profitable for at least one year.
• You should have at least one year of experience in your field.
• Your CIBIL score should be over 750.
• You should have income tax returns (ITRs) for the last three years. (Exception: You may apply even without proof of income.)
• You need a business proposal and financial forecast.
• You need a letter of request for the business loan.

2. Documents Required

• PAN card
• Proof of business ownership
• KYC documents
• Bank statements of promoters
• Partnership agreement (if any)
• Promoters' ITRs for the last three years
• Certificate of incorporation
• Service tax registration (if applicable)
• Promoter’s liabilities and asset statement

3. Business Loan Clauses:

Business loan agreements often include specific clauses that can impact your financing. It’s crucial to review these clauses to understand the risks and obligations. Common clauses include:

• Security Cover Clause: Specifies collateral or personal guarantees required for the loan, which can be seized if necessary. Banks might ask for additional collateral if the current value drops.
• Repayment Clause: Determines the loan repayment period, offering choices between fixed-term and on-demand repayments.
• Default Clause: Defines what constitutes a default, typically non-payment, legal issues, or the borrower’s death.
• Interest Rate Fluctuation Clause: Determines if the interest rate is fixed or variable. A fixed rate remains constant, while a variable rate changes based on market conditions.

Ensure you understand and negotiate these clauses before signing a loan agreement to avoid unexpected risks and obligations.

Advantages Of Long-Term Business Loans

• Builds A Good Credit Score:

Obtaining long term business loans boosts creditworthiness if the debt is repaid on time. Some long-term loans range from 10 to 20 years, with a few even going up to 30 years. If all the monthly installments are paid without a single miss, it establishes exceptional credit history which makes the business eligible for additional funds as well as increases the chances of qualifying easily for better loan terms for future loans.

• Avoids Debt Traps:

As compared to short-term loans, long-term loans help to scale a business. Often, business owners fund their immediate needs by taking recourse to risky funding options like credit cards. It should be emphasised here that the credit card interest rates, in case of default, can go up to 40%. On the other hand, long-term loans come with lower interest rates and longer tenure.

• Helps To Expand Business:

A long-term loan allows to borrow more and for longer. The loan amount can be used to buy office space or land for business, hiring staff, expanding business, starting new ventures, buying machinery or commercial vehicles, and marketing activities.

• Saves Money:

Through long-term loans businesses can borrow a higher amount for a longer tenure which makes it better than other credit lines. For example, in an overdraft facility (OD), businesses need to secure their loans with fixed deposits. Comparatively OD may be easy to obtain but they may escalate the overall costs because of higher interest rates and shorter tenure.

Disadvantages Of Long-Term Business Loans

• Needs Collateral:

When lenders offer long-term loans at lower interest rates and longer repayment tenure, they usually may ask for collateral to reduce their risk. As long-term loans are usually secured, business entities must back up their loan with assets like machinery, real estate, inventory, accounts receivable, etc.

• Long Processing Time:

Lenders approve long-term loans to businesses only after detailed verification, thus increasing the processing time. Most applicants may have to go through a tedious application and approval process to be eligible for such loans. So, rather than opting for long-term business loans, alternative funding options may be ideal for businesses with immediate cash requirements.

• Strict Eligibility Requirements:

Opting for a loan, especially one that involves a larger amount, has more stringent eligibility criteria. Requirement of a good credit score is one such criteria. Almost all lenders require borrowers to have a decent credit score to qualify for loans at lower interest rates. Likewise, all companies seeking funds are required to be in the market with a minimum number of operational years. Business owners who have recently started functioning may not qualify for a business loan.

When To Take A Long-Term Business Loan?

Loans taken from banks and NBFCs must be returned through EMIs. It is essential to understand the different types of funding options and then decide the right financing option that can help business in the long run.

Long-term business loans can be beneficial only if the interest rates and terms of the loan are favourable. The tenure of short-term loans is generally two-three years or less but they have higher rates of interest. The EMI on short-term loans may be higher but the biggest advantage of these loans is that they may not require any collateral.

So, business owners who are not sure of their repaying ability must think seriously before opting for a long-term loan as the lender may take the ownership of the pledged asset in case of a default.

How to Decide if a Long-Term Business Loan is Right for Your Business?

Choosing the right business financing option depends on your current situation and financial needs. Here's how to determine if a long-term business loan is right for you:

1. Long-Term Business Loan Lenders Prefer Established Businesses

Long-term business loans involve large sums, so lenders prefer established businesses with substantial revenues over several years. They often have a time-in-business requirement that may disqualify newer companies. 

To qualify for best long-term business loans, you’ll likely need to submit:

• Annual revenue
• Monthly bank statements
• Financial metrics over several years

Lenders may also request:

• Current credit card debts
• Outstanding loan information
• Other financial documents to assess your business's health

2. Lenders Need Confidence in Their Investment:

Lenders prefer businesses with high credit scores, as this indicates reliability in repaying the loan. Given the risks of long-term financing, they will closely review your credit score and business history. Alternative and online lenders might also require detailed plans on how you’ll use the loan. Accordingly, lenders might ask for the following:

• Business plans
• Cash flow projections
• Bank statements
• Tax returns

3. Long-Term Business Loans are a Major Commitment:

Taking out a long-term loan significantly impacts your finances. Here’s how:

• Monthly Payments: You’ll need to afford these, meaning less money for other expenses.
• Interest Payments: Even low rates add up over time, so calculate the total cost to ensure you can handle it along with other business expenses.
• Future Financing: Existing debt might make it harder to get future loans. This could be an issue during emergencies or new opportunities.

Remember, long-term debt is a liability. It remains on your books for a long time and increases risk, especially during economic downturns like the COVID-19 pandemic. If you're unsure about committing to a long-term loan in any manner, consider a shorter-term loan first. Proving you can repay responsibly might help you qualify for larger loans with extended terms later.

What to Do if You Don't Get Approved for a Long-Term Business Loan?

Business loan application getting rejected is disheartening, but it's not the end. Here’s what you can do to ensure the shortcomings don’t affect you the next time:

• Understand Why It Was Rejected:

Don’t just cut off contact. Reach out and ask for specific reasons. This will help you understand the weaknesses in your application and what you need to improve.

• Review and Improve Your Financials:

Take a close look at your business’s financials. Check your cash flow, credit history, debt-to-income ratio, and other relevant areas. Work on strengthening your financial position by paying down debts, enhancing your cash flow, and improving your credit score.

• Evaluate Your Business Plan:

Revisit your business plan and see if it needs refinement. Ensure it articulates your value proposition, competitive advantage, target market, and growth potential.

• Reapply With a Different Lender:

After addressing the issues that led to the rejection, consider reapplying with a different lender—research lenders with a history of financing businesses in your industry.

Conclusion

Long-term business loans are popular with businesses that need working capital. But these loans are best only when monthly cash flow can easily cover monthly repayments.

When it comes to choosing the term of the loan, the best way to decide is to go by the business needs as well as repayment capacity. Before taking a business term loan it is better to analyse the pros and cons of the types of business loans and then make an informed decision.

IIFL Finance offers both long and short-term business loans to companies who need financial assistance. IIFL Finance provides up to Rs 10 crore in secured business loans with a tenure of as long as 10 years. To avail a loan, applicants must fill the loan application form and provide primary business and personal information. Once the KYC is done and the verification process is completed the loan amount is credited directly into the customer’s bank account.