Commercial Lending

Commercial lending plays a huge role in the business world. Organizations may take out commercial loans to finance expansions, fund operational costs, survive economic downturns, and more. But navigating the lending industry can be complex and even intimidating, especially for small business owners. From knowing about the many types of commercial loans that exist, to understanding the loan process and knowing how to get approved, there’s a lot to keep in mind.

Consider a dental practice that’s looking to grow, for example. Doing so will require quite a bit of capital, especially if growth means expanding to a new location. In many cases, this requires acquisition financing, as well as funding for remodeling, purchasing or upgrading equipment, and a line of credit to cover operating expenses.

If any of those things give you concern as a small business owner, this article is for you. At Indiana Members Credit Union, we provide a whole suite of financial services to small businesses—from commercial loans to treasury management. But more importantly, we are passionate about member success, and that goes double for small businesses. Keep reading to learn more about what commercial business lending is, what types of bank loans there are, the process to expect, and what things you’ll want in order before applying.

What Is Commercial Lending in Banking?

Commercial lending is the process by which banks or credit unions loan money to businesses. These loans may be used for a variety of reasons, such as business expansion, purchasing real estate, working capital advances, and more. Depending on what a business needs the loan for, there are different types of commercial loans they can seek out to fill each need.

Most know that commercial banks are a place to take out loans, but not as many know that credit unions are also an option—one that is oftentimes a better choice for small businesses. Credit unions are nonprofit financial institutions that are owned by the members who use their services, meaning a credit union’s success depends on their members’ success. Small businesses gain a lot from working with credit unions because they’re able to get the banking services they need, with the high-touch service and care that will help them thrive.

What Is an Example of a Commercial Loan?

Commercial loans take on a wide variety of forms, so let’s use the specific example of a small business—namely, a local farm. Food is critical to the economy, and by extension so are farmers…but all too often, getting a farm off the ground can be a challenge. Making farming profitable requires not just a lot of knowledge, but equipment, workers, and (fertile) land. If someone wanted to get into the agricultural industry but didn’t have a bunch of extra money sitting around, they may instead take out a commercial loan with a local credit union to purchase farmland, tractors, manure spreaders, or any other essentials.

Many businesses with a lot of upfront costs could benefit greatly from using small business loans. Examples include construction companies, real estate agencies, medical practices, manufacturers, and similar industries.

What Is the Most Common Commercial Loan?

Since commercial loans take on a variety of forms, there isn’t a universally “most common” loan. However, there are a few types of commercial loans that come up frequently, including the following:

• Lines of Credit | Similar in function to a credit card, this gives businesses a maximum amount they can utilize for funding. With credit lines, businesses only pay interest on the amount they’re using, rather than the maximum amount possible.

• Term Loan | This refers to any number of loans with fixed repayment terms. The “fixed” part, ironically, can vary depending on the type of loan, as different variables can be fixed. But usually, the loan has a fixed payment schedule, interest rate, or ways the loan money may be used.

• Equipment Financing | Many businesses require large-scale equipment that is tough to purchase on the spot. In this case, they might want to take out a commercial loan. For example, healthcare practices may require ambulances, medical equipment, or other expensive items. Equipment loans help businesses make those purchases without breaking the bank before the business even gets going—which also makes it easier to pay off equipment, if the loan is on good terms.

Something to note here is that even within each industry, these subtypes of loans (along with others) may appear. For example, when working in real estate, there are various types of commercial real estate loans you may want to consider, including lines of credit, bridge loans, and even SBA-backed loans.

What is the Difference Between Commercial Lending and Business Lending?

There is no major difference between a commercial loan and a business loan; essentially, they are the same thing. The only small difference of note is their dollar amounts. Commercial loans are generally larger, and “business loans” will typically refer to loans more geared towards small businesses. But they are the same concept, and you may hear both of these terms used interchangeably in the lending space.

What Is the Role of Commercial Lending?

Commercial lending is, in short, a way of stabilizing the economy. Letting businesses borrow money allows them to grow faster, expand operations more easily, and even survive economic downturns. Without the ability to take out loans, many businesses would not grow to the point of profitability—and even if they could, a good number of them might not outlast a dip in consumer spending.

Additionally, loans are what allow banks and credit unions to exist in the first place. Financial institutions are known for safeguarding money, but they have to earn money as well—if for no other reason than to implement security measures and pay their employees. Banks and credit unions collect this money via the interest from their loans, which they give out to people and businesses.

It’s worth noting here that because credit unions are nonprofits, they take the “profit” earned from their interest and put it back into the organization in a variety of ways, including making their loan rates even better for members. None of that is possible without commercial lending. It’s arguable that even the existence of banks/credit unions would not be possible either.

What Is the Commercial Lending Process?

The commercial lending process is generally the same for each financial institution, though the order and specifics may vary. Essentially, the bank or credit union is gathering more information to assess your “5 Cs of Commercial Lending” (which we’ll discuss next). First, are a few things to expect as you apply for a business loan:

• Leadership Debrief | A financial institution will first want to sit down with key management staff, such as owners, chief financial officers, and similarly vital personnel. Here, they’ll gather information to better understand your business, such as a brief overview of the company, its products and services, or its potential markets.
• Company History Breakdown | Having a descriptive timeline of the business will be helpful for the financial institution’s decision making process. This applies to not just the key dates for the business, but also its evolution over time. Who does your business serve, and why? Who are its competitors, and how has that changed over the years (if at all)? You want to be able to speak clearly about your business and the economic space it has occupied throughout its existence.
• Financial Review | Here, the bank/credit union will analyze the business income statements. They are looking for not just a net-positive cash flow, but also trends—and reasonings for those trends. For example, if your profit margin dips at some point but it’s due to a positive reason (such as expansion), it’s better to explain this decrease yourself rather than let lenders assume the worst. Be prepared to explain and accurately attribute your business’s noteworthy trends.

By no means is this an exhaustive list, but these few examples above are critical things to be prepared for when applying for commercial loans. The stronger your “5 Cs of Commercial Lending” look to an institution, the better chance you have of getting the loan. And speaking of the 5 Cs…

What Are the 5 Cs of Commercial Lending?

The 5 Cs of commercial lending is a means of evaluating businesses (and their owners) when they are applying for a loan. Banks or credit unions will use these traits to better gauge an applicant’s creditworthiness—not just whether they should receive a loan, but how much of a loan they should get.

The 5 Cs are capacity, capital, collateral, condition, and character. Each of these will impact a financial institution’s decision-making process on your loan application, and for different reasons. Let’s examine them further.

1. Capacity | In the context of commercial lending, capacity relates to the borrower’s ability to repay the lender. Lenders determine a borrower’s capacity to repay by assessing their debt-to-income (DTI) ratio and by comparing their income against any recurring debts. More specifically, lenders calculate DTI by dividing the borrower’s total monthly debt payments by their gross monthly income. Ideally, the borrower’s DTI will be as low as possible, indicating a greater capacity to repay the loan in full and on time. To the extent that it’s possible, aim for a DTI of below 36%.

• Capital | Commercial lenders like to assess an organization’s capital, often referred to as cash flow, when determining whether to lend (or what terms to set). In this context, capital relates to how much money is coming into—and out of—the business. Capital plays a key role in how much confidence a bank or credit union can put into the ability for the loan to be repaid. While collateral (see below) plays a similar role, the process of actually seizing collateral is time-consuming and difficult, which is why many lenders prioritize capital over collateral.
• Collateral | Financial institutions use collateral as a means of insuring the loan. If a business ends up unable to pay back some portion of the loan balance, the bank/credit union wants to know they can collect the value via other means—be it physical items, property, or other things of value. Collateral, then, is anything a business can pledge as assurance they will repay the loan. This concept is somewhat unique to business loans because for personal loans, such as an auto loan or mortgage, the collateral is usually the item itself. But since business loans are often for more abstract needs, collateral creates assurance the loan’s value will still be retained. Keep in mind that financial institutions don’t actually want to take your collateral away from you; they simply want assurance that you will pay the loan.
• Condition | Commercial lenders aren’t just interested in a borrower’s income; they also like to take a broader look at their potential ability to repay a loan by examining external factors such as market conditions or industry trends. This helps to paint a more complete picture of how much potential risk they might incur by providing a specific loan. It’s important to note that lenders aren’t just looking for reasons to deny a loan (or set exorbitant conditions)—these conditions can just easily sway a lender’s decision in a borrower’s favor.
• Character | A very subjective piece of the puzzle, this is the institution’s judgment of both the business owner and the business itself. While “character” once had a long history of disproportionately harming minority applicants, it’s now more of a way to reward applicants who are organized and are clear about their intentions with the loan. As a business owner, a lot of your success in application will simply come from being prepared. By knowing exactly what you want to use the loan for, filling out everything accurately, and responding promptly to requests, you can easily distinguish yourself as an applicant.

Explore All Types of Commercial Lending With IMCU

When applying for a commercial loan, there is a lot to consider—but it’s not something that has to feel daunting, overwhelming, or like you’re missing out on key information. With the right financial institution, you can walk away feeling confident, well-informed, and taken care of as a business owner. 

That’s exactly the environment we provide at Indiana Members Credit Union. We pride ourselves on serving members with above-and-beyond customer experiences—for both personal and business banking needs. For small businesses especially, credit unions like IMCU are a great way to get your financial needs met in a place that is genuinely interested in your success. After all, credit unions are literally owned by the members they serve, which means they only thrive if you thrive. And at IMCU, we’re excited to help small businesses see the success they deserve.

If you’d like to explore more about how IMCU works with small businesses, feel free to visit our website, check out our commercial lending teams, or submit an inquiry about your loan options. We also encourage you to stop by a branch in-person. We’re happy to help you find the best option for your business, and see your business grow the way you want.