Banks

Commercial banks are usually one of the least expensive providers of loan capital. Banks are most interested in financing firms that can show an ability to repay the loan. This usually means a company must have a strong positive cash flow or assets as collateral that can be easily liquidated. Factors such as the content of the business plan and experience of the management are also considered.

Payment terms are usually up to seven years for loans from commercial banks. Most debt is secured, although some unsecured lines may be available. Personal guarantees are generally required resulting in exposure of the borrower's personal assets in the event of a business failure. Even if the business is formed as a corporation, the limited liability feature is superseded by a personal guarantee.

The interest rate on a loan is typically expressed as a percentage in excess of the prime rate. Prime is the rate the nation's largest banks charge their best customers. The prime rate itself will vary according to economic conditions; it is primarily dependent on the rate the banks themselves are charged by the Federal Reserve to borrow money. The percentage over prime that a customer is charged is based on the banker's perception of the risk taken by granting the loan.

Lending institutions have different policies towards risk. Some are inclined to follow relatively conservative lending practices; other engage in more creative banking practices. Banks borrow money elsewhere at a lower rate and lend it out at a higher rate; therefore, the commercial bank's primary concern is a borrower's ability to cover principal and interest repayments. Although bankers are interested in all financial aspects of a borrowing firm, hard assets provide their primary insurance if the business fails.

Commercial banks are among the largest sources of credit to small businesses. According to the SBA Office of Advocacy's 1999 report on small business lending activities, commercial banks had $371 billion in small commercial and industrial loans outstanding as of June 1998. The number of small business loans made by commercial banks increased from $7.9 million in June 1997 to $9.2 million in June 1998, with almost all of the increase in the under $100,000 loan category.