Term loans are best when your business needs to invest in a longer-term enhancement or business improvement. Additionally, when the expected return on investment (ROI) is greater than the cost of the loan, the term loan can be a great choice. It's less desirable to use a term loan when you are in a temporary cash crunch as this could drag your business down.
Good use case: Anything where the usefulness of the investment is greater than (or not significantly less than) the term of the loan.
For example, if your business takes out a 5-year / $100,000 term loan to purchase inventory, which you will sell within the next 6 months, then it is not good use case, since the term of the loan is 5 years and the inventory would have been sold within the first 6 months of the 5-year term. You will be paying off the inventory for 4.5 years after it was sold. It would have been best to structure your term loan as a 12 to 18-month loan, opposed to a 5-year loan. We can also flip this scenario on its head - for disciplined business owners this could become a good use case, ONLY if you were to pay off the term loan once the inventory is sold and your business earned its profit for selling the inventory. Whereby, the 5-year term loan was actually paid back within 6 to 12 months.
In the above example you would have enjoyed low payments for 6 months, and the loan would be paid back early. But let’s be honest – most business owners find this type of discipline quite challenging.
Terms loans are also for businesses and owners that have a very good credit profile, since a term loan will carry the lowest combination of fully amortizing interest rates or factor rates and longest-term length, which equates to lower payments than the other business funding options.
