Key Takeaways

  • Commercial finance companies provide flexible lending solutions for businesses that may not qualify for traditional bank loans.
  • These companies offer various financing products, such as equipment loans, invoice financing, and asset-based lending.
  • Unlike banks, commercial finance companies do not accept deposits and often approve loans faster with more flexible terms.
  • Key benefits include fast funding, fewer restrictions, and options for businesses with weaker credit profiles.
  • Risks include higher interest rates, personal guarantees, and limited regulatory oversight.

The definition of a commercial finances company refers to a company that makes loans to commercial businesses or helps finance the sale of a company's products to its customers.

Not all finance companies lend to commercial businesses, some lend to consumers. As finance companies do not take deposits from the public, they are not considered banks and thus are free from the strict regulations associated with banks. Instead, finance companies earn money from their own lending or from parent companies, which is then used to provide loans. Many finance companies base their loans on the value of the assets promised by their customers as security.

How Do Finance Companies Work?

Finance companies provide loans for their customers and typically have higher interest rates than those of banks. This loan interest is how finance companies generate revenue. Many people have poor credit history and will turn to finance companies to offer them loans. These clients offer collateral to secure their loans, typically by promising to give the finance company valuable person assets, if the loan is not repaid.

For example, if Stefano borrows $8,000 from a finance company to fund the launch of his cleaning business, the company may ask that he offer his personal vehicle as collateral. If Stefano fails to make his loan payments (as in, if he defaults on the loan), the company would take possession of his vehicle.

Types of Finance Companies

There are three primary types of finance companies:

  • Consumer finance companies.
  • Sales finance companies.
  • Commercial finance companies.

The first category, consumer finance companies, makes small loans to consumers (individuals), typically with terms that benefit the company and are unfavorable for the consumer. Direct-loan and payday loan companies fall within this category and have a poor reputation for taking advantage of people who are struggling and in need of quick cash.

Consumer finance companies offer loans with higher interest rates than the market average, which are called subprime loans. Many states in the US have small-loan laws that prohibit consumer finance companies from charging interest rates of more than 25 percent.

The second category is sales finance companies, which are also called acceptance companies. These finance companies offer services for businesses in a similar way that direct-loan companies offer services for individuals, with some key differences. The businesses that borrow money from sales finance companies are typically large corporations with impressive credit ratings. A large corporation does not need to secure its loan with collateral. In addition, these businesses often receive better interest rates than they would receive from a bank.

The third category is commercial finance companies, also known as commercial credit companies. These finance companies offer loans to both small and large businesses, usually to help them pay for new equipment or other significant upgrades.

As small businesses pose greater risks to commercial finance companies, they often have to pay higher interest rates than larger businesses. These subprime loans' interest rates are usually between 0.1 percent and 0.6 percent higher than the loans given by banks to more qualified customers (prime rate loans). This may appear to be a small difference, but for finance companies, this translates into thousands of additional dollars in revenue. However, finance companies are more likely to have delinquent clients than a bank, so this extra money from paying customers helps mitigate these losses.

Commercial Finance Companies

Banks usually offer lower interest rates, more flexible terms, and higher loan amounts than commercial finance companies, so why wouldn't one choose a bank with whom to finance their business expenses? The primary reason is that banks are extremely tight with their credit. Only 20 percent of business owners who apply for loans through a bank receive the loan.

On the other hand, alternative lenders, such as finance companies, have much more flexible financing options that allow many small business owners to use their services. Not only do these lenders offer lines of credit and term loans, but they also offer merchant cash advances, invoice financing, short term loans, working capital loans, and much more. In addition, commercial finance companies work much faster than banks. Some might even approve a loan the same day you apply.

Choosing the Right Commercial Finance Company

When selecting a commercial finance provider, consider:

  • Industry experience: Choose a lender that understands your sector and its challenges.
  • Loan product variety: Look for companies that offer multiple financing options.
  • Approval time and funding speed: Ensure the company meets your timeline needs.
  • Reputation and reviews: Research third-party ratings, testimonials, and Better Business Bureau (BBB) standings.
  • Transparency: Avoid lenders with hidden fees or vague terms.

Some reputable commercial finance firms specialize in niche sectors such as manufacturing, healthcare, or construction and can provide tailored insights and support.

Risks and Considerations

While commercial finance offers flexibility, there are important risks and trade-offs to consider:

  • Higher interest rates: Loans are often more expensive than those from banks.
  • Shorter repayment terms: Some loans must be repaid in months rather than years.
  • Collateral requirements: Many loans are secured by business or personal assets.
  • Limited consumer protections: These companies are not subject to the same regulations as banks.
  • Personal guarantees: Business owners may need to pledge personal assets, increasing financial risk.

Due diligence is essential when evaluating a commercial finance provider. Always compare loan terms, fees, and requirements before making a decision.

Common Uses for Commercial Finance

Commercial finance is used to address a variety of business needs, including:

  • Working capital support to manage day-to-day operations
  • Purchase of equipment or vehicles for business expansion
  • Real estate acquisition or renovation for commercial purposes
  • Inventory procurement to fulfill large orders
  • Bridge loans for temporary cash flow gaps
  • Debt consolidation to manage multiple obligations more effectively

These financing solutions can be critical during growth phases, periods of seasonal fluctuation, or economic downturns when traditional credit lines may tighten.

Benefits of Using Commercial Finance Companies

Businesses turn to commercial finance companies when traditional banks are too restrictive or slow. These lenders offer advantages such as:

  • Faster approval and funding: Some companies can fund loans within days, or even hours, compared to weeks with banks.
  • More flexible eligibility criteria: Businesses with lower credit scores or fewer assets may still qualify.
  • Diverse financial products: In addition to standard loans, many offer:
    • Asset-based lending
    • Invoice factoring
    • Merchant cash advances
    • Equipment financing
    • Inventory loans
  • Customized solutions: Lenders often tailor loan terms to fit unique business needs, which is particularly helpful for startups and small to mid-sized businesses.

Frequently Asked Questions

  1. What is the main difference between a commercial finance company and a bank?
    Commercial finance companies offer business loans without taking public deposits and are less regulated than banks, allowing more flexibility but often higher rates.
  2. Who typically uses commercial finance companies?
    Small to medium-sized businesses, startups, and companies with limited credit history often use them when traditional loans are inaccessible.
  3. Are commercial finance loans risky?
    They can be, especially due to higher interest rates, short repayment terms, and personal guarantees. Businesses should assess their repayment capacity carefully.
  4. Can a business with poor credit get financing?
    Yes, commercial finance companies often lend to businesses with lower credit scores, usually at higher rates or with collateral requirements.
  5. What types of loans do commercial finance companies offer?
    Common options include equipment financing, invoice factoring, working capital loans, lines of credit, and merchant cash advances.

If you need help understanding the definition of commercial finance companies, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.