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The interest rate of a business loan can vary widely and will depend on the market, the type of loan, and the lender.

On average, the annual percentage rate (APR) for a traditional bank loan ranges from 6.13% to 12.36% The APR for a business loan from an alternative or online lender, on the other hand, can run anywhere from 6% to 99%.

The actual rate that a lender will offer will also be based on your qualifications as a borrower, such as your personal and business credit score, annual revenue, debt-to-income ratio, cash flow, number of years in business, and whether or not you’re able to secure the loan with collateral.

Here’s what you need to know about business loan interest rates and how to get the best loan at the lowest cost for your business.

5 Factors That Determine Business Loan Interest Rates

Below are some of the key factors that influence interest rates on small business loans.

1. General Interest Rates

One of the biggest factors that affects what interest rate you’ll get on a small business loan is the current market rate. The current market rate is determined by the supply and demand in financial markets, central banks (such as the Federal Reserve), prevailing economic conditions, and inflation expectations.

2. Lenders

When you compare interest rates from different lenders, you’ll generally find that banks typically offer some of the lowest rates. These loans can be difficult to qualify for, however, and the application and approval process can take weeks or months to complete. Online and other alternative lenders tend to charge higher rates but have more flexible qualification criteria and are faster to fund.

3. Types of Loans

There are many types of small business loans on the market, and each has their own interest rate range. Here’s a look at the average interest rates for common types of business loans as of May 2024:

Bank Small Business Loans

A traditional bank term loan can be difficult to qualify for, but if you do, you’ll see they have some of the better interest rates on business loans — averaging 6.13% to 12.36% APR.

If you have strong credit and consistent revenue, have been in operation for a few years, and don’t need the funds right away, a bank or credit union may provide you with the best terms. If you’ve already established a relationship with a particular bank or credit union, say by opening a business bank account, you might want to explore their business loan options.

Online Term Loans

Average interest rates tend to run higher for business loans offered by online lenders — ranging anywhere from 6% to 99%. However, it’s typically easier to qualify for this type of business loan than it is for a bank term loan. As a result, online term loans can be a good option if your business has poor credit or hasn’t been in operation for very long. Online lenders also offer short-term loans that are not typically available from other sources.

SBA Loans

SBA loans are partially guaranteed by the U.S. Small Business Administration and issued by participating lenders, typically banks. Due to government backing, SBA loans offer businesses access to financing with more lenient credit requirements and lower down payment requirements compared to conventional bank loans. SBA loans also come with attractive rates (currently around 11.5% to 15%) and some of the best repayment periods — some as long as 25 years.

Business Lines of Credit

With a business line of credit), a company can borrow up to a certain amount of money, as needed, and use the funds for virtually any type of business expense.. As the business repays the funds, they become available to borrow again.

A line of credit can be a great option for small businesses facing frequent cash flow issues. It can also be a good thing to have in your back pocket in case of emergencies.

Advertised rates for lines of credit are almost always low, but your business’s characteristics will determine how much you’ll pay. Generally, the APR for a business line of credit can start around 10%, but they can go much higher. Like a credit card, though, you only pay interest on what you use.

Invoice Factoring

Invoice factoring is a short-term financing method that allows businesses to sell unpaid customer invoices to an invoice factoring company. You can often get up to 85% of your unpaid invoices up front. The factoring company then collects payment from your customers and gives you the remaining balance — minus fees. While these fees can be hefty — as high as 79% — invoice factoring can help a business get past difficult financial times.

Recommended: How to Dispute a Business Credit Report

Merchant Cash Advances

A merchant cash advance (MCA) allows your business to exchange your future earnings for immediate cash. With an MCA, you receive a lump sum of cash from an MCA provider, which you pay back using a percentage of your daily sales. MCAs are typically easier to qualify for than traditional business loans, but tend to come with higher costs. Instead of interest rates, MCAs come with factor rates — often around 1.20 to 1.50.
To determine the cost of an MCA, you multiply the total amount of cash advanced to you by the factor rate. For example, If you get $20,000 and have a factor rate of 1.25, the total cost is $25,000 ($20,000 x 1.25), which includes the $20,000 advanced to you and $5,000 in fees.

Keep in mind, though, that there may be additional fees on top of the factor rate.

Recommended: How Much Down Payment for Business Loan?

4. The Business’s Finances

No matter what type of lender you work with or what type of loan you pursue, your business’s finances will likely be thoroughly studied by an underwriter when you apply for a small business loan.

Here are some things lenders typically will look at when considering whether or not to give you a loan and, if so, at what rate.

Credit Scores: Personal and Business

Each lender has its own criteria for establishing interest rates, but personal and business credit scores are usually one of the main determining factors.

If you recently launched your business and don’t have much credit history, lenders will likely look at your personal credit profile. Generally, a higher score will help you get a lower interest rate.

Lenders often require a minimum personal credit score to qualify for financing. Banks may look for scores of 680 or higher, while online lenders may accept scores in the 500s.

Lenders will also look at your business’s credit score. Instead of ranging from 300 to 850, business credit scores typically range from 1 to 100. Dun & Bradstreet’s Paydex score (one of the more commonly used scoring models) has three risk categories, as follows:

Low risk: 80-100
Moderate risk: 50-79
High risk: 0-49

If you have a “low risk” business credit score, it likely means that you pay your bills on time and maintain a healthy credit utilization ratio. If this is the case, you can expect to receive some of the best rates on small business loans.

Business Income

How much money you bring in each year can be a key factor in determining whether you will get approved for a loan, how big of a business loan you can get, and what the interest rate will be.

A business with a strong, predictable revenue stream has a good chance of getting approved for a high loan amount with a low interest rate. If you’re just starting out and your monthly revenue is still picking up steam, you may have trouble taking out certain types of business loans.

Time in Business

The amount of time you’ve been in business also impacts the interest rate a lender will offer you. If your business is new, you will likely pay more in interest, even if your cash flow is better than more established companies. The magic number many banks want to see is often two years. It’s not uncommon for a new business to fail shortly after they’ve opened, so the fact that you’re still standing after two years is a good sign to a lender.

Quantity of Collateral

Lenders often require borrowers to put up a fixed asset (like property or equipment) to secure a loan. This reduces risk for the lender because if you default on the loan, they can seize your collateral and sell it to make up for their losses.

If you’re applying for an SBA loan or bank loan, for example, lenders will want to know what kind of collateral your small business has to offer and the value of that collateral. It’s possible to get a loan without collateral, but these loans, called unsecured loans, typically come with higher interest rates.

5. Industry

Some businesses are statistically more likely to fail than others. For example, first-year failure rates tend to be higher for companies in food service, finance/insurance, real estate, and professional/technical services.

If your business is considered a risky business to lend to, you may receive a higher rate. In addition, some lenders have certain industries that they won’t lend to (such as firearms businesses) that could affect their reputation.

Recommended: Mompreneurs: Generational Wealth and Real-Time Struggles

Fixed vs Variable Interest Rates

When looking at loans, you may have a choice of getting a fixed or variable interest rate.

A fixed-rate loan has the same interest rate and monthly payment for the life of the loan. This means your first payment will be the same amount as your last payment.

Businesses often choose loans with fixed interest rates so they can easily budget for the payments. In addition, if interest rates are currently low, a fixed interest loan is a way to lock in that rate for the duration of the loan.

A variable-rate loan may have different payments from one month to the next. If the market fluctuates, the rate you pay could go up or down over the life of the loan.

Variable-rate loans tend to have lower rates than fixed-rate loans at the outset. For a short-term loan, a variable interest rate can end up being a good deal for the borrower. But there is some risk involved, as the rate can increase and you need to be prepared to make that higher monthly payment.

Pros and Cons of Variable-Rate Business Loans

Pros and Cons of Fixed-Rate Business Loans

Recommended: A Guide to SBA Loans

How To Compare Business Loan Rates

When comparing small business loans, you’ll want to look at more than just the interest rate. In fact, when lenders advertise only a monthly interest rate, it can be deceiving.

A monthly interest rate is simply how much interest you would be charged in one month. It doesn’t include any other charges associated with the loan, which may include one-time charges like origination and application fees, or recurring fees like a monthly service charge.

To better understand how much money you’ll actually be required to pay over the lifetime of your loan, and to make sure you’re comparing loans apples to apples, you’ll be better off comparing annual percentage rates, or APRs. An APR includes not just the interest rate but also the associated loan fees. It gives you the total annual cost of the loan, expressed as a percentage.

Business Loan Fees

Possible fees for business loans include:

•  Application fee

•  Processing fee

•  Closing fee

•  Origination fee

•  Prepayment fee

•  Late payment fee

•  Monthly service fee

How To Calculate Total Business Loan Cost

Not all lenders use an APR when quoting the cost of their business loans. If all you see is an interest rate, you can figure out the total cost of taking out the loan by using one of the many business loan calculators available online. In order to use one of these tools, you’ll need a few pieces of information, including:

•  The loan amount

•  The annual interest rate

•  Other fees associated with the loan (origination fees, closing costs, etc.)

•  The loan term

From there, you can see the loan’s total cost as well as what your monthly payments will be.

The Takeaway

The average small business loan interest rate depends on the overall market rate, the type of loan, the lender, your business’s financials, and the industry your business is in. Overall, traditional bank loans tend to offer better rates than other loan products. However, they may not be the best fit for your business if it’s new, doesn’t have a strong or well-established credit profile, or needs financing relatively quickly.

To get the best rate on a small business loan, it’s important to shop around and compare offers, take steps to build your business credit profile, and consider using collateral to secure the loan.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What’s the difference between a fixed and a variable business loan rate?

A fixed business loan rate remains the same throughout the term of the loan, which means your first and last payment will be the same.. A variable business interest rate, on the other hand, fluctuates based on market conditions, potentially offering lower initial rates but with the risk of increasing over time.

How do you qualify for a low business interest rate?

To qualify for a low interest rate, your business will generally need to have a good credit score, a strong cash flow, and have been in business for two years or more. Offering collateral can also lead to a lower interest rate.

What is a good interest rate on a small business loan?

A good interest rate on a business loan depends on the type of loan you’re looking to get.. For example, a good interest rate on a bank term loan might be 6% or 7%, while rates on SBA 7(a) loans currently start at 11.5% APR.

What is the minimum interest charged by business loans?

Each loan type comes with its own interest rate range. An SBA 7(a) loan of more than $50,000, for example, comes with a base interest rate (current prime rate) plus a maximum of 6.5%.

Why are SBA loan rates so high?

SBA loan rates are tied to the prime rate, which is set by the Federal Reserve. As the Fed has steadily increased the market prime rate, SBA loan rates have climbed accordingly.

Photo credit: iStock/MicroStockHub

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSB-Q224-1878680-V1

If you’re in need of capital to help launch or grow your business, you might be thinking about taking on a partner. However, if you don’t want to share the strategic decision-making with another partner, you might want to have a silent partner who provides capital…but not opinions.

Here’s a look at what a silent partner is as well as what you need to know to create a silent partner agreement for your business.

What Are Silent Partners?

Silent partners are investors in a general partnership, limited liability partnership (LLP), or a limited liability company (LLC), who do not want to be involved in the management of the company. This is in contrast to general partners, who both invest and manage day-to-day operations.

The level of involvement for a silent partner can vary depending on the agreement between the partners. Some silent partners may want to be kept in the loop on the progress of the business, while others may not want to be involved at all.

Silent partners are also known as limited partners, since their liability is typically limited to the amount invested in the partnership. They can potentially lose their entire investment — but typically no more. General partners, on the other hand, have unlimited legal liability for the partnership, and are generally personally liable for the debts and financial obligations of the business.

Even though a silent partner doesn’t have control over the business, they can often offer valuable insights, expertise, and business connections. However, silent partners aren’t generally under any obligation to offer advice and support. Their role is typically limited to staying in the background, providing capital when necessary, and sharing in the profits when they start flowing in.

Recommended: Guide to Business Checks vs Personal Checks

How Do Silent Partner Agreements Work?

Whether you are setting up a new partnership or bringing in a silent partner into an existing business, you’ll want to draw up a silent partnership agreement that outlines everyone’s interests.

A silent partner agreement, or contact, is a legally binding document that designates which parties are general partners or silent partners. In addition, the agreement will outline which functions, both financial and operational, the general partner will perform, along with the financial obligations that are assumed by the silent partner. It will also include the earnings percentage due to each partner in regard to business profits.

Pros and Cons of Silent Partners

Before taking on a silent partner, it can be a good idea to carefully weigh the benefits and drawbacks.

Pros of Silent Partners

Silent partners can provide much-needed financial support to help a business venture get off the ground or finance expansion. And, while a silent partner doesn’t need to be consulted on day-to-day decisions, they may have industry knowledge that can be helpful to your business. A silent partner’s name and business contacts may also help open doors to opportunities that the company founders wouldn’t have on their own.

Cons of Silent Partners

Bringing on a partner means diluting equity in your company and having to share the profits. And, while having a partner who stays out of business decisions might sound good, you might actually benefit from having an experienced partner participate. In some cases, a silent partner may not have any relevant business experience or contacts to bring to the table, or may not be invested enough in the company to provide helpful advice or feedback when needed.

If your silent partner agreement isn’t clear and/or the silent partner doesn’t understand their inability to influence decisions, misunderstandings could arise.

Common Silent Partner Agreement Terms

Generally, the more details your silent partner agreement includes, the better. These agreements typically include:

•  The dollar amount the silent partner invested

•  How much the silent partner shares in gains and losses

•  Limits on the silent partner’s liability

•  If the silent partner is able to invest more (and, if so, how much more)

•  Details on when and how the silent partner can withdraw funds

•  A statement explaining that the silent partner won’t receive a salary or wages

•  A statement that the silent partner must remain silent on daily business operations

•  Details of how the partnership can be ended

What Are the Rights of a Silent Partner?

Generally, a silent partner’s business rights include the right to earn investment returns (proportionate to their initial investment) with limited involvement and liability. Silent partners also typically have the right to review the company’s financial statements and provide input on changes made to the partnership agreement.

3 Things to Include in a Silent Partner Contract

You may be able to create your silent partner agreement from scratch using a document. Or, you might want to use an online silent partner agreement template. Either way, here is some key information you’ll want to include when drawing up your contract.

1. Basic Partnership Information

Your agreement should include details about the partnership, including the names of all partners, the business name, where the business is located, and the purpose of the business.

2. Percentage of Ownership

The silent partner agreement should clearly outline the percentage of equity that each partner owns and the earnings percentage due to each partner in regard to business profits.

3. Terms of the Partnership

You’ll also want to include the exact terms of the partnership, including which functions each partner will perform.

It’s also a good idea to include terms for buying out the silent partner. You might welcome the capital provided by a silent partner when launching your business. However, once your business is successful, you may want to buy out the silent partner rather than share profits long-term.

Alternatives to Silent Partners to Finance Your Business

Not everyone wants to bring on a partner, silent or otherwise. Here are some other ways to raise capital for your business.

Business Loans

There are many types of business loans available from banks, credit unions, and online lenders. With a traditional term business loan, you receive a lump sum of capital upfront, then pay it back, plus interest, with regular payments over the term of the loan.

Rates for small business loans vary depending on the lender, type of loan, and your company’s qualifications. Banks and lenders affiliated with the Small Business Administration (SBA) tend to offer the best rates and terms but have fairly strict qualification requirements.

Online lenders tend to be more flexible (and are faster to fund loans) but rates are generally higher and loan terms are typically shorter.

Recommended: Comparing Business vs Personal Loans

Business Grants

There are a variety of government, nonprofit, and private entities that offer grants for small businesses. You may be able to qualify for a grant if your startup supports a specific government initiative, your ownership meets certain qualifications (such as women, veterans, or minorities), or you will be doing business in an underserved community. Unlike loans, grants do not need to be paid back. However, competition for this type of funding tends to be stiff.

Angel Investors

Angel investors are wealthy individuals who offer promising startup companies funding in exchange for a piece of the business, usually in the form of equity. Typically, angel investors get involved in the early (or “seed”) funding rounds. However, some will come in after a company has already received an initial round of funding from the founders/partners, friends and family of the founders, or the bank.

Discover Business Loan Rates

Wherever you are on your business journey, there may be a loan available to help you take it to the next level. If you’re interested in exploring your options (without making any commitment), SoFi can help.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What are silent partnership agreements?

A silent partnership agreement is a contract signed by a business owner and a silent investor. A silent investor is someone whose involvement in a partnership is limited to providing capital to the business. The agreement outlines the roles, responsibilities, liabilities, and expectations of both parties.

What percentage of a business does a silent partner typically get?

Silent partners typically own a minority stake (less than 50%), but exactly what percentage they get will depend on the dollar investment they make and the company’s total worth.

Are silent partners liable in case of bankruptcy or other problems?

Typically, a silent partner’s liability is limited to the amount invested in the partnership. In the event of bankruptcy or other financial problems, a silent partner could lose their investment but generally nothing more.

Photo credit: iStock/WorSangJun

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

This article is not intended to be legal advice. Please consult an attorney for advice.

SOSB-Q224-1869694-V1

Funds from operations (FFO) is a number used by real estate companies called real estate investment trusts (or REITs) to measure their operating performance. It is considered a more reliable measure of a REIT’s value than traditional metrics, such as earnings per share (EPS) or price-to-earnings (P/E) ratio.

REITs hold a portfolio of commercial real estate or real estate loans and are designed to provide small investors with access to income-producing commercial real estate. If you own a REIT or are looking to invest in one, it’s important to know its FFO.

Read on to learn how to calculate FFO, what this metric can tell you about a firm, and how FFO differs from other measures of performance and profitability.

What Is FFO?

FFO stands for “funds from operations” and describes cash flows produced by a REIT’s operations. FFO is calculated by adding depreciation and amortization and losses on sales of assets back to net earnings, and then subtracting any gains on sales of assets and any interest income.

It is sometimes quoted on a per-share basis, called the FFO-per-share ratio. To assess the value of a REIT, owners and investors are more likely to look at its FFO-per-share ratio than its EPS. Lenders might also look at a REIT’s FFO and FFO-per-share ratio when considering whether or not to issue a real estate business a small business loan.

While FFO is a valuable metric, it is not recognized by the Generally Accepted Accounting Principles (GAAP), the standardized set of principles public companies in the U.S. must follow.

FFO Formula

Calculating a REIT’s FFO is straightforward once you understand the terms and where to find the figures.
The FFO formula is:

FFO = (Net Income + Depreciation + Amortization + Losses on Property Sales) – Gains on Sales of Property – Interest Income

All the variables of the FFO formula can be found on a firm’s income statement.

FFO Calculation

The FFO calculation is important when assessing the cash flow of a REIT. How much a REIT can borrow with different types of small business loans might be based, in part, on its FFO because it indicates the company’s operational strength. Let’s look deeper into where to find each term in the FFO formula and explain its purpose.

•  Net income: This is the company’s profit and is listed on the bottom line of the income statement. It’s a GAAP measurement, but it’s not always the best method for assessing the value of a REIT.

•  Depreciation: This is an expense line item associated with the declining value of durable assets like property, plant, and equipment (PPE) and other fixed assets. However, real estate is different from most fixed-plant or equipment investments because property loses value infrequently. Instead, it often appreciates. Thus, it can make more sense to judge REITs by FFO, which excludes depreciation.

•  Amortization: This is like depreciation but it’s done with intangible assets, such as licenses, patents, and copyrights. These items do decline in value over time (due to expiration), but since this is a non-cash expense, it does not impact cash flow.

•  Losses and gains on property/asset sales: This typically includes long-term assets such as PPE. Because these losses and gains are considered one-time, or non-recurring, they are not part of normal operations and are not included in the FFO calculation.

•  Interest income: Interest income is also considered a non-recurring item, and is removed to arrive at a REIT’s FFO.

Uses of FFO

FFO is a useful tool for evaluating the performance of a REIT because it only includes items central to business operations and excludes non-cash items (like depreciation and amortization) and gains and losses on property sales. Interest income is also removed in calculating FFO.

REIT owners, investors, analysts, and lenders all might use FFO when digging into the profitability of a REIT. FFO can help these stakeholders understand a business better. For example, if a REIT is trying to secure a small business loan, a lender might look at both its FFO and its debt-to-FFO ratio to determine how well the company would be able to manage additional debt.

Recommended: Prime Rate vs. LIBOR

FFO vs EBITDA Compared

FFO is similar to another commonly used non-GAAP profitability metric called earnings before interest, taxes, depreciation and amortization, or EBITDA.

Both FFO and EBITDA are used as an alternative to net income, and both add back depreciation and amortization to net income. The main difference between FFO vs EBITDA is that FFO looks at free cash flow from operations, while EBITDA seeks to measure profitability from operations.

While a firm’s EBITDA is certainly important, REIT investors should use FFO vs EBITDA, since it’s more applicable to this unique corporate structure. Here’s a look at how FFO compares to EBITDA.

Pros and Cons of Using FFO

While FFO is a useful way to measure the actual amount of cash flow generated from a REIT’s business operations, it has some drawbacks. One of the biggest is that it does not deduct the cost of maintaining the existing portfolio of properties. Since real estate holdings must be maintained, FFO does not always represent the true cash flow after all expenditures.

What Makes FFO Good at Measuring REIT Performance?

FFO makes adjustments to standard cost-accounting methods that can inaccurately assess a REIT’s performance. While GAAP accounting requires companies to depreciate assets over time, many investment properties actually increase in value over time. As a result, depreciation isn’t accurate in describing the value of a REIT and it needs to be added back to net income to solve this issue.

In addition, FFO subtracts any gains on sales of property, since these sales are typically nonrecurring.

Adjusted FFO vs FFO

Adjusted funds from operations, or adjusted FFO, is a related metric that takes a REIT’s capital expenditures into account. These recurring capital expenditures might include maintenance expenses, such as painting apartments or roof replacements. Adjusted FFO was developed to provide a better measure of a REIT’s dividend-generating capacity. It’s sometimes referred to as cash (or funds) available for distribution.

FFO Calculation Example

As an example, let’s calculate the FFO of XYZ REIT and see how it compares to net income.

Net income = $60 million
Depreciation and amortization expenses = $10 million
Loss from an asset sale = $5 million
Gains from an asset sale = $3 million
Interest income = $7 million

To calculate the company’s FFO, we must take the $60 million of net income and add back $10 million of depreciation and amortization expense and $5 million from the asset sale loss, then subtract $3 million in gains on asset sale and $7 million of interest income.

FFO = ($60 million + $10 million + $5 million) – $3million – $7 million = $65 million

Recommended: Delayed Draw Term Loans

The Takeaway

The FFO formula is commonly used to measure the amount of cash flow generated by a REIT, a business that holds a portfolio of commercial real estate or real estate loans. FFO adjusts for one-time and non-standard income so that investors can get a better sense of true profitability. Lenders might also use the FFO gauge when determining whether to approve a REIT for a small business loan.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is a good FFO for a REIT?

Most REITs will report FFO (funds from operations) per share. To determine whether a REIT is cheap or expensive, you’ll want to compare its price-to-FFO (P/FFO) ratio to its peers.

Is FFO the same thing as EBITDA?

No. FFO (funds from operation) is similar to EBITDA (earnings before interest, taxes, depreciation, and amortization) in that both look at income before depreciation and amortization expenses. Unlike EBITDA, however, FFO does not exclude interest expenses and taxes.

What is the difference between NOI and FFO?

Net operating income (NOI) is sometimes used in REIT valuation, but it does not take into account general & administrative expenses, taxes, and interest expenses. The FFO calculation includes those items.

Photo credit: iStock/MicroStockHub

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOSB-Q224-1860193-V1

Renting space for your business is a big step. So, before you sign anything, it’s important that you understand and agree with the basic terms of the lease, such as the amount of rent, length of the lease, and what other costs (like property insurance and taxes) may be involved.

It’s also important to understand that commercial leases are typically very different from the residential variety. In general, commercial leases offer fewer protections, have longer lease terms, and offer more room for negotiation than residential leases.

Here are some key things to keep in mind when renting space for your small business, plus tips on how to negotiate the best lease deal for your company’s needs.

What Is a Commercial Lease Agreement?

A commercial lease agreement, or business lease agreement, is a legally binding contract between a landlord (the “lessor”) and a tenant (the “lessee”) for the rental of a commercial space or property.

The term “commercial” means that the space will be used for business purposes rather than housing. A commercial tenant could be a sole proprietor just starting a company or a large global corporation.

A commercial lease outlines what that tenant is expected to pay, what type of business or activities may take place in the rental property, as well as how long the space is to be rented.

How Does a Commercial Lease Differ From a Residential Lease?

Commercial leases have some similarities to residential leases, as well as a number of key differences. Here’s a look at how these two different types of leases compare.

Similarities

•  Contractual agreement: Both commercial and residential leases are legally binding contracts between the landlord (lessor) and the tenant (lessee).

•  Rent payments: In both cases, tenants are required to make regular rental payments to the landlord as specified in the lease agreement.

•  Obligations and responsibilities: Both types of leases outline the rights and responsibilities of both the landlord and the tenant, including maintenance obligations, adherence to rules and regulations, and adherence to the terms of the lease.

Differences

•  Longer and more binding: Unlike residential leases, which typically last one year, commercial leases can last for several years. A commercial lease also tends to be harder to break than a residential lease.

•  No standard form: Commercial leases typically aren’t based on a standard form or agreement, but are customized to the landlord’s needs. As a result, it’s a good idea to carefully examine every commercial lease agreement offered to you.

•  Fewer legal protections: Commercial lessors and lessees have less legal protection than residential ones because state and consumer laws typically only apply to residential leases. With a commercial lease, the tenant generally has no rights other than what is explicitly stated in the lease agreement.

•  More complex: Commercial leases tend to be more complex compared to residential leases due to the unique considerations involved in commercial properties, such as zoning regulations, maintenance of common areas, and additional provisions related to business operations.

•  Tenants may be responsible for property taxes: Renters in a residential lease agreement are usually not responsible for paying property taxes, whereas with commercial lease agreements, it’s very common for the tenant to pay at least a portion of the property taxes.

7 Types of Commercial Leases

Commercial leases can be structured in a variety of ways depending on the type of property, type of business, and number of tenants.

In some cases, the tenant is only responsible for rent; in others, the tenant is responsible for all costs, including property insurance, property taxes, and maintenance and repairs of the building. Generally, if a tenant is required to assume most of the building’s costs, the rent will be lower.

Here’s a look at some of the most common types of commercial lease structures.

1. Net Lease

The tenant pays rent, plus a percentage of the building’s operating costs, which includes insurance, maintenance fees, and real estate taxes. There are three types of net leases: single, double, and triple.

2. Single Net Lease

The tenant pays rent, utilities, and property taxes. They do not pay any insurance or maintenance costs (that is the responsibility of the landlord).

3. Double Net Lease

The tenant pays rent, utilities, property taxes, and insurance. Maintenance expenses are paid by the landlord.

4. Triple Net Lease

The tenant pays rent, utilities, property taxes, insurance, and maintenance expenses.

The maintenance expenses typically aren’t all inclusive, however. The landlord is generally still responsible for maintaining the structural components (structural walls, foundation, and roof) of the building.

5. Absolute NNN Lease

The tenant pays rent, utilities, property taxes, insurance, maintenance fees, and all upkeep of the building.

6. Gross Lease

The tenant is only responsible for rent (and possibly utilities). They are not responsible for property taxes, insurance, or maintenance costs.

Because of the increased risk on the part of the landlord, the rent will typically be higher with a gross lease than with other types of commercial leases. However, if you’re just starting a small business, having a predictable payment may be an advantage.

7. Percentage Lease

The tenant pays a static monthly rent, as well as a percentage of their monthly sales. A common amount is 7%.

What to Look For in Your Commercial Lease

Before you sign on the dotted line, it’s important to read the fine print of a commercial lease and make sure the terms meet your business’s needs. Here are some things to look for — and look out for — when combing through a lease agreement.

•  Duration of the lease: Businesses often have multi-year commitments as opposed to just one year. Make sure you understand how long you are agreeing to rent the property.
Space you are renting: What is the exact space that you are renting? Does it include common areas such as hallways, rest rooms, and elevators?

•  Penalties: What are the penalties for paying the rent late? How long do you have before you accrue any fines?

•  Rent amount: Is the rent amount what was discussed between you and the landlord? If it’s more, don’t be afraid to ask why. Also don’t be afraid to negotiate, even at this stage of the game. Negotiating commercial leases is common and often takes place until just before the contract is signed.

•  The end of the lease term: Does the lease expire after the term length passes, or will you have an option to go month-to-month or renew it for shorter periods of time?
Utilities: Who is responsible for paying the monthly utility bills, such as gas, electricity, and water? Depending on the type of lease you have, you may be responsible for everything, nothing, or only a portion of the cost of utilities.

•  Building maintenance: Are you responsible for lawn care, snow removal, or the overall maintenance of the parking lot and building? If you are being allocated a percentage of maintenance fees based on the percentage of the building you’re renting, be sure the percentage is based upon the overall size of the building and that it doesn’t vary based on how much of the building is rented out at any point in time.

•  Specifications for signs: Can you hang signs and, if so, where?

•  Insurance: Who is in charge of insuring the building? Many types of leases make it the tenant’s job to insure the building’s structure. It may be outlined in the lease that the landlord expects you to get commercial property insurance.

•  Alterations to the space: Are you allowed to make any changes or modifications to the building or space you are leasing? If you are, what is expected of you after your lease ends?

•  Security deposit: The security deposit is paid by the tenant to the property owner when signing the contract. The lease agreement should specify the amount that was paid in regards to the security deposit and the terms for its repayment.

•  Taxes: Are you expected to pay property taxes on the building? If so, are you expected to pay the entire amount or a percentage?

•  Personal guarantee: Typically, a landlord won’t sign unless you personally guarantee the lease. However, you may be able to negotiate the nature of the guarantee. Maybe you can provide a guarantee for only a portion of the lease term or arrange that the guarantee only last for six to 12 months after you terminate the lease.

•  Rent increases: Generally, rent for commercial property increases by a predefined percentage each year. However, you might be able to negotiate a longer time between increases.

•  Subleasing: Are you allowed to sublease? A sublessee is another business that works in your lease space under your lease terms. You pay the lease and the other party pays you a portion of the cost. Many landlords don’t allow sublessees, but you may want to negotiate this if you think you might want to take on a sublessee at some future point in time.

Common Terms in Your Lease, Explained

Lessor: Landlord, or the person who owns the space that is being rented.
Lessee: Tenant, or the person renting the space outlined in a lease.
Parties: Those who are signing the lease (landlord and tenant, or lessor and lessee).
Premise: The space that is being rented.
Use Clause: Outlines what can and cannot be done in the space being rented.
Exclusive Clause: Promise by a landlord that no one else in the building or mall may sell or carry out a certain kind of business that would compete with your company.
Term Clause: Specifies how long the lease is, or how long you will be able to use the space you are renting.
Incidental Expenses: Other costs besides rent that a tenant agrees to pay. This includes things such as insurance, utilities, property tax, maintenance and repairs.
CAM: This refers to “common area maintenance,” and can include costs for services such as landscaping, grass cutting, snow removal, and janitorial services, which are often shared among tenants in a building.
Escalations: Rent increases.

5 Steps to Getting a Commercial Lease

Finding the right location for your business is a crucial step towards success. Whether you’re starting a new venture or expanding an existing one, securing a commercial lease is an important process. Here are five key steps to guide you through obtaining a commercial lease.

1. Determine Your Requirements

A good first step is to assess your business needs and determine the specific requirements for your commercial space. Be sure to consider factors such as location, size, layout, amenities, and budget. Understanding your needs will help you narrow down your search.

2. Research Potential Spaces

Next, you’ll want to conduct thorough research to identify potential commercial spaces that align with your requirements. You may want to use online real estate platforms, work with commercial real estate agents, and explore local business directories. Take note of properties that meet your criteria and make a list of potential options.

3. Visit and Evaluate Properties

Now, you can schedule visits to your shortlisted properties. Some things to carefully evaluate during site visits include the location, accessibility, parking facilities, infrastructure, and any additional features important to your business. Also take note of any repairs or modifications that may be required to make the space work for your company and inquire about the terms and conditions of the lease.

4. Negotiate Lease Terms

Once you have identified a property that meets your needs, it’s time to negotiate the lease terms. This entails having a discussion with the property owner or leasing agent about specifics, such as rent, lease duration, renewal options, maintenance responsibilities, and any clauses or conditions. You might consider seeking legal advice to ensure the lease terms are fair and favorable to your business.

5. Review and Sign the Lease Agreement

You’ll want to carefully review the lease agreement before signing. Pay attention to any clauses related to rent increases, security deposits, maintenance obligations, subleasing options, and any restrictions that may impact your business. Be sure to ask for clarification on anything that isn’t clear or seek legal advice if needed. Once you are satisfied with the terms, you can sign the agreement and complete any necessary paperwork or payments.

How Does Your Loan Factor Into Your Lease?

When leasing commercial real estate, landlords will generally require some sort of financials and credit information about your business, as well as you personally.

If you currently have a small business loan, your loan payment comprises part of your debt-to-income (DTI) ratio, which shows how much of your business’s income is being spent on debt payments. A commercial landlord may look at your company’s DTI (which is part of your credit report) when evaluating your lease application in order to be sure you will be able to pay the rent.

As a business owner, you’ll also want to look at any existing debt when determining your budget for a business lease. If you are currently making monthly loan payments, you’ll want to make sure you can comfortably sustain both payments (your loan along with your commercial rent) before signing a lease.

Recommended: What Is Commercial Real Estate Crowdfunding?

The Takeaway

Unlike residential leases, there are many different types of commercial lease agreements that offer flexibility based on the needs of your business. Each one comes with its own pros and cons, so it’s important to read the lease agreement carefully before signing. You can also hire an experienced lawyer to help negotiate a lease on your behalf, especially if the terms are complex.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What is the most common type of commercial lease?

The most common type of commercial lease varies by area, but one of the most frequently used is the Triple Net Lease (NNN lease). In this type of lease, the tenant is responsible for paying a portion or all of the property expenses, including property taxes, insurance, and maintenance costs, in addition to the base rent.

What is the assignment clause in a commercial lease?

The assignment clause in a commercial lease allows a tenant to transfer their lease rights and obligations to another party. This allows the tenant to assign the lease to a new tenant or sublease the space to another business. The assignment clause typically spells out conditions and requirements associated with the assignment or sublease process.

What is the main difference between renting and leasing?

The main difference between renting and leasing is in the duration of the agreement. Renting typically refers to short-term occupancy of a property, often on a month-to-month basis, with the option to renew or terminate the agreement with relatively short notice.

Leasing, on the other hand, typically involves a longer-term commitment, often one year or more, with specified terms and conditions. Leases generally offer more stability and security for both tenants and landlords, while rentals provide more flexibility and the ability to easily change locations or arrangements.

Photo credit: iStock/Douglas Cliff

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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A rising force among today’s small business owners and entrepreneurs, crowdfunding can enable access to funds that may have been previously out of reach. Instead of relying on investors or financial institutions, it allows you to tap into a grassroots support system.

With rewards-based crowdfunding (also known as seed-based crowdfunding), entrepreneurs solicit financial donations from individuals in return for a product or service. It’s one of the most popular types of crowdfunding. Here’s why: It doesn’t require giving up any equity in your company or paying back any of the funds you raise.

While crowdfunding for a small business can be a game changer, a successful rewards-based campaign can take a fair amount of time, hustle, and salesmanship. You typically need to develop a convincing pitch that appeals to as many people as possible and offer attractive rewards at all donation levels.

Could rewards crowdfunding be a good fit for your business? Read on to find out.

What Is Rewards-Based Crowdfunding?

With rewards crowdfunding, a company asks for money from the general public in exchange for a gift. Generally, companies provide tiers: The more money you give, the greater your reward.

To launch a rewards-based crowdfunding campaign, you generally need to describe your project or idea on a crowdfunding platform. You’ll also likely need to set a specific fundraising goal, choose an end date, and ask the crowd to contribute to your campaign for the promise of a reward.

Crowdfunding rewards can be as basic as a personalized thank-you letter or branded T-shirt. The most popular crowdfunding gifts, however, often revolve around donors gaining early access to the product because they actually receive what excited them enough to fund your project in the first place.

Rewards crowdfunding differs from other types of crowdfunding. With equity crowdfunding, for example, companies give up a percentage of their company in exchange for funds. With loan crowdfunding, any money received is paid back with interest.

What Type of Business Is It Useful For?

Rewards-based crowdfunding can be great for startups that don’t qualify for traditional small-business loans.

It can also be a good choice for any small business that wants to test the waters on a new product or idea. Should a service or an aspect of your product need to be tweaked, user feedback from the crowdfunding process will likely quickly let you know.

Rewards crowdfunding might not be ideal, however, if your business has a complex product or service. It may be hard to explain the value of your company in layperson’s terms to a crowdfunding audience.

Recommended: Crowdfunding Loans Explained

Who Can Donate to Your Crowdfunding Campaign?

Anyone can donate to a rewards-based crowdfunding campaign — family, friends, business associates, customers, or people entirely outside your network. Crowdfunding doesn’t require donors to have any special training, experience, or, in many instances, large amounts of money to donate.

Often, business owners will share their campaign on social media, with the hope that their followers will share the campaign with their networks.

What Platforms Can I Use for Crowdfunding?

There are many reward-based crowdfunding platforms small businesses and entrepreneurs can explore. These include:

•  Kickstarter

•  Indiegogo

•  IFundWomen

•  Fundable

•  Patreon

•  Artistshare

Each platform has its own rules, procedures, and fees. Platforms typically charge a percentage (which can be around 5% or even 10%) of total funds raised, plus a credit card processing fee that can run around 3% to 5% of each transaction.

In many cases, companies won’t receive their money (and donors won’t get their rewards) unless funding targets are hit before the project’s deadline.

Researching Reward Ideas for Crowdfunding

Generally, the best rewards will excite your target audience no matter what tier they fall into, so it can be a good idea to provide multiple reward options.

You may want to start by researching successful crowdfunding campaigns that offer products similar to yours. What sort of crowdfunding gifts did they offer? How many tiers did they provide?

Ideally, you’ll want to find something that is both affordable for you and interesting to them.

For example, if you have an app you want to promote, you might consider providing the following rewards:

•  $1 Thank you email with a special sneak peek video of the progress your team has been making.

•  $5 Thank you postcard and weekly emails providing updates

•  $10 T-shirt and weekly emails providing updates

•  $15 Early access to the app

•  $20 T-shirt and early access to the app

•  $50 Honorary mention within app and early access

•  $75 T-shirt, early access, and honorary mention

What Are the Pros and Cons of Rewards Crowdfunding?

All fundraising strategies come with a unique set of benefits and drawbacks. Here are some of the pros and cons of rewards-based crowdfunding.

Pros

One of the biggest advantages of rewards-based crowdfunding is that you are not giving up a portion of your company, nor are you taking on any debt. All you’re doing is offering perks to donors for giving you donations.

Unlike applying for many small business loans, a crowdfunding campaign does not require you to pass a credit check or meet eligibility requirements.

Rewards-based crowdfunding can be a good funding option for a startup because of the exposure you can gain on the platform.

This can help establish your customer base and build brand awareness. If donors get really excited about your product, they may do a lot of your marketing for you by talking about it on social media. When this happens, not only are you generating money, but you’re also getting free advertising.

Rewards crowdfunding can also enable you to get consumer feedback during the early stages of product development to help you make it as good as it can be.

Cons

One major drawback to running a rewards-based crowdfunding campaign is the amount of time and effort you may have to put into it.

Entrepreneurs typically need to create a persuasive campaign, which may include producing promotional videos, in order to help get backers interested in the project. They will likely also need to continuously promote their product.

If you don’t reach your fundraising goal, all of the money you raised may be given back to the donors, leaving you with no return on your efforts.

Another potential drawback to rewards crowdfunding is that it can allow competitors to see and steal your idea. Patents can protect you, but they, too, can take time and money. Unfortunately, successful crowdfunds can sometimes lead to cheap knockoffs.

Recommended: How to Finance Equipment With Bad Credit

The Takeaway

Rewards-based crowdfunding is a form of crowdfunding where the creators of a new product, service, or business solicit capital from a large number of people (the “crowd”) in exchange for the promise of a reward. In many cases, these rewards are the product or service that the campaign was created to fund.

Rewards crowdfunding can help you raise money — as well as generate excitement — for your product or service. However, it can take a fair amount of effort to execute a successful campaign, and you may not be able to raise as much money as you might need to launch or grow your business.

Whether you decide to try your hand at rewards-based crowdfunding or not, you may want to check out other financing options as well.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

Photo credit: iStock/luplupme

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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