finance company

Company engaged in making loans to individuals or businesses. Unlike a bank, it does not receive deposits but rather obtains its financing from banks, institutions, and other money market sources. Generally, finance companies fall into three categories: (1) consumer finance companies, also known as small loan or direct loan companies, lend money to individuals under the small loan laws of the individual U.S. States; (2) sales finance companies, also called acceptance companies, purchase retail and wholesale paper from automobile and other consumer and capital goods dealers; (3) commercial finance companies, also called commercial credit companies, make loans to manufacturers and wholesalers; these loans are secured by accounts receivable, inventories, and equipment. Finance companies typically enjoy high credit ratings and are thus able to borrow at the lowest market rates, enabling them to make loans at rates not much higher than banks. Even though their customers usually do not qualify for bank credit, these companies have experienced a low rate of default. Finance companies in general tend to be interest rate-sensitive-increases and decreases in market interest rates affect their profits directly. For this reason, publicly held finance companies are sometimes referred to as money stocks. See also Captive Finance Company.

Commercial finance companies have in recent years become a favorite option for entrepreneurs seeking small business loans. These institutions generally charge higher interest rates than banks and credit unions, but they also are more likely to approve a loan request. Most loans obtained through finance companies are secured by a specific asset as collateral, and that asset can be seized if the entrepreneur defaults on the loan.

Consumer finance companies make small loans against personal assets and provide an option for individuals with poor credit ratings. Commercial finance companies provide small businesses with loans for inventory and equipment purchases and are a good resource for manufacturing enterprises. Insurance companies often make commercial loans as a way of reinvesting their income. They usually provide payment terms and interest rates comparable to a commercial bank, but require a business to have more assets available as collateral.

"In general, finance companies want to see strong assets to back up a loan and will monitor those assets much more carefully," one expert told Entrepreneur. "For that reason, they can loan more against the assets. So chances are a smaller business might get a larger loan from a finance company" than from a bank. Paola Banchero of Kansas City Business Journal noted that commercial finance companies have also grown because they are more flexible in arranging loan repayment schedules than are banks. Whereas banks typically require a seven-year repayment schedule on term loans and 15-year schedules for loans on commercial property, finance companies may extend payment schedules up to 10 years for term loans and up to 25 years for loans on commercial real estate.

Finance companies have experienced sustained growth throughout the 1990s. By the end of the decade, finance companies had become America's second largest source of business credit, behind banking institutions. Larger commercial finance companies often offer small business owners a variety of lending options from which to choose. These include factoring, working capital loans, equipment financing and leasing, working capital loans, specialized equity investments, collateral-based financing, and cash-flow financing. Some also offer additional services in connection with those loans, such as assistance with collections.

Commercial finance companies, though, come in all shapes and sizes, and the breadth of their services often has some bearing on their exact services. The nation's largest finance firms (The Money Store, AT&T Small Business Lending Corp.) have established networks of offices across the country, and they sometimes offer lending services that even banks do not. For example, The Money Store—which made more than 1,700 loans worth $635 million in fiscal year 1996—offers loans to entrepreneurs looking to take ownership of a franchise, an option that is not available at all banks. But as Entrepreneur's Cynthia Griffin noted, "in addition to the mega players, the commercial finance industry is populated by hundreds of smaller firms." These firms generally make assetbased loans, providing services to small business owners who are unable to secure loans from their banks.

Further Reading:

Andresky Fraser, Jill. "Show Me the Money: You Can Look for Money in All the Wrong Places." Inc. March 1997.

Banchero, Paola. "Financing Fight: Nonbank Lenders Want Nothing More Than to Take Business Away from Traditional Banks." Kansas City Business Journal. October 10, 1997.

Financing for the Small Business. Small Business Administration, 1990.

Griffin, Cynthia E. "Breaking the Bank." Entrepreneur. March 1998.

"How to Make Them Give You the Money." Money. June 1995.

Prins, Ruth. "From the Frying Pan to the Fire?" U.S. Banker. December 1997.

Sherman, Andrew J. The Complete Guide to Running and Growing Your Business. Times Books, 1997.

Smith, Sharon. "Techno Mecca: The Use of Factoring and Commercial Finance Companies." Accountancy. September 2000.

Whittemore, Meg. "Creative Financing that Succeeds." Nation's Business. April 1995.

Wolf, F. David. "How to Select a Commercial Bank Vs. A Non-Bank Lender." Tampa Bay Business Journal. July 28, 1995.

For more information on finance company, visit Britannica.com.

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