Commercial loans and commercial paper are two ways corporations obtain capital in order to finance a variety of business activities. Commercial loans operate similar to consumer loans, while commercial paper is more similar to issuing corporate bonds. Commercial loans and commercial paper may serve the same purpose of paying for business expenses, but they have very different and defining characteristics.
Commercial Loan Characteristics
Commercial loans can be short or long term loans with either a fixed or variable interest rate. Businesses can obtain secured commercial loans by using a business asset as collateral or an unsecured loan, where the business uses no collateral to secure the loan. In order to get an unsecured commercial loan, the company has to have good business credit. Lending institutions often require businesses that obtain commercial loans through them submit quarterly, semi-annual or yearly financial statements.
Commercial Paper Characteristics
Businesses issue commercial paper in the form of a promissory note. Commercial paper is always short term, with repayment within nine months from the time the company issues the note. Businesses issue commercial paper at a discount to investors, meaning, investors can buy a commercial paper note for $80, with a payback of $100 when the note comes due. The amount of the discount depends on the discount rate the company offers. Companies do not have to register commercial paper with the Securities Exchange Commission.
With commercial loans, the risk lies with the lender. Lenders protect themselves against risk by adjusting interest rates on the loan accordingly. If a business poses little risk of defaulting on their loan, the interest rate is lower. If a business poses a higher risk of defaulting, then the interest rate is higher on the commercial loan. With commercial paper, the risk lies with the investor. If a business issuing commercial paper files for bankruptcy or otherwise becomes insolvent during the term stated on the commercial paper promissory note, investors risk losing their entire investment.
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