Investment Loan – simply explained

Key facts at a glance:

• An investment loan serves to finance fixed assets and secure further growth.

• Repayment can be made from the newly generated cash flow.

• Development banks, traditional credit institutions and alternative lenders offer investment loans.

What Is an Investment Loan?

With an investment loan, a company can finance fixed assets that will subsequently be available to it on a long-term basis. Through these investments, a company can drive its growth forward.

Possible investment projects can include:

• Modernisation measures

• Business expansion, additional production facilities

• Acquisition of machinery, vehicles

• Purchase of land for site expansion

• Acquisition of intangible assets, e.g. patents, licences

• Investment in a company

• Company acquisition

• Financing of research and development projects

The aforementioned investments usually involve high costs. It is often more sensible for a business to take out a favourable investment loan and obtain the required capital in this way, rather than burdening its equity.

Within the framework of traditional financing for business investments, development banks such as the Kreditanstalt fuer Wiederaufbau (KfW) offer corresponding investment loans. Subsidised funding is usually tied to certain conditions, such as the availability of collateral or a minimum period of market presence.

In addition to government-subsidised investment financing, companies can also apply for a loan through a traditional bank. Credit institutions also require certain conditions. These include, for example, the commitment of a certain amount of equity, which reduces the lender's risk. Furthermore, investment loans are secured due to their long-term nature — the acquired fixed assets such as machinery, vehicles or land typically serve as collateral. An investment loan is therefore usually provided with strict purpose restrictions.

The term of an investment loan is based on the useful life of the financed assets. Repayment is made through instalments that are aligned with the returns from the investment. However, the loan can also be structured as a bullet loan.

Alternative lenders like Teylor are increasingly becoming the focus for SMEs when they need fresh capital for important investments. Due to the numerous providers, comparing conditions — such as the level of interest rates — is worthwhile. These vary not only in their level but also in their structure. Some lenders offer fixed interest rates so that conditions remain constant throughout the entire term (e.g. annuity loans). Other providers incorporate a variable interest rate that adjusts to the market situation (e.g. roll-over loans).

What Is Special About Investment Loans?

Unlike a working capital loan, which is used, for example, to finance materials, raw materials and supplies, companies use an investment loan to finance fixed assets.

A working capital loan is typically intended to secure the company's liquidity in the short term and therefore runs for shorter periods. An investment loan, on the other hand, is designed for medium and long-term durations of several years.

The goal is to repay the investment loan from the newly generated revenue: the acquired fixed assets, such as a new production facility, generate a cash flow from which the entrepreneur can repay the loan.

The advantages of this form of financing are numerous: stable monthly instalments ensure better planning for the borrower. A further advantage lies in the tax deductibility of interest.

The disadvantage of an investment loan: as is typical for loans, they come with obligations. If calculations are incorrect, the instalments can become too burdensome. In the event of non-payment, far-reaching consequences may follow. Therefore, companies must realistically and prudently calculate which instalments they can truly afford with an investment loan. Negative scenarios should also be considered, such as the default of customer payments.

Special Forms of Investment Loans

Roll-over loans

For financing investments, entrepreneurs can also use loans in which the interest rate is adjusted at regular intervals to the current money market conditions and the relevant market reference rate (e.g. EURIBOR, LIBOR). This type of loan is called a roll-over loan.

The interest rate is therefore not fixed for the entire term, as it would be with an annuity loan, for example. The interest rate fixing periods typically range from a minimum of one month to a maximum of 12 months. The opportunities and risks of interest rate adjustments due to changing money market conditions are thus transferred to the borrower.

The term is typical for an investment loan, set for medium to longer periods. In particular, medium-sized and large companies, the public sector and sovereign states act as borrowers in this context.

Bonds

Bonds are among the classic means of raising debt capital. Especially companies that find banking regulations and processes too strict and inflexible choose to finance themselves through bonds.

The fresh capital generated through the issuance of bonds typically flows directly into the company's value creation. Therefore, this can also be considered a special form of investment loan. Bonds are frequently issued without collateral. Investors receive no rights of influence or co-determination. Like loans, bonds also differ in their conditions, including varying terms, currencies and types of interest.

There are three types of interest: fixed-rate securities, variable-rate bonds (floaters) and structured securities. With bonds, however, there is no guarantee that the company will actually be able to raise the capital needed for the investment through its public bond offering. In contrast, a traditional investment loan is in any case available in the desired amount. Moreover, the issuance of bonds is costly and therefore only suitable for larger companies.