A Guide to Private Business Loans
Newer small business owners may think that a bank is their only option for a small business loan, and could become discouraged if their loan application is rejected. The good news is that a bank is just one of many funding sources, and there might be good reasons to avoid going to a bank for a loan.
In the world of business funding, private lenders exist to help businesses of all sizes and types fill their capital needs. Even if you have not applied at a bank, you might find that a private loan better serves your business.
What is a private loan?
A private loan is funding that is not extended through a bank. It could be from an alternative lender, an online lender, or another investor, but you do not apply at a brick and mortar bank.
Which types of borrowers seek out private loans?
Private loans fill a need for many small business owners. If your business’ capital needs fall into one or more of these categories, they could be the best choice for you.
Those who have bad credit and are unable to qualify for a traditional loan turn to the alternative lending market for their capital needs. Private lenders look at factors other than a credit score when making a lending decision. They could consider business history, monthly and annual cash flows, and collateral to be more important than a credit score.
Small business owners who need capital quickly also borrow from private lenders. The typical turnaround time for a bank to approve a small business loan can be anywhere between two to three months. Often, if you need cash in a hurry, you can’t wait that long. Private lenders specialize in a quick approval process, as little as 24 hours in some cases.
One of the reasons that an underwriter at a bank can take so long to approve your loan is the time involved in reviewing your application and supporting documentation. Banks require a significant amount of documents when you apply for a loan. You could have to provide bank statements, tax returns, credit card statements, financial statements which have been certified by an accountant, and more.
Not only can it take quite a while to pull together all of this information, complying with their requests could add additional costs to your loan application. You may have to pay an accountant to prepare or review your financials. A lawyer might have to sign off on your business plan. Even if they would eventually qualify for a bank loan, many small business owners choose to skip these additional requirements and costs.
When applying with a private lender, all you could be asked to provide would be a few months of bank statements, a copy of your business license, and your driver’s license. While some private business loans, such as equipment financing, could ask for more documentation, they rarely approach the level of a bank’s requests.
No matter how high your credit score, or how successful your business, banks are reluctant to lend to companies that have not been in business for longer than two years. Sometimes a private lender is a small business person’s only option for no other reason than that they have not been in operation long. Private lenders will extend credit to a business with as little as two months of operations.
Most banks insist upon a monthly, fixed payment to repay your loan. This often does not align with a business’ cash flow pattern, particularly if you are seeking capital to manage your cash flow better. Private lenders work with a borrower to arrange a payment schedule which works for their business. They want to see you succeed in repaying your loan. Payments can be made on a daily, weekly, bi-weekly, or monthly basis.
There are compelling reasons to seek out private financing, and only one of them relates to a credit score. This can be a common misconception amongst borrowers, but expanding your business loan search give you access to more options which could be a better fit.
What are the characteristics of a private loan?
While each type of private loan will have differing characteristics, they all have certain things in common.
- Quick and easy approval
- Fast funding
- Flexible repayment terms
- Personal guarantee
- Possibly higher interest rates
- Shorter terms
Alternative lenders have developed algorithms to help them make a loan approval process in the fraction of the time as a traditional bank. Using the data collected through loan applications, they can turnaround an application in as little as 24 hours. A small business owner does not have to wait months to find out if they have been approved.
As well, they can disburse capital within two to three days. In some situations, fast access to capital could save your business. Most private lenders pride themselves on a faster time to approve and fund a loan than a traditional bank. They have a much higher approval rate than banks, accepting 75% of applications versus the 56% approval rate at large banks.
Flexible repayment terms give you the power to align your payments with your business facts. While not all private loans have flexible payments; equipment financing loans are a common exception, most will have more options than at a bank.
Private lenders do take on more risk than banks, which is why they typically require that you sign a personal guarantee. A personal guarantee reassures the lender that they could seek recourse from your personal assets should you default on your loan. Even if you have structured your business as an LLC or S-Corp, a personal guarantee circumnavigates the protection your business structure offers.
Types of Private Business Loans
If you have decided to seek out a private loan for one of the many reasons listed above, you will quickly discover that there are different types of private loans. You can apply for most of them online, or by calling the lender directly. Not all lenders disclose their interest rates and terms online, due to the individuality of borrowers.
1. Bad Credit Business Loans
Bad credit business loans, offered by alternative lenders such as Shield Lending, serve those who cannot qualify for a loan with a bank. While the term “bad credit” could have a negative connotation, it simply means that the borrower is outside a bank’s lending requirements. It does not necessarily mean that the borrower has a low credit score or is a bad risk. It could indicate that they have not been in operation long enough for a bank to be willing to lend to them.
Bad credit business loans are unsecured, which means that the lender does not require collateral. Instead, they take into account your monthly revenues when the underwriter decides whether or not to lend. To qualify with an alternative lender, you will need a minimum credit score of 500 and monthly revenues of $8,000. The loan’s term can be as short as two months and as long as eighteen months.
Businesses with strong cash flows could find a bad credit business loan to be an excellent option. They’re approved and funded within a matter of days.
Best for: Borrowers with poor credit. Small business owners who need cash in a hurry.
Interest Rates: 12% – 45%
Loan Amounts: $5,000 – $1 million
2. Business Credit Cards
It is extremely common for start-ups and small business owners to use business credit cards for financing. You do not have to pledge collateral or sign a personal guarantee to open a business credit card, and applying can take just a few minutes online. Used wisely and with an eye on interest charges and annual fees, they could help you successfully grow your business and manage cash flow.
When shopping around, find a business credit card with a 0% introductory APR. You can take advantage of this initial period to borrow for “free,” but once the period ends the interest rate will rise to anywhere between 12-25%. You can also take advantage of the grace period during which anything you have charged is not subject to interest. If you plan your spending, you can pay the balance in full before the grace period expires and never be charged interest. Be aware that most business credit cards charge an annual fee.
Qualifying for a business credit card can be easy, and lenders do not ask for collateral, but it’s crucial to manage this type of credit wisely, or you will wind up paying significant interest fees.
Best for: Cashflow management. Short-term spending.
Interest Rates: 12% – 25% + annual fee
Credit Limits: Amounts Vary
3. Business or Commercial Line of Credit
Similar to a credit card, if you open a business line of credit, you can draw upon it at any time. This unsecured form of credit is great to have opened just in case. While banks do extend business lines of credit, they often insist that you also have all your other banking relationships with them. Unless you have time to move all your accounts, this can be annoying.
A line of credit is a revolving source of funds. You can draw on at any time, pay down the balance, and then borrow against it again. Lines of credit have maximum limits on what you can borrow. While you will not pay interest or charges unless you have taken a withdrawal, the lender could charge an annual fee to keep it open.
With unsecured loans, the lender could require a higher credit score to qualify. If you have a lower score, expect to pay high interest to offset their risk.
Best for: Cash flow management. Recurring cash flow needs.
Interest Rates: 4.8% to 25%
Loan Amounts: $10,000 to $250,000
4. Unsecured Business Loans
Unlike revolving credit, which can stay open indefinitely, a term loan has a set repayment period. Unsecured business loans are short term loans granted to small business owners who do not wish to pledge collateral, or who do not have any to pledge. Typically given for shorter terms of two months to three years, they are more likely to come with a fixed monthly payment than other forms of private business loans. Because these loans are unsecured, though you could be asked to sign a personal guarantee, the interest rate could be between 9 to 45%.
Unsecured business loans have stricter qualification requirements. This is because the credit can be extended for a longer time, which increases the lender’s risk of non-payment. At many lenders, your business must have been operating for one year and have monthly revenues of $10,000. A general rule of thumbs is that the shorter your loan’s term, the higher the interest. This leads to higher monthly payments.
Best for: Longer-term business needs. Expansion plans. Businesses with predictable cash flow.
Interest Rates: 9% to 45%
Loan Amounts: $5,000 to $1 million
5. Merchant Cash Advance
A merchant cash advance or MCA is a private loan which requires collateral. However, you are not pledging current assets but rather a percentage of your future credit card sales for repayment.
An average of your monthly credit card sales is produced from an analysis of your past few months of activity. The private lender then predicts what your credit card sales will be over a future time, and makes a lending decision based upon this prediction. After you’ve accepted their terms and received funding, every time you swipe a credit card, the lender deducts a percentage. Their percentage includes both principal and interest.
This type of private loan can quickly become quite expensive than you had planned. The interest is expressed as a factor rate, so if you took out a $100,000 loan with a factor rate of 1.25x, you would pay $25,000 in interest. If you have time to shop around and compare different private loans, you will find that an MCA can be one of the most expensive options.
Some lenders insert clauses allowing them to raise your interest rate over the life of the loan if repayment is taking too long. When deciding to take out an MCA, make sure that the payments will not harm your business’s future cash flow. Because these are private loans, they have little to no regulatory oversight, and predatory lenders do exist. Educate yourself thoroughly about all of the loan’s terms before signing the loan documents.
Best for: Businesses with a high volume of credit card sales.
Interest Rates: 1.00% to 1.50%
Loan Amounts: $5,000 to $150,000
6. Invoice Financing and Factoring
Private invoice financing and factoring companies help small business owners who have a large balance of past due receivables by turning those invoices into cash.
If you sign an invoice financing contract, it pledges the total amounts of your past due receivables to the lender. That does not mean they will advance you 100% of the invoice’s face value. Invoice financing lenders hold back a reserve to protect themselves from customers who will never pay. The reserve could be as high as 20% of the invoice’s total and is in addition to the profit they also deduct.
With invoice financing, your credit score or a past bankruptcy is not a factor. If it is your first time working with the lender, they may check your customers’ credit. However, you retain control of the invoices. With an invoice factoring company, you sell your past due invoices outright, at a discount. The lender collects on the past due balances, which could be a good solution for businesses who struggle with collections.
Best for: Businesses with a large amount of past-due accounts receivable.
Interest Rates: 1.15% to 4.5%
Loan Amounts: Will depend upon the balance of invoices due.
7. Working Capital Business Loans
Working capital loans keep your business running. Net working capital is defined by the difference between a business’ current assets and current liabilities, and it is used to gauge a business’ health and liquidity. Current assets include cash, accounts receivable, and relatively liquid assets. Current liabilities could be accounts payable.
Working capital funds a company’s day-to-day operations, such as paying vendors or funding payroll. A restaurant owner might need a working capital loan if, for example, they must close the space to remodel but still need to pay employees.
If your business has a seasonal cash flow cycles, a working capital loan could help you cover expenses during the down months. Terms can be from one to three years. For smaller, daily expenditures, a credit card could be a better choice.
Banks prefer to lend working capital loans in larger sums, to borrowers with a long business history and previous borrowing experience. At an alternative lender, you only have to have been in business for two months and need no borrowing experience. Rates will be between 6% to 45%, depending on your credit score and other factors such as the term and the amount borrowed. For most private lenders, you must have a minimum credit score of 650, and your business’s revenues should be at or above $10,000 a month.
Best for: Cashflow management, taking advantage of a business opportunity, funding growth.
Interest Rates: 6% – 45%
Loan Amounts: $1,000 – $2 million
Equipment Financing Loans
An equipment financing loan has one purpose – to finance the acquisition of new equipment. You may need new machinery to expand or have the capacity to take on a new customer and meet more orders. Equipment financing loans help finance these purchases.
The equipment or machinery purchased with an equipment financing loan is also the loan’s collateral. Because the loan has collateral, it will have a lower interest rate than other private loans. It is often your best choice to finance the acquisition of a capital asset. It is also easier to qualify if you have a lower credit score. Always remember that the machinery will be seized if you default, which could impair your ability to continue operating.
Equipment financing terms usually match the equipment’s depreciation schedule, such as 2-3 years. You can fund up to 100% of the machinery’s value plus expenses such as shipping. Alternatively, if your credit score indicates that you might be a large risk, the lender could require a 20% down payment on the purchase price.
Another nice thing about an equipment financing loan is that many lenders give you a 90-day grace period before your first payment comes due. This means that you can generate revenues from the equipment before having to pay for it.
Best for: Purchasing new equipment
Interest Rates: 8% – 30%
Loan Amounts: Depends upon the value of the equipment
Commercial Real Estate Mortgages
Another type of private loan which is intended for a single purpose, a commercial real estate loan funds the purchase of a new building. Commercial mortgages have longer terms and lower interest rates than other private lending options, but many lenders will not lend less than a loan amount of $100,000. In most cases, banks insist that you have two years of operations and annual revenues of $250,000.
The real estate that you are considering buying must also meet lender-specified loan-to-value ratios. A required 75% LTV ratio on the mortgage means that you will have to put down the remaining 25% from your funds. They will have an independent appraisal performed to determine the property’s true value. If it appraises for less than you anticipated, you might have to put more down.
Terms on a commercial mortgage can be shorter than a residential mortgage, at seven years, to just as long at thirty years. There is more risk of default or foreclosure in commercial lending, as this is not your primary residence, so you will pay a higher interest rate.
Best for: Purchasing commercial real estate
Interest Rates: 4.38% – 30.00%
Loan Amounts: $150,000 to $5 million
The Final Word on Private Business Loans
Once you become comfortable with the world of private ending, you may find yourself exclusively using private lenders to meet capital needs. The right private lender will learn your business and become a partner in ensuring its success.