Bad Credit Business Loans for Good Credit Borrowers
Why would a borrower with good credit come to an alternative lender for funds? The answers are many, but boil down to making the best decision for their business.
The bureaucracy at traditional banks has forced many business owners to acquire funding in the private market. This increase in demand for private money has led to the development of a financial product commonly called bad credit business loans.
When you hear the term “bad credit,” you might think that these are bad loans, or that there is something wrong with the borrower that they need to apply for a bad credit business loan. This is not the case. In the lending industry, “bad credit” simply refers to a credit history or background that does not meet the lending requirements of banks.
Under the umbrella term bad credit business loans, borrowers will find a wide variety of financial loans to meet their needs. These include, but are not limited to; working capital loans, unsecured business loans, merchant or business cash advances, small business loans for women, restaurant loans, a business line of credit, and more.
So what are the reasons that a borrower with good credit would seek out a bad credit business loan?
Borrowing Constraints at Traditional Lenders
Banks are constrained in their lending practices by regulators and shareholders. If they grant too many high-risk loans, the Federal Reserve requires that they place more on deposit with them to cover those loans. The bank then has less capital available to lend.
This has led to a slow down in small business funding from traditional banks and lenders. In March of 2019, banks approved a record 27.3% of small business loan applications. This was higher than normal, but that means that if you apply for a small business loan at a bank you have an almost 75% chance of being rejected. Also, it is more likely that every applicant for a bank business loan had good credit and excellent business financials.
Even a borrower with excellent credit could be turned down for a loan by a bank. Their business could be in a high-risk industry, such as restaurants. Or, they could have been operating for less than two years. Banks require strong annual cash flows and revenue projections so high you would think they don’t want to take on any risk at all.
Banks also require up to three years of tax returns, bank statements, and financial statements. They could ask to see a comprehensive business plan and additional documentation. Small business owners may have to pay professionals, such as accountants and lawyers, to prepare these documents. This adds to the overall cost of the loan.
Borrowing Qualifications for Alternative Lenders
Alternative lenders do not have these same restraints. They are funded differently, primarily through private equity or investors. These investors want a higher return from their funds than they could get in the market. Therefore, alternative lenders are encouraged to take smart risks.
They will lend to those with credit scores down to 500 on some products because the primary concern of an alternative lender is your monthly cash flows. The minimum needed to qualify are monthly revenues of $8,000, though some products such as working capital loans might require $10,000.
If your business is doing well, an alternative lender does not make you wait until you hit the two-year mark to borrow. As long as you have been in business for two months, they will lend to you.
It is rare for an alternative lender to require more than a few simple pieces of proof of identity, business licenses, and revenues. Their borrowing qualifications make it easier to be approved, particularly if you have good credit but banks are rejecting your loan application for other reasons.
Approval Times at Traditional Lenders
Another reason a small business owner with excellent credit might apply for a bad credit business loan is the approval time. Banks can take months to approve a loan, particularly if it is for a larger amount. During that time, opportunities can pass you by.
Small business owners might have a time sensitive chance to grow their business, whether it is buying the assets of a liquidated competitor at a significant discount or jumping on the chance to lease the next door storefront and expand. They simply cannot wait 90 days to find out if their loan has been approved and they can receive funding.
Alternative lenders can approve a loan in as little as 24 hours. The money could be deposited within a few days.
Mitigate Personal Risk
A business owner with good personal credit might simply not want to risk their personal capital to expand their business. Utilizing outside capital for business expansion purposes allows a business to scale up faster than its cash flows would permit.
Because many of these bad credit financial instruments are unsecured, business owners are applying and receiving funding without having to pledge personal assets as collateral. Although most of these loans come at a premium, the fact that there is less risk on the personal assets of the business owner balances the risk.
While a small business loan at Bank of America could only cost you 5.00% in interest, it must be secured by collateral. If you default on that loan, they would seize that collateral. An unsecured business loan at an alternative lender could cost you 9% but you would not have to pledge either personal or business assets which you could lose.
Alternative lenders offer unsecured business loans, though with slightly stricter requirements. You must have been in business for a year and have minimum monthly revenues above $10,000.
Loan Amount and Traditional vs. Alternative Lenders
The amount that a business owner needs to borrow could also lead someone with good credit to an alternative lender. Banks have lending floors, or amounts of capital that they will not lend less than, and you could be forced to borrow more than you need just to get a loan.
Banks prefer to lend larger amounts, and one of the main reasons for that is that it cost the same to service a small business loan as it does to service large business loans; basically they can make more money off the latter. They are collecting interest on a larger sum of capital and amortizing the same fees over a longer term.
If a small business owner with excellent credit only needs a loan in the amount of $5,000, a bank might not even be willing to talk to them. It simply is not worth their time. But alternative lenders secure business loans for as little as $5,000.
Alternative lenders operate primarily online, and with little overhead. Therefore, it does not cost them as much to lend as a brick and mortar institution. Because they do not have to cover as many operational costs and generate more money from each loan, they can lend smaller amounts.
Personal vs. Business Credit
Small business owners might choose to borrow with an alternative lender because of differences between their personal and business credit. One could be good and the other poor, leading them to a “no” from a bank.
Personal credit is the credit you have built over a lifetime of paying bills on time, taking out credit cards, and paying off auto loans. Mistakes in your past can stay on your credit report for quite a while. Your personal credit score could now be a reflection of lessons you learned along the way rather than your current financial management skills.
Business credit consists of credit tied directly to your business. This could be a business credit card taken out under the LLC’s number, or your repayment history with vendors. After learning how to manage money personally, your business credit score could be much higher than your personal score.
Depending on which way they go, either credit score could prevent a small business owner from borrowing at a bank. But an alternative lender might be willing to just look at a good business credit score, or vice versa.
Start-Up Owners with Good Credit
Start-ups have a notoriously difficult time obtaining funding from traditional lenders. While many go to angel investors or private equity to obtain funds, it’s rare that those investors will lend to a small business.
Banks like to see consistent revenue growth and a stable business history. They will rarely lend to a business that has been in business less than two years, and prefer a period of five years or longer. Alternative lenders have no qualms about lending to start-ups who only have two months of history.
Banks are also wary of the bumps in the road that are common in start-ups. Perhaps you had a few months of negative cash flows, or dips in your growth pattern. Alternative lenders are much more understanding of these realities as long as revenues have evened out.
The Truth About Bad Credit Business Loans
Bad credit business loans were established to fill the lending gap left by banks. Borrowers who could repay the capital, and who needed it to grow their businesses, could not obtain the capital. Lending requirements at banks were just too rigid.
Alternative lenders entered the market to meet that need. They know that a credit score is just one piece of the lending puzzle. Online lenders approve 75% of the loan applications they receive, which quite the change from the rejection rate at a bank.
Many strong and healthy businesses are taking advantage of the availability of additional working capital in order to stay ahead or move past their competition. They know that properly leveraging their debt to hire more employees, build new construction or buy ore equipment, can yield good returns. Bad credit business loans are helping good companies become better.