Startup Business Loans and Bad Credit
Starting a new business is an exciting and nerve-wracking time. There are many things to consider, from the product you will sell to renting a storefront. Obtaining capital to fund your new business venture soon becomes a priority for many small business owners. If you have begun the search for startup business loans, you may be hoping that it will be easy to get funding, even with bad credit. While many lenders claim to offer startup loans, this is not entirely true. Many of the types of loans they offer are only truly available if you are already in business. The business loans often require that your business already has revenues and cash flow. Many lenders drive you to their website by claiming to offer startup loans but then suggest other options instead. Alternative lenders can be a great resource for bad credit business funding but they require that you are generating revenue. Overall it is very difficult to obtain a business loan if you are not already in business but there are some options worth exploring if you are determined to launch your company.
Small Business Administration (“SBA”) Loans
Small Business Administration loans, or “SBA” loans, are the gold standard. Normally the government partially guarantees a portion of the loan so lenders are eager to offer them. The chances of getting SBA loans has grown since the Covid-19 outbreak. The SBA is forgiving portions if not all of the loan for a limited period of time, and they are guaranteeing all of the loan amounts so both local and regional banks are eager to lend. They are also waiving many of the typical requirements requiring good credit and collateral so this would be a great option even if you have poor credit. This will not last very long though and they will likely return to only guaranteeing a portion of the loan.
Once the business funding for Coronavirus ends, the loans will only be available to individuals with excellent credit and who meet stringent criteria. Most banks and traditional lenders that offer SBA loans require a strong business history and revenues, as well as collateral and other detailed requirments. Investment funds licensed as a Small Business Investment Company, or SBIC, require that the business has revenues. Investment funds licensed with the Small Business Administration as Small Business Technology Transfer funds, or STTR’s, only work with science and research companies. Community Development Financial Institutions, or CFDI’s, are institutions sponsored by the government which lend to low-income or disadvantaged individuals in distressed communities. But again as often is the case, you must already be in business and your business must operate in a community which qualifies for this funding.
Who Qualifies: Businesses with excellent credit and a longer business history.
How Do You Apply? Inquire at your local bank, or find a CFDI in your area on their website.
A grant is a gift given by an organization, business, or person, for a particular purpose. Grants can be offered for various purposes, such as to support women or refugee-owned businesses, to promote growth in certain industries, or to incentivize businesses to open in geographic areas. Grant applications often have yearly deadlines, and then close for a period of time. Their qualification requirements may not include your credit score, but could get quite specific as to type of business and other factors. Start your research at the state level.
Who Qualifies: typically only businesses which are already in operation and meet other requirements.
How Do You Apply? The application instructions will vary by grant. Sometimes you will have to write and request an application packet, other times the information and application will be on the organization’s website.
Friends and Family
When searching for ways to obtain small business startup financing much of the advice you will read essentially boils down to – borrow money from friends and family. Make a list of the people in your network that you think might have the capital to lend you, and then put together your value proposition. Will you pay them back with interest, or are you asking for an interest-free loan from your parents? How will you make more money on the money that they’re lending you, and how will you return their money to them? Think about the questions that you’d ask a friend before lending them money for their business and be prepared to answer those questions.
Listing crowdfunding in an article on a small business loan is deceptive; this is not a loan from a traditional bank or alternative lender but just soliciting funds from friends, family, your network, or others who believe in the product you want to sell or business that you are launching. Most crowdfunding sites take a percentage of the funds you raise, and you will have to offer rewards in exchange for contributions. Some require that you meet your goal before you can get any money. Do your research and pick the best site for your needs. Unless you have a wide network which has significant access to capital of their own, it will be difficult to raise the funds needed to get a new business off the ground through this method.
Who Qualifies: Anyone who can set up a crowdfunding campaign that meets a crowdfunding website’s criteria.
How Do You Apply? Set up a crowdfunding campaign.
Seeking out Angel Investors and Venture Capitalists
The terms “angel investors” and “venture capital” often appear on lists of possible startup loans for small businesses. These are not truly loans, and it is a misrepresentation to present them as funding options for small businesses. It would be more accurate to call these forms of startup loans investments instead. Angel investors are companies with funds to invest who take an equity percentage in return. Venture capital investors will also invest in exchange for equity, anywhere from 10-30% of your company. In both instances, you are giving up control of your business, possibly one to two seats on the board, and you should expect them to want to have a high level of involvement in your operations. These types of investors invest in exchange for high rates of return, and are not interested in true small businesses but rather businesses which can scale up quickly. Companies who qualify are typically tech startups, not a local mom and pop business. The average investment size is $2.6 million, and they invest in only one out of a hundred deals that they consider. You do not pay back angel investors or venture capitalists through monthly payments, nor will your relationship with these companies end when the loan is done. While both angel investors and venture capital firms will lend to those with bad credit, this is because they are looking for high-growth and high rates of return. They are lending on the basis of a robust business plan, the industry, and potential growth. A small corner bakery does not interest them.
Who Qualifies: Companies who will be able to provide high rates of return, massive growth potential, and who are willing to surrender significant ownership in their business.
How Do You Apply? Contact an investment banking firm or advisor to find firms in your area.
Another option frequently mentioned to small business owners seeking to raise capital are 401K rollover loans. It is possible, and legal, to take money from your 401K in order to fund a startup. Bad credit is not an issue because you are not working with a traditional or alternative lender. In fact, you are not working with a lender at all. With a 401K rollover loan, you are borrowing money from yourself and your future. You will need to have been putting money into a 401K and have funds available to access. Individuals who have a 401K are the only people who qualify, as you can’t take a loan out against something you don’t have. To get started, you must contact the company who services your 401K, such as Fidelity or Ameriprise, and ask which loan options are available to you. You can only take out loans against vested amounts, so if your employer has deposited funds through a 401K and they have not vested they will not be available to you. Loans have to be repaid through payroll deductions and you have to be currently working for the company where you have the 401K. If you lose your job during the repayment period the entire amount will come due in full. This could spell bad news for you if your small business hasn’t yet generated enough revenues to cover the loan. If not repaid, the tax penalties on the loan amount can be significant. These are some major drawbacks to 401K loans.
Who Qualifies: Anyone with a 401K over $10,000 with their current employer whose employer also offers loan programs.
How Do You Apply? Start by contacting your 401K provider or Human Resources Department.
Business Lines of Credit
A business loan is a lump sum of capital disbursed to the borrower, to be repaid over a period of time through payments which comprise principal and interest. Many lenders offer “startup loans” as business lines of credit. A line of credit is an amount of money that a lender has agreed you can borrow. Unlike a loan, however, it’s not all disbursed at once. Instead, you can draw on it when needed for however much you need, up to the maximum amount. Your monthly payment varies, depending on how much you’ve drawn. Your ability to qualify will depend upon your business’ history and/or your personal credit score.
Who Qualifies: With traditional lenders, only those with excellent credit scores, strong revenues and a business history of one to two years, or just great personal credit and personal banking data will qualify. Alternative lenders provide lines of credit to those with lower credit scores and a business history of just six months.
How Do You Apply? Contact your bank or alternative lender to find out their lending qualifications.
Business Credit Cards
Business credit cards charge high interest rates, which many small business owners are trying to avoid by obtaining a loan instead. For those with poor personal credit, an alternative lender might be willing to work with you in opening a credit card or funding a line of credit, but it might be necessary to pledge collateral or obtain a co-signer. Rates range from 13.49% to 24.99%, and the rate you pay will depend in part upon your personal credit score. Often, you can get an introductory APR of 0% but beware – if your balance isn’t paid in full by the time the introductory rate expires you could pay a hefty interest charge. Some of the best business credit options are Bank of America® Business Advantage Cash Rewards Mastercard®, which offers cash back and no annual fee, or the Blue Business Plus Credit Card from American Express, which rewards you with points and also has no annual fee.
Who Qualifies: Anyone with a legitimate business, six months to a year of business history, and a decent to great credit score.
How Do You Apply? Contact your bank or alternative lender.
Nonprofit organizations in your area may provide loans to startups. While they will pull your credit, they also look at a business plan and twelve-month projected cash flow when making a lending decision. Veterans and woman-owned businesses often receive priority. As local organizations, they will have geographic lending limitations. There might not be one near you, nor may your business idea meet their criteria. Accion is one government-based option. The Women’s Foundation of Boston is an example of a regional and gender-based non-profit that provides loans and grants, and the Atlanta Women’s Foundation is another.
Who Qualifies: Qualification requirements depend upon the non-profit. Some only loan to veterans or women, others within a geographic area.
How Do You Apply? Once you have determined whether or not you meet their requirements, their website will likely have instructions.
The reality is that with no revenues, no business history, and poor credit, you cannot get a loan in the truest sense of the word. Even alternative lenders require some business history and revenues, though much less than traditional lenders. As a startup, you will typically access capital through the strength of your personal finances. If you own a home, you can often obtain a home equity line of credit which you can draw upon to finance your startup. It’s necessary to have 20-30% equity in your home. Personal credit scores are considered in the loan application process, though since your home serves as collateral those with lower credit scores will not be automatically disqualified. Personal loans could also be available to you, but your credit score and personal assets will be factored into the underwriting process and approval decision. Some lenders will extend personal loans to individuals with credit scores down to 600 if their income covers the payments.
Who qualifies: Those with assets such as a house that they can borrow against, people with good to excellent credit and sufficient income to cover loan payments.
How Do You Apply? Contact your bank, credit union or alternative lender.
Peer to Peer Loans
If you don’t own a house or your home’s equity isn’t sufficient, and can’t qualify for a bank personal loan, look to peer to peer options. Peer to peer lending is when an individual with capital chooses to lend privately, typically in exchange for a higher rate of return than they could receive in the market. Platforms such as Perform match those who want to lend with those who need to borrow. Some only require identity and income verification and do not check credit scores. Upstart, for example, takes into consideration the school you attended, your academic performance, and what you studied when making lending decisions.
Who qualifies: At a minimum, hose with monthly income that can cover the payments on the amount they want to borrow. Other qualifications may be necessary depending on the peer to peer website and the loan amount.
How Do You Apply? Gather together your proof of identity and last two paystubs, plus any other information you need, and fill out an application on any one of the peer to peer lending websites. A true startup is not yet in business. It may have a business plan and dreams, but without perfect personal credit obtaining a loan will not be possible. While startups can get funding, it will be in the form of credit cards and lines of credit. The bottom line is that it is very difficult to obtain a startup business loan in any form if you have bad credit. In fact, even if you have great credit you will not be able to obtain a startup business loan as most lenders require time in business and existing revenues. Personal loans, credit cards, family and friends are likely to be the only source of business funding in the startup phase. There are always exceptions, but many SBA or Non-Profit funding requires a specific criteria and a very lengthy approval process. The lending industry is also changing everyday so if you are in the startup phase it always makes sense to do some initial research, just utilize the information above to assist in your research.