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June 13th, 2019

Business Loans Risks and Rewards

Bad Credit Business Loans Risks vs Reward

You applied for a small business loan and received a rejection. Or, the banker told you not to even bother applying. But your business still needs capital.

It is at this point that many small business owners begin looking into alternative forms of business funding with bad credit. They may think about taking out a small business credit card or start looking into a bad credit small business loan, but the options and risks and rewards can be confusing.

If you are a small business owner who needs capital outside of the traditional banking system a bad credit business loan is an excellent option. Here is everything you need to know about the risks and rewards of this type of capital.

What is a Bad Credit Business Loan?

A bad credit business loan is a loan product designed to meet the needs of borrowers who are unable to meet a bank or traditional lender’s requirements. The term “bad credit” is slightly confusing to those outside the lending world, as they might assume it only refers to their credit score. But this is not the case.

There is more to qualifying for a bank loan than your credit score. You could be disqualified as a borrower because you have not been in business for longer than two years. Many traditional lenders will not lend to high risk industries, such as restaurants or gambling enterprises, and that could be the disqualifying factor on your application. And banks will rarely lend to someone with a credit score below 650.

If you do not meet any of a bank’s requirements you will have to seek out business funding through a bad credit small business lender, even if your personal credit is quite good.

Is a Bad Credit Business Loan a Bad Loan?

Absolutely not. A bad loan is one that traps a borrower in impossible repayment terms and harms their ability to stay in business. A “bad” credit business loan is quite the contrary as alternative lenders have a vested interest in ensuring that the business loan works for you.

Lenders make their money by charging interest on the capital that they lend. If you do not repay your loan, they do not make their expected profit. This hurts their bottom line, as they could have leant those funds to another customer in the meantime.

Alternative lenders want you to repay your loan, so much so that many do not charge prepayment penalties. They will not lend if they are concerned about your repayment ability, and will not put you in a product that is not good for your business in the long run. While they may have fewer qualification requirements than a bank, they still do their due diligence to ensure a successful lending and borrowing experience for all concerned.

Why Would you Take out a Bad Credit Business Loan?

First and foremost, you should only take out a loan if you need the capital. You may be planning a business expansion, or need to purchase new machinery to meet existing orders. Many small business owners struggle with managing their cash flow and having access to capital helps them manage the gaps between when bills are due and when customers pay their invoices.

You might apply at an alternative lender simply because you do not meet some or all of the requirements to get approved for a business loan at a bank. If you have a credit score above 750 and excellent revenues but have only been in business for two months, you could still struggle to obtain funding in the traditional banking world.

Alternative lenders make it easier and faster to get access to working capital loans, which is why many business owners go to them to have their funding needs met. Traditional banks can take months to approve a loan, but an alternative lender can have a funding decision within 24 hours.

If you need money in a hurry, nothing beats an alternative lender. Once you’ve been approved they can deposit the money in your account within a few days.

It is also much easier to be approved for a bad credit business loan, and you will not waste time applying and waiting for a possible rejection. Lending requirements include a credit score above 500 and minimum revenues of $8,000 a month. You can get a loan for an amount between $5,000 up to a $1 million business loan, though it will take longer to be approved for larger business loan amounts.

The convenience, quickness, and easy qualification process are three major reasons to take out a bad credit business loan.

What are the Rewards of a Bad Credit Business Loan?

One of the biggest rewards to a bad credit business loan is that you get money to meet your business needs when you need it.  You can move forward with your business plans, meet your payroll obligations, or pay vendors without wasting time jumping through a bank’s hoops.

Getting capital at just the right time can help your business stay on track. It will prevent cash flow issues from damaging key vendor relationships, or avoid the risk of losing an important employee. A bad credit business loan rewards you by how it serves your business’ needs.

Avoiding the lengthy loan application at a bank has its own rewards. It frees up time for you to spend running and growing your business. It lowers your overall aggravation levels, and you may be less frustrated dealing with an easier lending process.

No business owner goes into business because they’re just dying to spend hours filling out paperwork only to eventually be rejected. At a large bank, the rejection rates are 44%, at a small bank 32%, whereas alternative lenders approve 75% of loan applications. Less hassle, better approval rates, and quicker access to funds, there are a lot of pluses to bad credit business loans.

What are the Risks of a Bad Credit Business Loan?

Due to the fact that the lender is taking more risk when lending to you, they pass this risk onto you in the form of higher rates. Typical factor rates range from 12% to 45%, which is higher than some forms of traditional credit but could be lower than a business credit card or line of credit.

The interest or fees you pay reflects their risk, and because you do not qualify for a loan with a bank you are seen as a potentially riskier borrower, although every case is treated differently depending on the reasons for not qualifying from a traditional lender. But no matter what position a borrower presents, as with any form of lending, you risk default. Not paying back the entirety of your loan will hurt your credit score, impair your future ability to obtain capital, and could lead to legal proceedings.

Another major concern that is directly tied to increased lending costs is whether or not your business endeavor will generate enough revenue to cover the cost of the initiative as well as help your business grow. Why would you invest money in an endeavor if the total costs exceeds total profit or projected profits? This may involve complex calculations but it is an important question that needs to be explored.

Lastly, when you pay more for capital, you could struggle to repay it if cash flows do not align or business finances are not managed correctly. This is why alternative lenders set up extremely flexible payment plans. You can make monthly, bi-weekly, weekly, or even daily payments on your loan. The lender will help you analyze your cash flow and the characteristics of your business to pick a payment plan which is easiest for you to follow in an effort to help mitigate risk.

How can I Minimize the Risks of a Bad Credit Business Loan?

Defaulting on a loan has serious consequences which will follow you for years. Before taking out a bad credit business loan, or any loan, here are a few things you can do to minimize your risk.

Make a monthly budget for your business, and include your loan payments. Take a good, hard look at your cash flow and revenues. Do you make enough money to cover the monthly payments on your loan? If you are taking out the loan to fund an expansion or business plans which will generate more revenue, how will you make payments in the meantime?

In the rush of starting a small business if you have been able to pay bills and make money, you might never have had the time to formalize a budget. Before taking on debt is the perfect time. Have a spreadsheet which lays out your repayment plan, interest, and capital, and be certain that you can repay the loan.

Calculating your debt service coverage ratio or DSCR can help you determine if you can afford the loan. Your debt service ratio is a percentage which expresses how much of your net income must go to servicing your debt. If you have monthly debt payments of $600 and monthly net operating income of $10,000, then 6% of your net income (or profit) must be allocated to servicing debt.

The higher that this ratio creeps, the more there is cause for concern about your repayment ability. You should know what your DSCR ratio is both before and after taking on any debt because it’s a measure of your ability to manage additional debt levels.

The Final Word on the Risks and Rewards of Bad Credit Business Loans

Only you can decide if a bad credit business loan is good for your business. Weighing options and evaluating risk versus reward is a skill that every business owner needs, but if you’re still developing it working with the right lender can help ease your mind.

Reputable alternative lenders such as Shield Funding have been in business for years. If they made poor lending decisions which did not serve their customers, they would not have lasted in the business. Just like bad credit business loans are not truly bad, neither are alternative lenders. They serve a useful purpose filling a gap in the lending marketplace, and if you decide to work with one you can rest assured that you are working with a lender who wants to see your business succeed.

Dena Landon

Dena is a senior writer at Shield Funding, reporting on various topics related to small business loans and business financing. Previously her work has appeared on The Washington Post, Narrative.ly, Salon, and others. Her first novel was published by Dutton Children’s Publishing in 2005. She has a Master's in Business Administration from Capella University and has worked in the finance field for over fifteen years.
Dena Landon