How to Choose Your Small Business Lender
While you may have started up your company with enough business capital to fund its early stages, as it grows you will likely need access to additional working capital. Capital can be accessed privately, through friends and family, or through crowdfunding. Those always carry the risk of disappointing and damaging relationships, not to mention that you are drawing on a limited pool of financing.
At some point, most small business owners decide that taking out a small business loan is the best way to finance their growth plan. “I want a small business loan,” is just the beginning, however. Choosing the right lender for your business impacts your future cash flow, your ability to repay the funds, and if you will be able to use that capital for its intended purpose. Savvy business owners know that they need to research lenders before applying.
But searching online for a small business lender can yield hundreds of results. So how do you choose the right lender for your business?
Why does your lender matter?
Business lending is not a “one size fits all” industry. Lenders often specialize in certain industries. Picking a lender who knows and understands your business’ ups and downs, and cyclical funding needs improves your odds of being approved for a loan. As well, if you need a bad credit business loan you will have better luck if the lender knows your industry.
Lenders offer Different Products
Some lenders only offer certain products, such as merchant cash advances or business lines of credit. You may be looking for a short term business loan with certain terms. Disreputable salespeople will push you into their products rather than telling you that they can’t fill your business’ needs. If you already know what type of funding you want, ensure that any lender you’re considering offers that product. If you are unsure, choose a lender who offers a variety of products.
Cost of Capital, or Interest Rates, Term and Fees Varies by Lender
The cost of working capital of your loan, or what you pay to use that money, can significantly impact your business’ long-term health. If you are not careful, monthly interest charges could eat up most of the funds you had planned to use on expansion. Or you could struggle to cover the monthly payments from your business’ revenues. The interest rates that a lender charges are an important consideration when making the decision to borrow.
Most lenders publish a typical range of interest rates for certain products. They will only give you a range at the beginning of the process because they do not yet know your credit-worthiness. The best rates are reserved for the best borrowers. But also pay attention to fees, as they will hike up the annual percentage rate, which is a better expression of your total cost of capital.
A loan’s term is the period of time over which you repay the money. It can be anywhere from a month to years. The cost of borrowing is spread out over that term. For example, 10k of interest or fees spread out for a year adds over $800 to your monthly costs, whereas spread over three years it only adds close to $300 (using a simple interest calculation). Obviously, your loan’s term matters for the cost of capital and your flexibility in using that capital.
The term should also match the business’ purpose. If you are using the money to buy inventory for a three-month time period it makes no sense to be paying on that loan three years later. On the other hand, if you are financing a larger capital project you will want to spread the loan’s payments over the project’s length. In short, examine and interest rates, fees, and terms when deciding on a lender.
Repayment Options that Align with your Cash Flow
Cash flow can have its ups and downs. If you bill for a monthly service during the first two weeks of the month your cash flow may drop off significantly during the last two weeks. Scheduling a loan payment after you have collected most of your month’s revenues just makes sense.
Depending upon your cash flow cycle, it may be better for your business to make your loan payments on a daily, weekly, bi-weekly or monthly basis. You will be able to find a lender who offers some, if not all, of these options. Lenders who extend merchant cash advances, which are discounted advances on future credit card receivables, often require daily repayments from incoming credit card charges.
It is in your best interest to find a lender whose repayment options align with your cash flow cycle. Remember that your payment history impacts your credit score, and you do not want to be in a situation where you struggle to repay the loan.
Different Lenders Work with Different Types of Borrowers
If you are concerned that your credit and business’ finances may not satisfy loan qualification requirements, ask if the lender allows or requires collateral or a co-signer. Standard practice varies. If you think you might be in the situation of needing either collateral or a co-signer to secure a loan do not waste your time working with a lender who doesn’t grant loans on that basis.
Turnaround Time on Funding Varies
Sometimes you need cash in a hurry. A major customer has not paid their invoice but you need to pay bills. The window is closing to order seasonal inventory. Turnaround time on loan approval matters in those instances. A traditional lender can take months to approve a loan, requiring large amounts of documentation, a business plan, and more. By that time your business could have shuttered.
Alternative lenders can often give you an answer within days, if not sooner. They require much less documentation, though in exchange for quick access to cash you will pay a higher business funding costs. They could be the best choice for your business if you need rapid funding.
Making the best possible decision for your company’s capital needs requires thinking about these factors before applying. Once you have answered all of these questions and narrowed down on what you need in a lender, you have a few more things to consider.
Will you be applying with a bank or an alternative lender?
Traditional lenders offer the lowest interest rates and fees, fixed monthly payments, and the longest repayment terms. Their cost of capital is the lowest, which means that you pay the least amount of money to access funding for your business. Banks and approved lenders are the only sources for small business administration (or “SBA”) loans, too. SBA loans have a partial government guarantee and thus have some of the lowest rates.
The problem with banks is their high standards for borrowers often lead to low acceptance rates. Loan application packages can be extensive, requiring multiple years of bank statements, business plans, and tax filings for several years and much more. They rarely work with anyone who has a credit score less than 700. Most small businesses simply will not have the credit or the required years of documentation to be accepted by a bank.
A small business owner should monitor their credit score, as it impacts their ability to access capital. If you have a lower credit score it is to your advantage to work to raise it. Those with lower scores pay a higher cost of capital, and are limited in the lenders who will lend to them. On-time payments and manageable debt repayment terms will impact your score, and the right borrowing decision can actually improve your score.
Traditional lenders and banks also will run background checks. A simple background check only takes a matter of days, but this still delays funds disbursement. If you know of a small misstep in your past it might be best to begin with an alternative lender and save yourself the time. Alternative lenders rarely perform background checks and, even if they do, depending on the type of crime might work with someone who has a record.
Alternative lenders offer short term business loans, merchant cash advances, and even bad credit business loans. Alternative lenders typically have lower documentation standards and will work with individuals who have lower credit scores. They offer more flexible payment terms but generally feature shorter terms. While they have higher acceptance rates, they are taking on more risk by working with less credit-worthy borrowers. To hedge their risk and protect themselves from the risk of non-payment, they charge much higher interest rates than traditional lenders.
Your credit score will be impacted by your decision.
When lenders make a decision for a borrower, they pull your credit score. There are two different ways to pull a credit score: a hard pull, or a soft pull. With a hard pull, the research done on your credit score will impact your score negatively. Soft pulls, on the other hand, will not.
Banks require hard pulls, while many alternative lenders will require soft pulls. That being said, each alternative lender will have its own protocol, so it’s best to ask about the credit report pull before you apply.
What will you have to guarantee in order to get the loan?
Perhaps one of the most crucial things to consider when choosing a lender is what type of guarantee is required. A personal guarantee is a document that forces the business owner to be personally liable for any loan-related debt the business can’t pay, but there are certain limitations on the lender’s recourse options. Another type of guarantee is a confession of judgment or COJ. A confession of judgment allows lenders to avoid litigation in order to get a judgment against you. In certain cases unscrupulous lenders can utilize a COJ to get all of their money back and legal fees with just one missed payment.
Most lenders will require borrowers to sign a document with a guarantee before business funding takes place, so it is a good idea to know what your lender requires and how signing that document can affect you and your business.
Is your small business lender reputable?
It can be easy to fall into the trap of evaluating the lender’s offerings, and your likelihood of being approved, without considering the lender’s overall reputation. Sometimes you may need the money so badly that you are just grateful to be approved. But lending and borrowing is a two-way street.
Lenders need borrowers to make money. They earn their profit on the net interest margin, which is the difference between what they pay to borrow money and what they charge you to borrow it from them. If you are a borrower with an excellent credit score and strong business fundamentals you are attractive to lenders and they will compete for your business.
Even less credit-worthy borrowers are valuable to lenders. Vetting your lender protects you from disreputable lending practices, such as selling you a product that is not the best for your business, or charging hidden fees. But it will also give you an idea of what to expect from the entire loan process, from application to approval to servicing.
Search out and read reviews on neutral websites and in business funding forums, such as the Better Business Bureau. Pay attention to comments about the lender’s customer service, as communication can be the key to a successful loan relationship. Read up on the speed and ease of the application and underwriting process, particularly if you need to quick funding.
Look for factors which suggest professionalism and experience in the industry. A company that has years of experience has proven that they know how to operate a successful lending business and service borrowers’ needs. Inquire with other business owners in your geographic area or industry about their lending experiences, particularly if you need to work with a lender who has industry experience.
Above all else, try to perform due diligence before selecting a lender. It is a business relationship which will have an important impact upon your future. A loan from the right small business lender for your business will be a good fit for you both.
Sam is an expert in small business financing and has been CEO at Shield Funding for more than a decade. The company has funded more than 1000 small businesses and has been a significant contributor to the phenomenal growth that many of those companies have experienced.
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