Top Reasons to Avoid Using a Bank for a Small Business Loan
When most small business owners realize that it is time to get a small business loan, they might think that a bank or traditional lender is their only option. Even if they are aware of other options, such as alternative lenders, they might think that a loan from a bank is the best option. But there are many reasons for which going to a bank for a loan could be the wrong move for your business and you should opt for a private business loan.
Banks may offer the lowest rates, but they also offer the slowed turnaround times, have the strictest qualification requirements, and the most inflexible payment plans. The total cost of a loan through a traditional bank could be much higher than you anticipate once you include fees and compliance with the loan’s terms.
Due to the lengthy funding process and red tape bureaucracy with traditional lenders there has been a rise in the use of alternative lenders. An alternative lender can provide small business loans in a much shorter time with competitive rates and terms and almost no red tape. Here are the top reasons to bypass a bank and go straight to an alternative lender for your small business funding needs.
Banks Have a Slow Speed of Funding
Banks can take weeks to months to approve a small business loan. If you need cash in a hurry, whether it’s to jump on a great deal for next season’s inventory or to cover a shortfall when rent is due, you might not have time to wait months for approval. And if you missed something on their lengthy application checklists your application could be delayed in underwriting until you can provide it.
Because banks require extensive documentation, have strict underwriting requirements, and layers of bureaucracy to navigate, processing a commercial bank loan does not move quickly. Over 39 percent of bankers in one industry survey said that it typically takes from three to six weeks to close a new commercial loan. And over 36 percent said it takes more than six weeks.
In comparison, alternative lenders can turn around a loan application in a matter of days. Shield Funding, a leading small business loan provider has had same day turnaround on some small business loans. In general, alternative lenders have far fewer loan application requirements and sometimes can approve a loan on as little as a business’ revenues and time in business.
Banks have Burdensome Documentation Requests
Bank loans require more documentation than almost every other type of loan out there. It can take considerable time to pull together tax returns and bank statements, prepare a comprehensive business plan, and comply with all their underwriters’ requests. Banks could request any and all of the following;
- Personal and Business Credit Report
- Bank Statements and Tax Returns
- Financial Statements
- Documentation of Collateral
- Proof of Business Ownership
- Business Licenses or Registration
- Business Plan
This a short list and depending on the type of bank loan and amount of capital that you are applying for a bank could require even more documentation. If they ask for an accountant or lawyer to certify your financial statements, you will have to pay a professional their hourly rate and make any changes that they request. This will, in turn, drive up the loan’s overall expense and that boost in cost and overall annual percentage rates will not appear anywhere in the contract or loan offer.
Alternative lenders in comparison can approve a small business loan with just a business bank account, identification, and proof of ownership.
Banks Charge More Fees
There often is an expense to applying for a bank loan, too. Most charge application fees which are non-refundable. They also charge a variety of other fees such as; underwriting fees, closing fees, appraisal fees and more. Additionally, the expense to produce certified documents and other lengthy paperwork cost money, and these costs are definitely not included in the advertised annual percentage rate. These fees should be factored into the total cost of the loan, and should be considered when you are considering borrowing.
The simple interest rate that a bank quotes a small business borrower does not reflect many fees and other costs associated with the loan. While that rate could look more attractive than the rate offered by an alternative lender, by the time the loan’s total costs are included the bank’s rate could end up much higher than anticipated.
Alternative lenders rarely charge application fees. It is completely free to fill out an application with an alternative lender. Due to their streamlined process, other fees such as underwriting or processing fees may not be applicable either.
With a Bank You Have a Worse Likelihood of Being Approved
Why waste your time on a loan application that is likely to be denied? Even if speed is not a factor, it can be frustrating to put your business plans on hold while waiting from a loan decision from a bank. Worse, if you are denied, you will have to start the process all over with a different lender and could have wasted valuable time.
The approval rate for small business loans at traditional banks was 26.5% in 2018, which means that banks denied roughly 74 out of every 100 small business loan applications. In comparison, approval rates at alternative lenders were 56.5%, so they approved over half their small business loan applications. In fact, there are many alternative lenders that have approval rates significantly higher with their business loans for bad credit. Your odds are much better getting an approval with an alternative lender.
Banks Have Tougher Credit Requirements
Banks often will not lend to a business owner whose personal credit score is below 700. The reality is that you might have a low score because you missed a payment here and there, or went through a rough patch in your business. If you have a lower score, it’s unlikely that your business’s other financials will help you overcome that fact.
Alternative lenders know that life can be unpredictable and that people make mistakes on their path to financial wellness. They are willing to work with borrowers who have credit scores down to 500. While you still may not be approved for business funding, you have a viable chance if you are in business for a few months no matter what your credit score may be.
Banks Have Tougher Approval Requirements in General
Banks cannot serve all industries and every borrower’s needs. They specialize in niches. Many will not lend to businesses in certain industries such as gambling or cannabis, and they may avoid lending to high-risk industries like restaurants.
They will also want to know how you intend to use the loan’s capital, and you might have to demonstrate this intention with a business plan or other documentation. The loan’s purpose and the use of funds matters more to a traditional bank, in part due to government regulations with which they must comply.
In addition, they will consider your debt and liquidity ratios when lending, or other metrics which measure profitability and your repayment ability. A liquidity ratio measures your available cash on hand’s ability to repay your current liabilities. If a bank wants to see a conservative ratio you will need to have a lot of liquid capital in order to gain access to more capital.
Inconsistent cash flow, a shorter time in business, or a less-experienced management team could also cause a bank to deny your loan application. It can be very difficult for many small businesses to meet their tough approval requirements, which is why alternative lenders have arisen to fill the funding gaps for small businesses.
Alternative lenders do look at debt ratios and other factors, but they do not consider things like profit, management experience, or use of funds, and there is generally no one thing that disqualifies your application. Alternative lenders have experience working with a wide array of industries and small businesses which streamlines the process so they do not have as many approval requirements and can provide working capital loans to most existing business owners.
Banks Offer Less Flexibility in Payments
Banks do not offer flexible payment terms. A monthly payment is standard. The risk for a small business owner is that the monthly payment could not align with their cash flow.
What if the bank wants to debit your account on the 25th of every month, but your customers don’t pay until the 30th? You either have to become a budgeting mastermind and hold onto that payment amount for the next three weeks or always keep enough in your account to cover that payment.
Few businesses can afford to have money just sitting in their accounts to cover a loan payment withdrawal that occurs at an inconvenient time. Alternative lenders give borrowers the flexibility that they need. Payments can be made on a daily, weekly, bi-weekly or sometimes even a monthly basis. They will work with you to match your payment schedule to your cash cycle. For a struggling business, this kind of flexibility is invaluable.
Banks Processes are Overly Complicated
In order to apply for a small business loan with a bank you will have to go into a branch and speak with a small business lender. After the initial meeting you will likely have to return with all the required documents and completed loan application. They could require other visits if a banker wants to meet with you to learn more about your business and the loan’s intended purpose.
All of this takes time away from the day-to-day of running your business. When applying for a bank loan you will encounter levels of bureaucracy that slow the process. An alternative lending application, in contrast, can be completed online in a few clicks. You may only have to speak with a loan officer one time over the phone before the funds are deposited into your account.
Banks Might Require Audits throughout the Loan’s Term
Even if you can qualify for a bank loan, and have the time to wait for approval, its ongoing requirements could prove to be burdensome. For particularly large or riskier loans banks often require audits. The audits could be quarterly or yearly.
During those audits, you will have to provide financial statements prepared by a certified public accountant or other professionals. The bank may ask to see recent bank statements or progress reports on the business plan that you presented them with when applying for the loan. These audits can prove to be a time and money drain on your business, quickly offsetting any cost savings you might have received with a lower interest rate.
These are compelling reasons for a small business owner to walk by their local bank’s branch office and apply online with an alternative lender instead. The benefits of quick funding time, lower or no additional fees, flexible payment terms and more could make an alternative lender the right choice for your business.
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.