Choosing A Lender? Watch out for These Costly Traps

Small-business owners seeking financing have hundreds of options thanks to a proliferation of lending firms and programs offering fast and easy solutions.  But the reality is only a few of these choices will be the right fit for your nascent business.  Although the lure of quick cash regardless of personal credit can be tempting, be wary of common traps when considering a lender for your company:

1. Know when business credit services are necessary — and when they absolutely are not.  While business credit can be important as your business matures, it doesn’t make a difference for a startup applying for a loan.  Startups are not expected to have a strong business credit file, so any firm extolling the necessity of business credit services to apply for a loan may actually be doing you a disservice.

Instead, concentrate on the strength of your personal credit, as lenders will focus on this more because you will ultimately be responsible for paying back the loan.

2. Know the price you pay for speed and convenience.  Some short-term lenders and cash advance companies offer so-called “fast” loans with quick application processes and a lax review of personal credit.  This speed and convenience comes at a cost, however.  Entrepreneurs should be careful when considering a cash advance, especially if rates and pay off timeframes are extremely harsh.  Some firms offer annualized percentage rates as high as 200 percent with amortizations as slow as three to four months — terms like these can be a nail in the coffin before a business is even birthed.

Protect your business by reading all terms carefully and make sure you have a clear plan to pay back the loan before signing on the dotted line for a cash advance.

3. Don’t outsource; know your own business plan.  Be wary of any company insisting that you need a business plan and financial forecast in order to sell you an expensive business plan package.  Additionally, if you’re paying someone else to do this work for you, then your business may have bigger problems.  Having a direct hand in developing the business plan and financial projections ensures that you as the business owner know the ins and outs of the company and have defined goals for growth.

Have a good understanding of what makes your business tick in the present, and where it is realistically headed in the future to protect it from other unnecessary expenditures that you may encounter throughout the startup journey.

The Absolutely Best Time to Borrow Money, as published by Inc.

Consider taking out a business loan when you least expect you’ll need it.  Here’s what I mean.

At my loan brokerage firm, I receive calls from small business owners everyday who are desperate for loans–not only to save their businesses, but just to keep the roofs over their heads.  If they had called me a few months earlier, when financial needs were just emerging, securing a loan or line of credit would have been much easier.

It’s common sense, but many small business owners ignore the fact that it’s easier to get a loan when you don’t need one than when the situation is dire.

The High-Interest Treadmill to Avoid

Imagine a scenario in which it’s the middle of the summer and your air conditioner blows up on you.  It’s going to cost $25,000 to replace it and you need to do it quickly.  There is not much time to think, or your business is at risk.  If you have a line of credit in place for an emergency like this, you can write a check and pay a low interest rate of 5 percent to 6 percent until you figure out a longer-term plan.  If you don’t make that contingency plan, and you don’t have the cash on hand, you could be forced to call a quick short-term lender who will charge 60 percent to 80 percent interest.  This is what you don’t want to do.

Small business owners tend to have short-term memories and wind up concentrating on present victories and defeats.  If things are going well, you probably think that they’ll continue that way.  But if the recession made anything clear, it’s that the world can change quickly and unexpectedly.  No one is immune.

Just as people take out life insurance plans to help take care of their affairs in case of unforeseen death, so should owners have lifelines for their businesses.  The most successful entrepreneurs anticipate potential problems down the road and plan accordingly before hitting them.

You Know You’re in a Good Position to Borrow When…

If your business is doing well, now is the right time to evaluate your contingency plan options.  When cash flow is steady and building, banks will line up to give you money at the best rate possible.  A line of credit can be a lifesaver in case of an unforeseen emergency or during a slow season.  While there might be some small expenses to get a line of credit set up, once you have it, you only pay for it if you use it.

If you have accounts receivable, your industry is showing growth, and you have good credit, you’re in a good position to take a loan or a high line of credit at a good rate.  With business that is turning profits, you can be confident that you’ll also be able to pay back the loan, which is something that helps all small business owners and entrepreneurs sleep better at night.

You Know You’re in the Worst Position to Borrow When…

On the flip side, if you wait until you aren’t able to make your payroll or aren’t able to pay your lease, it will be more difficult to get any sort of loan because banks and alternative lenders are hesitant to lend money to a business that is at risk of shutting down or going bankrupt.

When you get desperate, your choices dwindle and you may be stuck with a high interest loan with short amortization period that will leave you right back where you started after a few months.  This is when businesses can get sucked into the trap of short-term loan renewals that they have trouble getting out of and rates that they struggle to pay.

For many businesses, a call for a lifesaver loan is completely avoidable if a loan or line of credit is taken a little earlier in the game.

Are you prepared to weather potential storms looming on the horizon?  Do you have a small business contingency plan?  Let me know in the comments section below.

A New Group of Alternative Lenders: Investment Lenders

How we refer to lenders helps shape the industry.

Over the past year there has been an important shift in the alternative lending landscape for small business owners and entrepreneurs. A new group of non-bank lenders have entered the market and are willing to lend to businesses at amortizations that spread three to five years at interest rates that are typically in the mid to high teens. Some of the primary players in this category include Lending Club, DealStruck, Fundation and Funding Circle.

These new players create a big and important shift from the short-term cash advance or on-line daily ACH lenders who typically lend money at six-month amortizations with APR’s that can range from 30-200 percent. Some of the big players in this market include OnDeck and CanCapital, among others.

In my opinion, any entrepreneur who is looking for an alternative loan should consider one of these new players first, before considering a cash advance.  While their credit standards are tougher, if you are lucky enough to get one of these loans, your rates will be a fraction of the price of the cash advance lenders, you will have reasonable monthly payments vs. daily debits from your checking account, and you will have no or minimal prepayment penalties.

That being said, many entrepreneurs still don’t know about the new players–and a big reason for this is there is not a name for their category of lending.

“Alternative Lenders” is a broad term that often refers to many of the big names in the space and encompasses a lot of types of loans, including cash advance merchants. These new lenders are not short-term cash advance lenders, so it would be unfair to pigeonhole them into this grouping.

I would like to suggest that we call the new group of lenders “investment lenders”. The reasoning behind the nomenclature is that these types of loans give businesses enough time to take a loan to make an investment in their company, let the loan improve their business, and pay it back over a reasonable period of time. This is in sharp contrast to the cash advance lenders whose short-term loans often force the borrowers into multiple renewals and increased rates.

If we can all agree on a term, it will be a good thing for the lending industry and entrepreneurs. I think the term “investment lenders” provides an important contrast and distinction between the two products and I plan to use it in my talking and writing about the industry going forward.