It can be hard to anticipate events that require a significant influx of cash into your business. Perhaps you landed a new contract that requires production ramped up quickly, or you run a seasonal business and, while you’ve jobs lined up, there’s not quite enough cash from last year. Whatever the case may be, the underwriting process for a bank loan may be too lengthy, causing business owners to turn to alternative lenders, i.e. lenders that, in most cases, are not attached to banks.
There can be drawbacks, however. The need for immediate cash often comes with rather aggressive terms. Many alternative lenders look beyond the credit scores of the business and business owner, focusing on everything from online reviews to daily cash flow. Some alternative lenders can approve loans in minutes from an online application only. These lenders scour the web, using over 2000 data points, in some cases, to gather enough data before making a decision.
Their review and approval process can be speedy because they’re primarily gathering information from the internet, and, in many cases, running that information through an algorithm to determine eligibility. Some, like Kabbage, state that the time it takes to create an account (which they use to determine eligibility) “can take as few as 7 minutes.” In the lending world, that might as well be instantaneous.
However appealing that sounds, many alternative lenders have interest rates well above those of banks, and often require daily repayments. There’s a good reason banks have been hesitant to enter the small and mirco loan market: it’s hard to make a profit. Four percent interest on $1,000,000 is $40,000; on $40,000 it’s $400. So alternative lenders charge higher interest rates – anywhere from 10% and up – in order to be profitable. Those interest rates make payments significantly higher, however, and wise business owners check for additional fees and triggers that could cause additional interest rate increases.
For more information on types of alternative lending, visit our alternative lending page.
How to Avoid Seeking the Alternative
In order to avoid some of the pitfalls that come with alternative lending, its best to plan ahead. Banks will approve smaller loans, but they’re very judicial about it. And they don’t like the desperation. When a business owner comes in needing capital almost immediately, red flags go up. Try to anticipate when you will need funding, and apply for it early. Several months out if you can.
Establishing a relationship with a banker early in the life of your business can help. Even if they don’t initially support you with funding, keep in touch with them; let them know how you’re faring, invite them to visit your business, go to them first when you need funding, and generally be transparent with them. Once a banker has worked and familiar with you and your business, they may be more likely to extend a loan on short(er) notice.
And don’t overlook your business (and personal) credit. No matter the rapport you have with a banker, the state of your business credit and/or your personal credit can weight their decisions. Beginning the process early, and actively monitoring and building it, may provide you when the credibility to attain funding from a bank on short notice.
[CC image credit to Simon Cunningham]