It’s been more than a decade since the Financial Crisis yet small business owners are still facing an uphill struggle to get approved for bank loans to expand their company. In fact, small business loans from large banks came to a virtual standstill during the crisis, according to Investopedia. Between 2008 and 2010, nationwide commercial loans to small businesses actually declined by $40 billion. And while the economy has recovered since then, small business loan originations are still down “40% from pre-crisis levels”, according to the Small Business Administration.
But thankfully, the United States has a capitalist economy and new forms of business financing began to arise to fill the vacuum. If banks weren’t going to lend to small businesses, then private lenders decided to step forward and offer business loans. The worldwide web provided access to everyone in the country who needed business financing.
Don’t Confuse Private Business Loans with Equity Investors
Private business loans are not the same as equity investors, angel investors, or venture capitalists. The latter are outside investors who want to buy a percentage of your company in exchange for operating funds. Many of these investors want an executive role in the running of the business to protect their investment. It’s a viable financing solution for some owners who have an idea with explosive growth potential. Some success stories are Apple, Facebook, Google, and Twitter. But its difficult to attract investors and most small business owners need operating cash quickly.
Alternatively, private business loans offer the owner a faster way to access financing through alternative lending sources. The loan needs to be paid back under the terms of the agreement and the owner doesn’t have to give up equity in the business. It also provides financing options for those who have a lower credit rating.
Fast Facts on Private Business Loans
A 2017 (the most recent figures available) survey by the Small Business Association found that:
Types of Private Business Loans
Options for private business financing depend on a wide variety of risk factors from the applicant’s credit score to length of time in business. Those with bad credit ratings can still qualify for business financing as noted above with a 75% loan approval rating from alternative online lenders. We’ve cited several options that may fit your particular financial circumstances.
Community Development Financial Institutions Fund (CDFI Fund)
The CDFI Fund is operated by the U.S. Department of the Treasury. It’s a public-private joint venture where the federal government invests “federal dollars alongside private sector capital” in economically disadvantaged communities. The CDFI Fund is not to be confused with Small Business Administration business loans. CDFI loans have a high approval rating for those with plans to operate in a certified community and have a good credit rating. This fund was a financing option for 5% of business owners in 2017.
Short-Term Private Business Loans
Short-term financing varies among private lenders as to how the loan is paid back. Some agreements call for daily, weekly, or monthly payments while others are paid back in a lump sum within the term limit. This loan type typically has a term of less than one year.
The cost of borrowing will depend on a variety of risk factors calculated by the lending firm. Those with a good credit score, steady streams of revenue and business longevity will qualify for more favorable terms than those without those credentials.
Typically, short-term private business financing is used when cash is low, but payment obligations still need to be met such as payroll, inventory, and taxes. The loan is then paid when customer accounts receivable are received and inventory is sold. They may also be used as bridge financing while waiting for long-term business loans to be approved.
Private Line-of-Credit Loans
Establishing a line-of-credit that can be accessed as needed is an option for some business owners. Acting much like a credit card, but typically with lower interest rates, business owners have a steady access to working capital. It can be used for any business purpose as long as you don’t exceed the line-of-credit limit. You’re not committed to making regular payments on the amount borrowed but you will be subject to interest charges as long as the loan is outstanding.
There are two types of Line-of-Credit Business Financing:
Equipment and Real Estate Financing
Asset-backed financing can help companies purchase equipment or real estate needed for business expansion. The purchased asset becomes collateral for the loan in the event of a default. This type of loan is typically easier to be approved and comes with a lower interest rate than unsecured business financing as it offers less risk to the private lender.
Invoice Financing or Factoring
If you don’t qualify for a short-term loan or line-of-credit, invoice factoring may be an option for some business owners. If your company issues invoices to customers with 30- or 60-day payment terms you can use the accounts receivable asset as security for the loan. The invoice factoring lender will issue funds up to 90% of the invoice value within a few days of approval. The customer then pays the factor 100% of the invoice and the business owner receives the balance less accumulated interest.
Private Merchant Cash Advances
If you have an established business and need cash in a hurry, a private merchant cash advance may be a solution to your business financing challenges. A merchant cash advance is rather easy to qualify for even with a poor credit rating because your company’s future sales revenue acts as security for the loan.
Even though the merchant cash advance is sometimes referred to as a bad credit business loan, it’s not its sole purpose. Many companies choose this option because its easily accessible with funds accessible within a few days. It can be used to pay bills during a short-term cash crunch or for buying inventory to prepare for a seasonal business surge.
Unlike an ACH loan, private merchant cash advances are used predominately by businesses that have a high volume of credit card and Interact/bank card sales. These private business loans are based on future sales receipts and a percentage deducted daily by the merchant lender. As you ring up sales, the revenue flows through the lender where it deducts a percentage of the loan plus the factor and interest rates agreed upon.
For example, if you receive a merchant advance of $10,000 at a factor rate of 1.15, you would have to pay back $11,500. You’ll also be charged an interest rate based on your outstanding balance. A typical private merchant cash advance has a payback term of 6 to 18 months but can be paid back faster depending on your sales volume. If you plan it correctly, you can pay off the loan quickly and avoid excessive interest charges.
Private Online Lenders a Growing Industry
As has been true throughout commercial history, a vacuum is created when industry abandons a particular market segment. That vacuum is quickly filled by investors who are looking to get a better return-on-investment and willing to accept both higher risks and rewards. Large banks abandoned small business owners on the B2B financing side, a key driver of the economy, because they saw higher returns elsewhere.
Alternative online lenders quickly stepped in to fill the void to provide private business loans. We’ve described various options for business financing to fit any company’s financial situation. Let us know if you have further questions.