Because you need money to make money

High-Risk Business Loans – What to Expect and Watch Out For

Date published: May 2, 2017
When you need working capital, but can't qualify for bank funding, here are some things you should know about alternative cash for your company.
Loan Advice

High-Risk Business Loans

You need money to make money. But when a bank loan isn't an option, you might lean toward high-risk business loans. Here’s what to know before taking the plunge.

Step 1. Figure Out Why the Bank Rejected You

First, you should figure out why the banks rejected your application and what dangers you face if you end up signing that dotted line with somebody else.

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Businesses are finding it harder to get approved for funding. It's perplexing because there seem to be more alternatives every day.

Still, studies show that when a small business owner needs money, odds are he'll from his personal savings rather than obtain a loan. One of the primary reasons for rejection is because of one’s business credit score.

Your business credit score is an indicator of how likely you are to pay back a loan. Several different companies calculate your score, including Equifax, Experian, FICO, and Dun & Bradstreet.

It can take years to build up a good business credit score. Even if you haven't made any big mistakes, your score may still be low. For instance, if the credit reporting agencies don't have a record of you paying your vendors and suppliers, then your score will suffer.

The better you understand your small business credit score, the more likely you'll be able to improve it. And if you improve it, then you'll increase the likelihood of loan approval.

We recommend speaking with a financial expert to determine the specific ways you can increase your business credit score.

We should note that you can be rejected for other reasons as well:

  • There's an issue with your cash flow. Use our business calculator to figure out your debt service coverage ratio (DSCR). This number will give you an idea as to whether the amount of money you have coming in is enough to cover the loan you want.
  • You are a startup. Many providers simply won't lend to startups. They'll funnel you out of their application system before even looking at your DSCR.
  • Your business plan doesn't look stable. This is a tough one because if your plan to make money were super obvious, then everyone would be doing it. Still, some providers want to know you'll reimburse them.
  • You already took out a loan. If you already have debt, then a provider is going to count that against you. Even if you just have an open line of credit, that will likely go against you when you're applying for a loan.
  • The collateral isn't there. There are many ways to come up with collateral. You can put up your personal assets, business assets, property, equipment, and pretty much anything else you own that's valuable. That's risky, of course. You don't want to lose everything at the same time. But if you don't have any collateral to speak of, you shouldn't be surprised if your application gets rejected.

At the end of the day, the provider wants to be confident that you will be able to pay off your loan. If something makes them think otherwise, then you will not be approved for the funding.

Another thing we should point out is that banks and the Federal Reserve define small businesses differently than the rest of us do. To be considered a small business to the Federal Reserve, you need to have a revenue under $50 million. Banks will sometimes define small business lending as providing funding to companies with revenue under $20 million. But most U.S. small businesses have revenue less than $1 million.

The bigger banks (and that's most of them) don't have any interest lending to companies that make less than a million dollars a year. So even if you have a great business credit score and a solid business plan, you might still be rejected by the bank because you're too small to be worth their time.

Step 2. Learn About High-Risk Business Loans

High-risk business loans are sometimes considered to be a final resource for many businesses that are viewed as being too risky for traditional lending services. To be considered for a business loan, traditional lenders often review their respective creditworthiness. Businesses that hold a lower than desired credit score will face difficulties in obtaining a loan. This is why risky businesses often opt towards locating a reliable high-risk loan.

High-risk business loans consist of high-interest rates, larger payment amounts, or maybe even more frequent payments. These loans are spread over a short-term period rather than longer debt terms as with traditional loans. While the terms and conditions for these loans are similar to traditional loans, they do often differ from one option to another.

Getting a high-risk loan can depend on many factors that lenders often rely upon.

● Income and ability to repay

Since these loans do not entirely rely upon their borrowers' credit scores, they must focus on the customer’s current financial state, including income and all else. Lenders may factor into their decision their borrowers' income in accordance with the amount requested.

● Collateral

When applying for the loan amount, any assets that can be put up as collateral will be considered an extra advantage for the borrower to get the loan. In case the borrower is unable to repay the loan amount, the collateral asset can be used to cover their debt.

● A co-signer

Getting a co-signer to step in and sign off on loan will help lenders provide approval. When the borrower fails to repay their debt, the co-signer will take over the loan and finish off the repayments.

Step 3. Know the Risks of Alternative Small Business Lending

The problem with the word "alternative" is that it's open-ended. An "alternative lender" can be any provider that's not a bank. It's an awfully big range. Within that range are reputable companies. There are also the other guys.

The other guys can be downright dangerous. It shouldn't be too surprising, though – the industry is largely unregulated.

Here are some warning signs you should look out for:

  • The fees are unacceptable. While the small business loan industry is largely unregulated, you should expect your provider to offer you a loan agreement that clearly shows the costs that you'll be expected to pay. Those fees should be reasonable and affordable.
  • Your loan agreement is missing information. An incomplete loan agreement is a showstopper. Don't sign anything until you know everything.
  • You can't find the business's address anywhere on its website. We're not saying they're a crook. But, if they don't look like a real business, then they might not be.
  • Nobody has ever heard of the company before. If you type the company's name into your search browser, then reviews should pop up. If the company has no footprint, then you might not want to be the first customer to try them out.
  • The company has received a lot of terrible reviews. No company is going to please everyone. But, if it looks like an abnormally high number of customers have a beef with your potential loan provider, then run away. Fast.

Even if you deal with a reputable company, there's still the risk that you won't be able to pay back the loan. That's the biggest danger involved with small business lending. It's what you need to be the most careful about, but all this other stuff is important, too.

Step 4. Study Tips on How to Find High-Risk Business Loans

If you have a bad or poor credit score and are looking for ways to fund your business ideas, there might be other options for you out there than traditional loans.

When conducting your research, make sure to work with bad credit loans and secure lenders that advertise high-risk business loans. This will give you a better chance of getting the cash you need.

Make sure to complete the application process fully and provide them with all the information and documentation required. The process may be long, and you might need to go through more than one website or lender, but once you locate what you are looking for, it will be worth it.

There are many loan options out there for a variety of financial situations. Extremely high-risk business loans may just be a reliable source of fast cash if you do not hold a good credit score.

Small business owners should proceed with caution when searching for high-risk business loans. These loans do entail a few risks but also provide their customers with some benefits. Their primary benefits are easy accessibility and fast access to cash.

What to Know About High-Risk Business Loans for Bad Credit

When searching for a high-risk small business financing, you must be ready to expect higher interest rates than usual. The lender will seek to minimize their risk while offering the loan with high-interest rates or even short-term periods for the loan. There are other viable places to look for such loans, and that is through the web. Finding a small business lender might be easier if you do it online. Nontraditional lenders are keener on providing loans to small businesses and often strive to cater to their customers' needs.

While bad credit is often regarded as a risk to traditional lending systems, so are no credit histories. Startups and new businesses do not hold a credit history. An older business can begin their loan process by presenting the lender with bank statements, profits and loss statements, and other legal forms to prove that the business can generate revenue. New businesses have not begun to establish a reputation, let alone a track of financial records. Lending to startups is risky to traditional lenders. However, this does not mean that startups or new businesses are out of choices when it comes to loan options. What these new entrepreneurs can do is draw up a well-established business plan in order to project profits. High-risk business loans can be a quick form of startup funding and just the right method to get your businesses started.

The method through which you choose to finance your business is highly important and can impact your overall business structure. Understanding your options and learning more about what high-risk business loans have to offer can help provide a more informed decision. It is essential to analyze every loan option carefully and determine what works best for your business. Once you receive the funding, you must manage your cash flow adequately and proficiently to avoid any further imbalances. Being a high-risk business should not stop you from getting the funding or an ongoing business line of credit to keep your operations flowing.

Ethan James   Lead Writer
Ethan James is an experienced Financial Writer at Lendza with over a decade of experience.