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

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 May 2, 2017

 

You need money to make money. But when a bank loan isn’t an option, you might lean toward high-risk business loans.

First, though, 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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Why the Bank Rejected You

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 the 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.

 

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. So, if you haven’t heard of them, there’s a chance they could be just about anyone doing just about anything.

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.

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