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What do I need to know when applying for a business loan?

The most important thing to understand is what your options are so you do not waste your valuable time pursuing financing alternatives that you may not qualify for or may not be right for you. There are a wide variety of loan products on the market, but there are significant differences between each option. Before pursuing any of these options, you should first define two things: 1) what are your plans for using the cash, and 2) what type of business you are and your perceived credit quality. With respect to the second point, it is important to be honest with yourself about this question because pursuing a bank loan can be a major consumption of your time. According to the NY Federal Reserves’ most recent small business credit survey, the average small business spent 26 hours seeking credit!

small-business-loan-optionsTraditional Bank Lending
Most businesses immediately think that their bank should be the first avenue they pursue. There is no question that banks can lend money at the lowest rates. So, if you are convinced you will qualify and have the time, then this is definitely a worthwhile option.

Unfortunately, the vast majority of banks are simply not structured to service small business customers. Branch personnel are not trained to analyze and offer credit, and commercial loan officers are busy chasing “bigger fish.” Case in point, almost half of the small businesses with annual revenues of $250,000 to $1 million do not have access to bank credit (source: Federal Reserve Bank of New York – May 2011 Small Business Borrowers Poll).

More importantly, banks lend to only the lowest risk small businesses that have adequate collateral. Banks put a heavy emphasis on collateral that they can access should a loan cease to perform. Unfortunately, most service-based businesses have little or no collateral to offer.

The final factor to consider with bank loans is time. You should expect the average time from application to approval to take at least 30 days. In addition, it is very likely that you will need to react to a series of questions and requests for more information or documentation during the process. So, before proceeding, it’s best to have your “house in order.”

Non-Bank Lending Options
Recently, many non-bank financing platforms have come to market offering a wide variety of products that traditional bank lenders simply do not. These platforms have been referred to as “Alternative Lenders.” Each offers a different value proposition and serves different types of customers for different purposes. We view the market in terms of two distinct sets of product categories. There are short-term financing options that allow businesses to satisfy a short-term cash flow need that require daily payments. We call these “Daily Payment Contracts.” Then, there are longer-term lenders (2-5 year loans) offering customers the opportunity to invest in their businesses for more “productive” purposes.

Daily Payment Contracts
These providers such as OnDeck Capital, CAN Capital and Kabbage offer short-term financing options that are typically below $50,000 in size and require daily payments. These financing products are typically best suited for businesses that need cash quickly and have less-than-desirable credit (FICO scores below 650) or businesses that have very high inventory turns (restaurants for example). Given the duration (length of time to repay these contracts) and their fees, the effective Annual Percentage Rate on these loans are very high. For example, if a daily payment lender offers a borrower $1.15 repayment for every $1.00 they advance, then that results in an effective APR in excess of 50% given the duration of the loan. What’s more, these contracts are not technically loans. Meaning if they advance you $1.00 for a $1.15 in return, then no matter when you pay them back, you still owe them $1.15. So, when you take money from these firms you are really agreeing to a fixed amount of payment.

Longer Term Lenders:
These providers offer small businesses with longer-term loans (2-5 years) and their product structure is most similar to a bank loan. The key difference is that they have the willingness to lend to a broader spectrum of customers. They utilize a concept called risk-based pricing to issue loans which means the price of the loan (interest rate) is determined by the predicted likelihood of non-repayment. Risk based pricing allows these lenders to focus on stability of business borrowers rather than collateral and therefore they can serve many more customers.

Because these loans permit a 2–5 year repayment period, the payments are very manageable and they permit thriving businesses to invest in their businesses and see a return on that investment.

In addition, like many of the alternative lenders in the market, you can complete the entire application and funding process within 72 hours. The key player to focus on in this category is Fundation. When Fundation approves a loan, they typically provide customers with options on their repayment period. The goal is to find the product structure that makes the most sense for each individual borrower.

If you would like to learn more about Fundation and how they can help you expand your small business, you can visit their website directly here to apply for a loan or you can call them for more information at (888) 498-4597.

fundation-small-business-lending

Tags: business loans, alternative financing, small business, Ryan Himmel

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What do I need to know when applying for a business loan? was last modified: April 11th, 2014 by Ryan Himmel, CPA
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