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3 Things to Ask Yourself Before You Accept an Alternative Loan

You'll get more trouble than money if you don't fully understand what you're getting into.

If you're in big need of very quick money, an alternative lender may be a viable option. Most screen out startups and other businesses that don't meet minimum annual revenue thresholds or that lack the necessary amount of historic financial data. Assuming you meet all criteria, make sure you can answer these questions before signing anything:

1. How are you using the money?

Buying inventory, expanding your restaurant, or covering a one-time shortfall are good answers. These projects allow you to increase revenue in the future. If you need money for general business purposes or to consolidate debt, look elsewhere.

2. Are you absolutely sure about what you're paying back?

The stated interest rate is probably not the effective interest rate, especially if interest is compounded daily and the term is less than one year. Origination fees and prepayment fees boost the effective interest rate even higher. Make sure you know how much will come out of your bank account and when.

3. Will cash in match cash out?

Ideally, the cash you're expecting from the project you finance will come in as quickly as you need to repay the loan, which is almost immediately. Using a six-month loan to buy a year's worth of inventory is trouble, because the revenue from selling inventory will lag the payback period. You can use other cash flow--even the loan itself--to make payments in the very short term, but only if you can achieve cash-flow equilibrium fast.


From the May 2014 issue of Inc. magazine

ALIX STUART | Contributing Writer

Alix Stuart is a freelance writer based in Boston. She covered corporate finance and management for more than a decade at CFO magazine. Her work has appeared in The Wall Street Journal, The Boston Globe, and On Wall Street, among other publications.

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