One of the few bright spots of the pandemic was that many of the short-term online lenders and merchant cash companies disappeared. But now that conditions have returned to near business as usual, those companies are beginning to reappear and are casting their spells at struggling or desperate companies. Considering just how badly the pandemic damaged so many businesses, there are sure to be takers.
To that, I repeat my slightly modified version of Nike's famous slogan: Just Don't Do It! Short-term loans are akin to the fast food of the lending world. Yeah, it's temporary nutrition, but at what cost? The loans are usually easy to obtain, with the process taking as little as a couple days. You can apply online and you don't need an extensive credit history - or even a great credit score - and you won't need to provide a detailed look at your financials.
So, what can be wrong with easy money? Especially since the increased cash flow might mean making payroll or even paying your rent?
For starters, the lender probably isn't well established. That means they could go out of business at any moment. And to add insult to injury, online lenders aren't always as well regulated as their traditional brethren and you'll get little to no financial counseling. More importantly, the price you're going to pay will be a high one in more ways than one.
You're going to get stuck with an outrageous interest rate - an effective APR of more than 100% is a possibility. The repayment terms (short payback periods, balloon payments, prepayment penalties and so on) can well be crippling, especially if your business' cash flow is erratic.
Another big problem is that a short-term loan can send you into a debt cycle that you're never able to escape.
Too often, I've heard stories about companies that take out a short-term loan and end up getting a second one before the first one is paid off. That's rarely tenable, turning the debt cycle into a death spiral.
Let's consider an example. A lender might say, "I'll lend you $100,000. You pay us back $120,000." Thus, you may think that's only a 20% interest rate, which seems manageable.
However, that $120,000 may have to be paid back within six months, making the effective APR 40%.
But wait, it gets worse. Instead of making a monthly payment, the online lender is likely to debit daily payments from your checking account, which can theoretically push the effective APR to 80%.
Before considering a short-term loan, business should instead cut expenses and go into bare-bones mode.
Surely, there are places you can cut expenses. You likely can slow down your payables and maybe speed up your receivables.
Anyone who's ever watched "Shark Tank" knows how entrepreneurs are conditioned to be in perpetual growth mode - and it's certainly more fun to grow than to maintain status quo or shrink - but no business grows in a straight line. Ups and downs are merely part of the process (and clearly better than getting stuck with crippling debt).
If you decide that you can't avoid taking on a loan, first make sure you have considered all your other options.
Many of my clients are stunned to find out they are eligible for loans backed by the federal Small Business Administration. While there's a lot distrust about the government these days, the SBA is an example of a government program that is actually working. Both Republicans and Democrats in Congress fully support the program. You should as well - unless you're not interested in loans at good interest rates, lengthy repayment periods and other favorable terms.
If you do take the plunge into short-term debt, make sure you understand the terms and know what the monthly or daily payment is going to be. Take the smallest amount possible. A short-term loan should be to cover the bare essentials - nothing else. And be confident that, with this infusion of cash, the improved condition of your business will allow you to repay the loan.