When traditional bank lending began to plummet in during the Great Recession of 2008, alternative lending institutions stepped in to serve prospective borrowers left in the cold.
These borrowers, many of whom were small business owners, struggled to compete with more established companies for an increasingly tiny pool of loan products. Alternative lenders offered a more accessible option: short-term financing.
This kind of financing allows borrowers to secure and pay back business loans more quickly than they would traditional term loans, with minimal processing time and a lower barrier to entry, in exchange for higher rates and fees. The rise of short-term financing means more businesses can get the funding they need to keep thriving, provided they can keep up with the accelerated repayment term.
When does it make sense to take on short-term debt? Well, it depends. Weigh these pros and cons when considering short-term financing.
Pro: Short-Term Financing Can Get You Funded Fast
The application process for short-term loans is typically digital, meaning you won't need to spend time meeting with your lender in-person, collecting paper documents, and mailing your application. Borrowers can expect to wait only a few days (or even hours, in some cases) for approval. Banks, on the other hand, can take weeks or even months to approve an application.
Less stringent eligibility requirements also make the approval process faster. Rather than digging through your history and picking apart your business plan, alternative lenders typically only need a handful of documents to prove your ownership, see your cash flow, and check your credit score.
If you need last-minute funding after a delinquent account leaves you in the lurch, short-term financing can make sure you have it--fast.
Pro: Crummy Credit? No Problem
Strong credit--the kinds of top-tier scores banks expect from their borrowers--takes time to build, and many small businesses simply don't have the borrowing history to appeal to traditional lenders. Alternative lenders are filling this gap by taking on borrowers with less-than-stellar credit scores (including those that fall below the "fair" range).
As charitable as this may seem, alternative lenders do take steps to minimize the risks presented by borrowers with poor credit histories. As we'll discuss in the "Cons" below, expect higher rates and more aggressive repercussions for defaulting with short-term financing.
Pro: Even Young Businesses Can Land Short-Term Financing
Most traditional lenders expect their borrowers to have a very strong financial history to qualify for a small business loan. Alternative lenders, however, may accept borrowers who've only been in business a year and generate only $100,000 in annual revenue--or even less. This allows business owners to begin building their borrowing history while they're still growing, which they'll need to graduate to longer-term financing.
Con: Short-Term Financing Packs a Higher Annual Cost
For all its pros, short-term financing still carries a higher annual cost than longer-term financing. What you get in speed and accessibility with short-term financing, you pay for in higher rates and fees.
Many forms of short-term financing charge a factor rate rather than an interest rate. Unlike interest payments, which decrease over time as the principal amount you still owe decreases, factor rates determine what you'll pay back in addition to your principal at the very beginning of your term; your payments will remain constant over time. Those payment amounts will stay high (and frequent, as we'll discuss next) for the duration of your condensed loan term.
Con: Shorter Terms Mean More Frequent Payments
Unlike long-term financing, where borrowers typically pay monthly, most short-term loans require borrowers to make weekly or even daily payments. These rapid-fire payments can prove challenging if there's any fluctuation in your cash flow--a slow few weeks of business could leave you saddled with penalties or at risk of default. (This is especially true of merchant cash advances, a particularly expensive form of short-term financing.)
If your business is particularly susceptible to late invoice payments or lags in credit card sales, consider the frequency of the proposed payment schedule before agreeing to a short-term loan. Don't let yourself get caught in a debt cycle, taking on new debt to pay off loans you already can't afford.
Short-term financing comes with its own unique pros and cons and isn't always the right solution for every business owner. However, if your small business finds itself in need of fast cash to take advantage of a once-in-a-lifetime business opportunity or tide your business over during a temporary slump, alternative lenders are there to provide you with fast, accessible funds through short-term financing.