One of the most common questions I get from entrepreneurs is whether they can get a small business loan if they have bad credit. A poor credit rating does not mean it is impossible to secure a business loan. However, the options available and the cost of capital are much higher than for someone who has good credit.
The key is knowing where to look. If you own a small firm and have been in operation for less than three years and have a credit score of below 650, you likely won't be able to secure a small business loan from a large bank.
Big banks (over $10 billion in assets) are lending at unprecedented post-recession rates, but still reject three out of four loan applications and are typically conservative in their lending parameters. Approaching them when you have bad credit will be a waste of time.
SBA loans are an option for many small business borrowers. The government backing lessens the risk for the lender. This arrangement makes loans to startups and existing businesses with poor credit histories less risky for the financial institution.
The growth of online lenders has provided a broad range of options. Many of them are non-bank lenders accept higher risk but do so by charging a higher cost of capital.
The advantages of working with non-bank lenders.
Non-bank lenders are more willing to accept risk, so the odds of getting funded are better than they would be at a bank. They make decisions quickly, which helps entrepreneurs who have hit a rough patch or are trying to get a business off the ground.
Knowing your personal credit score is helpful. Check to see if there are any mistakes on your record. If you have paid off all back taxes, be sure that the blemish no longer is reported as current.
If your credit score is 700 or above, the likelihood of securing capital from a bank is good. With scores of 650 to 700, an SBA loan is potentially in reach. Anyone with a score of less than 650 will have to explore non-traditional funding options. The company will have to make a strong case that it is on an upward trajectory. The bright future would have to outweigh past setbacks.
Here are three things that non-bank lenders will examine:
1. Annual Revenue
Yearly sales will play a big role in funder's decision-making. If revenues are rising, lenders will be more willing to take a chance. They want to be sure that the borrower will be able to repay the loan. Naturally, lenders look for profitability. It's not just what you earn, it's what you keep.
2. Current Debt
Lenders will ask who else the business owes money to. A company already paying off a business loan may have trouble securing another one. New lenders don't want to be in "second position" for repayment.
3. Cash Flow
Lenders want to determine how well a company's money is managed and how much cash is on hand. This information will help lenders determine whether the borrower is able to repay debts. Most lenders will ask for at least three months of bank statements that show recent cash flow.
Loans available to business owners with bad credit.
Merchant cash advances are common for businesses with bad credit. These lenders will front companies a sum of money that will be paid back - with interest - from daily credit card receipts. Since the lenders take a percentage of a day's sales, the business owner pays less when sales are slow and more when business is brisk.
Cash advance financing provides money quickly when a business owner needs to complete a deal, pay an unexpected bill, or simply needs working capital. Payment schedules are tied to the success of the company, rather than the calendar.
Advances can be as small as $5,000 and as large as $200,000. Approvals are often made within a day or two. Cash advance companies base decisions on current operations and upcoming sales projections. Typically, they prefer businesses in operation for at least one year with monthly credit card sales north of $10,000. The typical payback period is six to 12 months.
Because merchant cash advance companies have a high cost of capital, the danger is that a company that borrows from them will continuously pay 20 percent interest or more. That is not sustainable over the long haul.
So how can a company with bad credit eventually get lower cost funding?
• Pay debts on time
• Maintain a higher average daily bank balance
• Become profitable (if that's not the case currently)
• Continuously check your credit score to determine if it is improving
Eventually, if a company is successful, the owner can apply for a lower cost loan.