Before I started Fundastic to help small business owners navigate the myriad of funding options, I worked in tech companies like Yahoo! and Facebook for over a decade. Some of my former co-workers later started their own tech companies and I got to know a lot of tech entrepreneurs throughout the years. One common challenge faced by startup founders is fundraising. They have to jump through a lot of loops to get angel capital, seed capital, venture capital etc. to create a sustainable high-growth business. I thought that was hard. When I first started Fundastic, I thought small business fundraising should be a lot easier as it's primarily loans. What I didn't realize is that it's really not much easier for main street businesses. It's not uncommon that a cash flow positive business with good growth fails to secure loans with an affordable interest rate. Here are 3 very surprising facts about small business loans:
1. Bank loans are extremely hard to obtain. Bank loans or SBA loans offered through banks have affordable terms: typically 6-8% interest rate amortized over 10 years. However, the bar for these bank loans is extremely high. A typical bank loan borrower has to be 2 years in business, have at least $250,000 of annual revenue, have good personal and business credit, and be cash flow positive. Even if your business meets all the criteria, you might still get turned down by a bank because you don't have sufficient collateral. I spoke to an advisor who works for SBA, who told me quite a few small business owners were turned down by banks because they didn't own a home, hence no strong collateral to back the loan up, despite the profitability of their business. Banks like to lend to strong businesses which have sufficient assets. Or in other words, banks like to lend to strong businesses who don't really *need* their money but can utilize the extra capital to fuel growth. Practically, only a small percentage of businesses would qualify for a bank loan.
2. Alternative business loans are extremely expensive. I was talking to a friend the other day about Square Capital, which I think is a pretty good deal for Square merchants with 24% APR. My friend, a software engineer from a well known Silicon Valley internet company, couldn't understand why a 24% APR loan is a good deal. Well, welcome to the world of alternative business loans. Up until about a year ago, 24% APR for alternative business loans were considered dirt cheap because most of the merchant cash advance and daily debit loan providers are charging 50+% APR even if you have a profitable business. A merchant cash advance with 4 month repayment and 100% APR is typical. The landscape is quickly changing with all the new online term loan lenders like FundingCircle, LendingClub, Dealstruck and Fundation. But a *good* alternative loan APR today is still around 15-25% with 1-4 year repayment terms. It's hard to get the interest rate down further as the default rate for business loans is high and alternative loans are not subsidized/guaranteed like SBA loans. After all, 80% of businesses failed within 5 years.
3. It's almost impossible for startups to get loans. If you are a tech startup with a working prototype, you might be able to convince an angel investor or an accelerator to give you money to further develop your business. If you are a main street small business, it's basically impossible to get a loan pre-revenue. In fact, you have to be at least 6 months in business with $100K annual revenue to convince a loan shark to give you a 100% APR loan that is expected to be paid back within 6 months. In other words, nobody lends to startups. If you are just starting out, you have to use your savings, borrow from friends and family or use credit cards to fund your business. In recent years, you can also use crowdfunding sites like Kickstarter, Indiegogo or Kiva Zip to get your company off ground. But it takes a lot of hard work and creativity to create a successful crowdfunding campaign. Starting up a business is hard. I have tons of respect for business owners who create a profitable business from scratch, provide for their family and create jobs. We are only talking about funding in this article. But if you consider the obstacles they have to overcome, it's pretty amazing that they make it work.