Following the COVID crisis many small businesses may find themselves facing problems with cash flow, or in need of funding to expand or diversify. Many of these businesses will look to secure funding from their governments or from the banks, but for obvious reasons many will be turned down. Their other option is private lenders, especially the short term small business loan companies.
So, what’s the lowdown on these short term business loans?
What are short term (unsecured) small business loans?
There are so many situations where a small business finds itself in need of funding or capital to fix a short-term problem or contingency, or to rush through an expansion project. In these scenarios a short term loan is the best option because these loans can usually be processed quickly, with a minimum of paperwork.
Traditional lending banks typically operate slowly when processing loan applications, so they aren’t the best places to run to when a small business needs a short term loan.
Following the financial crisis of 2007, getting a small business loan from the banks wasn’t even possible depending where you lived, because certain banks stopped lending altogether, and the ones who were still in the loan business were looking for reasons not to lend, instead of reasons to lend!
This caused the evolution of (private) small business lenders. Most of these operate online, which makes them even more accessible. They are more accessible, yes, but therein lies another problem – how do you choose the right companies to work with?
In the spirit of full disclosure, these short term business lenders are not for everyone, although many small business owners will use one at some point in their career.
And this is because they make is easier for business owners to get quick loans, processing times are much shorter, they require fewer documents, they are more tolerant of bad credit (they value cash flow over credit score), they require no collateral, and unlike banks, they will look at every angle to get the loan approved instead of looking for every reason not to approve.
What are the different types of short term small business loans?
There are basically two types of small business short-term loans – the regular short term business loan and the merchant cash advance.
The loans share the same concept and the same pricing structure, same loan rates, and the only difference is in the payback scheme.
With the merchant cash advance the business pays back the loan with micropayments that are deducted from their credit card processing revenue. This kind of short term loan is ideal for businesses with high credit card point-of-sale cash flow, such as restaurants or retailers.
Who needs a short term small business loan?
Short term business loans are great for businesses looking to fix small problems caused by unforeseen shortfalls in revenues, or pay for unplanned expenses or to respond to emergencies. For example,
- A business can take a loan to pay taxes
- Or to make payroll
- To finance new equipment purchases
- To fund a renovation or an expansion
- To buy or acquire another business
Other reasons include simply to increase working capital, or in the case of seasonal businesses to bridge a gap of time. Some other times a business needs to pay for large orders so that it can benefit from a large discount, or to fund a marketing campaign or a hiring campaign, or simply to settle another debt.
All sorts of other emergencies can strike, requiring a small business to seek short term funding, for example if a storm damaged some of their equipment, or if a key employee leaves and they have to hire another.
What are some advantages of short term small business loans?
One of the biggest advantages is of course that they are quick loans. So, a business can get liquidity in a matter of days or a week, instead of months as is usually the case with traditional bank loans.
The other pros include:
- Fast processing times
- Very few documents required
- Less stringent credit score requirements to qualify
What are some disadvantages?
One of the biggest drawbacks is the loan rates, which are higher than for bank or government business loans. You have to remember that these are high risk loans, because the lender isn’t asking for collateral, plus, they’re lending to people/businesses with bad credit scores sometimes.
The other disadvantage is that because of the high risk, most of these lenders cannot help you fund longer projects. So, if you’re looking to buy commercial real estate for example, then these loans are not for you, since it could take you years to pay back the loan.
What are the loan rates for these loans?
Short term business lenders use something called “factor rate” instead of interest rate when calculating your payback. This is a figure typically between 1.2 and 1.5.
This is the multiplier you multiply the borrowed amount with to get the full amount you have to pay back.
So, for example, if you’re borrowing $40,000 at a factor rate of 1.3, to find the total cost of the loan multiply 1.3 by 40,000. This gives us $52,000.
This is of course a lot higher than a bank would charge you over the same period, but it’s a lot lower than the rate on a house mortgage, where the “factor rate” can go as high as 3.3 or 3.4 – just that you pay back over a much longer period (say 30 years).
What are the maximum and minimum loan amounts?
Short term lenders will typically approve a business to the tune of close to the amount of its monthly sales volume. So, if your monthly sales volume is $20,000, you will be eligible for a loan amount of $20,000, although this depends on the loan company. Some will give you more, others less.
Generally speaking, they give out small business loans between $10,000 and $500,000, although some loan companies can lend up to $1,000,000. These figures are based on pre-COVID records.
Who can qualify for these loans?
To qualify for these small business short term loans, here’s what you need to have:
- To have been at least 4 months in business
- Business must make at least $10,000 in monthly cash flow from sales
- A minimum credit score of 500
- Must be making a minimum 3 deposits per month into a business bank account
- Minimal NSF’s
I have bad credit, what credit scores are required to qualify?
A credit score of 500 and higher is required. By contrast, banks typically require a minimum credit score of 680. Again, these are pre-COVID records.
What documents are needed by the short term small business lenders?
Here’s what these small business short term lending companies typically need to process a loan:
- Generally, a one page E-App or paper application
- 3 months of business account bank statements
- The most recent year’s filed business taxes
- Copy of driver’s license
- A voided check
Compared to what a bank would ask for, this is a huge relief!
How fast can you get the loan money?
Assuming there are no serious issues with the documents you deliver to the lenders, these loans can usually be processed within a few days, normally within the week.
How do you pay back the loan?
Because of the high risk involved (for the lender) compared to collateralized funding, these loans tend to have short payback terms, and the higher the risk involved, the shorter will be the payback period.
Payback period is usually between three months to 2 years for amounts in the range $10,000 to $500,000.
Here’s how the payment structure usually works to make the most sense for both lender and borrower. The lenders usually prefer to receive so-called micropayments on a daily basis, in an arrangement that is favorable to both parties.
The micropayments will usually be spread out over the term of the loan to be collected, and they’re deducted from the business’s daily revenue.
What this means is that as the business owner, you will see daily automatic withdraws from your business bank account. For the short term business lender, this is a quick fix because they begin collecting immediately after the loan hits the business owner’s bank account.
In the case of a merchant cash advance, the business pays back the loan with micropayments that are deducted from their credit card processing revenue. This means that the micropayments are practically made in real time as the point of sales payments are being processed.
For the business, this is advantageous because instead of a hefty monthly deduction from their bank account, now they have to endure small micropayments deducted from credit card transactions.
For the lender this is advantageous too, because in essence, the business’ credit card revenue sort of becomes the collateral.
Where do you find the short term small business lenders/brokers?
The small business short term loan companies we are talking about are not banks. This means they do not operate like banks, and you’ll typically not find them in offices on Main Street!
But, although they typically do not operate in imposing offices, they’re all over the place. In a lot of cases, they do not even have an office in the conventional sense of the word. Many are web based, with virtual offices, and they have agents working remotely. Some may still use call centers.
To find the online loan companies, simply type “business loans” or “no-collateral business capital” without the quotes. You may add your state, for example “business loans Florida”.
Here are two companies that I have heard some good things about, but remember to do your due diligence: GoKapital (GoKapital.com) and David Allen Capital (DavidAllenCapital.com)
Short term small business loans cost a lot more than traditional bank loans but because they are easier and quicker to get, they are a good option when the bank loans aren’t an option, for example if you’ve been turned down, or your need couldn’t wait for the 2-6 months it would typically take the banks to give you the money, etc.
Do a cost/benefit analysis for your particular case and if the benefits of taking the loan outweigh the higher cost, then taking a short term business loan will make a lot of sense.
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This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.