My name is Meredith Wood, and I am the V.P. of content education and editor in chief at Fundera. Fundera is a three-year-old technology company. We’re looking to replace traditional loan brokers with an online system. So instead of going door to door to try to find the right lender for their business, business owners can now come to Fundera to complete one application. You’re able to apply to dozens of lenders with that one application so you can find the best lender for whatever it is you’re looking for.
We know that the lending process can be very overwhelming for business owners. You didn’t start a business because you’re a financial specialist—unless you are, in fact, an accountant or a financial specialist. Most likely you started a business because you like to bake a cake or build homes or things of this sort. We’re there to be a partner and really educate you throughout the process, so you understand all the financial terms headed your way and are very much empowered to make the right decision.
How Business Loans Differ from Consumer Loans
You might have financing experience from a different perspective, if you’ve gotten a student loan, a home loan, or a car loan, for example. Business lending, however, is a lot more overwhelming than consumer lending. That’s because with consumer lending you traditionally have one type of product, such as a mortgage. You know exactly how a mortgage works—what the terms are like, what you’ll pay back, and so on, but when it comes to business lending, there are up to a dozen different types of products and the way they differ can be the way the terms are laid out, the frequency with which pay back the loan, or how the loan is priced. When you start a search for a business loan, understand that it’s not going to be just comparing interest rates, which you might do with a mortgage. In fact, it’s going to be understanding how these loans are different so that you don’t accidentally get into a loan not understanding what that means for your business in terms of payment frequency or price.
Traditional Bank Loans
The first things you think of when you think of a business loan are a bank loan, a bank term loan, or a bank line of credit. This is where you go down to your larger bank such as Bank of America or Chase, or a smaller community bank and you get your traditional term loan.
This loan usually extends for many years and you pay it back with monthly payments, usually at a single-digit interest rate, or perhaps you have a line of credit. Sometimes they might collateralize it based on the assets you have with the bank, or not. You know that at any given time you can pull on, let’s say, up to $25,000 of a line of credit. It works very similarly to how a credit card works. You only pay for what you use. There’s a cushion if you need it.
The issue is that banks are not lending to small businesses like they used to. In fact, banks deny about 80 percent of small business loan applications. This has allowed the online lending, non-bank industry to pop up, and that’s where it can get overwhelming.
The first and foremost is the SBA loan. This is something you can apply for at your bank, but you can also apply online and they recommend doing that because the process is easier, faster and allows you to compare a couple of options.
An SBA loan is very traditional in how it works. It is a term loan, you have monthly payments over a very long-term period, and the interest rate is affordable—it’s in the single-digit range. SBA has a few different programs that are a little more complicated and I won’t get into them because the most popular is the 7A, which is the lowest cost loan you can find online.
A lot of people get confused about what an SBA loan is and the SBA giving them money. With the 7A program they’re not; they’re simply guaranteeing a portion of the loan for these lenders, which encourages them to essentially give more money out to small businesses. It’s a fantastic program. It will, however, take some time to apply. So if you’re in need of fast cash, it’s not the best solution.
Online Long-Term Loans
If you have a little bit of a timetable and need to get money fast, but you know you’re a good borrower and qualify for good terms, then your next best option is what we call an online long-term loan. These are offered by lenders like Bond Street or Funding Circle or Lending Club. These are term loans a couple of years in length. They can have single-digit interest rates—sometimes they will be in the teens—and they’re able to do larger sums. They can move pretty fast on an application. We’ve seen people do it in under a week, or it could be a couple of weeks. but if time is of the essence and you are willing to pay a little more to get it fast, then an online long-term loan is a great option.
Lines of Credit
Now is where we go into a different credit tier. Maybe you still are working on building your personal credit score. This is where the products start to get a little more diverse. The nice thing about online lending is that these lenders are able to serve a wider credit tier, but the thing to note is that if you have less than stellar credit, you’re not profitable, or you’re just starting to generate revenue, you’re going to have trouble finding an affordable option.
The option here is lines of credit. These are offered from places such as BlueVine or Cabbage. They’re very quick and they can close within a day. One downside, though, is that the pricing structure can be a little bit confusing and that’s something that we really like to work on with people so they understand what happens every time they draw and how much they’re paying. Then they can compare that alongside a traditional term loan option, but this is a great product if you’re looking for an easy experience and a fast experience.
Another product you’ll hear a lot about is called a short-term loan. These are loans that are about 3 months to 18 months in length and they have usually daily or weekly payments. They are priced with something most often called a factor rate, which again is important to know because you may look at the factor rate and think you can just compare it alongside interest.If you’re ever priced something with a factor rate, we ask that you convert it to APR so you can compare it alongside a loan that might have a traditional interest or APR attached to it. Then you can really understand how much it is.
These loans can get very, very pricey and it has to do with the fact you are paying interest on the full principal. With those shorter terms it can help make the APR look a little more expensive. The cost of capital can sometimes be cheaper than a longer term on online loan, so always look at the total cost of capital and ask yourself, “Do I want to pay less in total for my financing over time, or do I want lower payments?” That’s something to look into.
With short-term loans, look at what the prepayment option is. If you decide you’re going to pay SBA loan, an online long-term loan, or a bank loan, early, it’s not a problem. Your interest will be forgiven and you will save money by paying off early. However, if you decide to pay some of the short-term loan products off early, you might have to pay the full interest or a portion of the interest remaining. If that’s something you think you might do, look into that as you’re comparing options. Make sure you wind up with a lender that will forgive the interest or a portion of the interest.
Merchant Cash Advance
One product you’ll see a lot of is something called a merchant cash advance. These are by far the most expensive product on the market. They are also the easiest to qualify for and they have the lowest credit requirements. This is when a financing company advances you a certain amount of money and you pay it back with a percent of your daily credit card receipts. It’s nice because payments will fluctuate based on your own cash flow: when it’s good, you pay back more; when it’s not as good, you pay back less.
The issue is that it also eats into your cash flow and it can be one of the most expensive products on the market. You want to be really careful with this. If this is all you’re qualifying for, you want to make sure that it doesn’t break your business, that in fact it is a loan you can afford.
Now we get into specialty financing. There are some lenders that will use equipment to collateralize your loans, so that’s equipment financing. If you’re looking specifically to purchase a piece of equipment, that is what you would use as collateral on the loan and the loan can be up to the full amount of the equipment. You’ve got invoice financing, where the invoices serve as collateral for the loan, which is a product a lot of people know quite well, especially if you operate on terms with a lot of different people.
There’s a new version of invoice financing, which is incredibly automated and incredibly easy to use, and that’s with companies like Fundbox and BlueVine. You can go right in, hook it up to your QuickBooks and select which invoices you’d like to finance. I’m a huge fan of those products if you’re considering invoice financing, and then there are some specialty people that do purchase order financing or inventory financing, where those specific things are used to collateralize the product. You have to take a holistic look at your business and say, “Okay, I know I have these assets. I want to look at this type of lender and compare them alongside say an online term loan or bank loan.”
Business Credit Cards
The last thing I always want to bring up is an option that people often forget: you can use a business credit card for financing, especially because a lot of business credit cards have a zero percent introductory APR period. I’ve seen one product go up to 15 months right now. So that’s a 15-month period where you have no interest. Of course, you don’t know what kind of credit line you’ll get with them and you have to be prepared to pay it back. But always consider that as a potential option as well.
Red Flags for Bad Offers
Guarantees and no credit checks. The first red flag is anybody that says they can guarantee you financing or anybody that says that it’s a no credit check financing. Generally, if it’s no credit check it’s either going to be not real or insanely expensive. As I think through all those options that I just talked through I can only think of one that doesn’t look at credit. You want your credit to be checked because it means that they are doing a good analysis of you as a borrower to see what kind of risk they are taking on. So be wary of that and be wary of any guarantee. They may ask you a couple of questions and based on your answers, it may sound like they can fund you, but good lenders are going to look at you. They want to see if there are bankruptcies in the past. Are there liens and other things that they need to look at on the credit report? You want lenders to look at those things because it means they’re doing their risk analysis and their contribution to it all. So be careful of that language.
Brokers. Another thing that so many people are unaware of is brokers. Everybody knows what a broker does. A lot of people are confused when they’re called by somebody and they think they’re talking to a lender but they’re actually talking to a broker. Always ask, “Are you funding me the money, or are you in fact facilitating a relationship with the lender?” There are a lot of great brokers out there, but there are also a lot of bad news brokers. The reason I say that is because when you’re working with a broker, the way that they usually make money is by adding points to whatever your loan is. So when you get an offer back from them, you don’t realize that six or more points could be the fee that you’re paying to them.
So please ask them to disclose how they make money and know that a lot of them will charge quite a large percentage, and they may not even disclose this to you. Be very careful when you’re working with brokers. Ask for references and things of that sort. Like I said, there are a lot of awesome ones out there that will really save you time and help bring transparency into the process. But if you’re not careful you might end up paying quite a bit more for a service you didn’t realize you were getting.
Uninitiated phone calls. You may have gotten financing before, and if the lender puts a blanket lien on your business, which most lenders will, you all of a sudden are added to this UCC lien, which lenders and brokers use to call and get new business. So you will find, when you take out a loan, all of a sudden you could get multiple phone calls a day with people trying to offer you money et cetera. Be careful. Don’t just say, “Oh, that sounds nice. You know what? I need money tomorrow.” So you say yes to the first person that calls. Don’t. Go online and do your research if you need money fast. There are reputable lenders that can do it. You want to be very careful because there are going to be people that try to explain pricing in a way that’s confusing and makes it sound like it’s a lot less expensive than it. There are going to be people that, again, are charging you unknowingly for using their service. Most importantly, always make sure you’re getting the right product for your business even if you’re in a pinch.
What to Do If You Have a Bad Credit Score
If you have a bad credit score, you should work on making your credit score better. Many people are unaware of how important the personal credit score is in the business loan process. It’s only when you’re working with much larger loans and you’ve been around for a while that your business credit score will really come into play. It’s very important to build that and pay attention to the number. When you’re first entering into the business financing world, your personal credit will matter. As I said, there are a couple of lenders where credit isn’t checked, but other things will matter too. So let’s say you’re using an invoice financing lender. They’re going to be looking at the health of your business, the health of your cash flow, and the health of the customers whose invoices you would be financing. And so that would be one situation.
Now specific to the credit score, we usually say 500 or 550 is where you will really start to see financing options. But let’s say you had a bankruptcy or a tax lien, for example. Those are two of the more popular. Bankruptcies after seven years won’t be on your report. We have a lot of lenders that have different benchmarks, so it could be two, or three, or five years past discharge. They will consider an application once you’ve reached a specific year past discharge. So if you’ve had a bankruptcy, this is hard information to find on the lender’s site.
On Fundera we have a lender review site. You can Google reviews from different lenders and we get really specific with the ineligibility requirements with things like bankruptcy, tax lien, states you’re in, working with home-based businesses, and those sorts of questions. As much as this is about educating you, this is also the value of a service like Fundera. We’re able to look at all that information across all of our different lenders and say, if you discharged out of a bankruptcy five years ago, we will know which lenders will actually look at your application.
Similarly with a tax lien. Some can’t touch it if you have a tax lien but some can if you have a payment plan going with the government. It’s kind of like you choose your own adventure novel, is what I always say to borrowers. There’s not a cookie cutter solution for anybody. There are a lot of these very variable, minute details that can send you down a different path. So again, knowing your situation very well, doing as much research as you can, and taking a shopping approach will help. Don’t get discouraged if the first answer is no. Perhaps you didn’t know it, but you may have applied with one of the strictest lenders in the industry. Don’t be discouraged.
Typical Eligibility Requirements
Personal credit score. If you are a startup and you have no revenue, you have no cash flow, and you have no years in business, the most important thing is going to be your personal credit score. And really 700+ is where you’re going to want to be. There are some potential options in the 640+ areas. Those will be personal loans that can be used for business purposes. Also you can look at a business credit card and go for something that has that zero percent introductory period.
Bank balance. For more established businesses, some really good benchmarks to hit to start seeing some options—albeit they may not be incredibly cheap options—would be two years in business, $65,000 in annual revenue, a personal credit score of 550+, and an average bank balance. The average bank balance is going to be more dependent on the loan size you’re looking for. When you’re in that period you’re still not generating a lot of revenue or maybe your credit’s okay, where the average bank balance is going to come into play is with these short-term lenders. They will look at your bank statements, so be very careful that you take care of things; you don’t want to have a lot of overdraft fees and you want to show that you are maintaining a good sum there, because the way they see it as they will daily ACH right out of that bank account. They want to know that there’s enough money in there, and that historically there has been enough money in there, to take care of those payments. So this is for the short-term phase.
Tax returns and P&Ls. As you start looking at less expensive, larger, longer term loans, they’ll start to pull in other things, like your P&Ls, your tax returns—both business and personal—and your balance sheet. This is where things like whether or not you’re profitable on your tax returns matters, and a lot of businesses are profitable but don’t show it on their tax returns. So that’s something you need to talk to your accountant about. If you know in the next year you want to go for financing, discuss how you want to go about that on your tax returns. This is why I think it’s so important to invest in an accountant early on, because they will help make sure that your books are always awesome and your P&Ls and balance sheets are accurate. This makes it easier come tax time especially.
So that’s what I like to call the bare minimum. But the way you have to think about those four factors is the better along you are in one of those categories, it definitely helps self-adjust. So the better your credit score, the less the other things might matter. The longer you’ve been in business, the less the other things might matter. The more revenue you’re producing, the less the other things might matter. Or if you have incredible cash flow, the less the other things might matter. Something we see—not necessarily a lot—is young businesses that are doing extraordinarily well and lenders aren’t quite sure how to underwrite for them.
Take, for example, an e-commerce business. They could be young, a couple of years in business, they’re doing a ton in revenue, but maybe their cash flow is still shaky because they’re figuring out their sales cycle, such as when they need to purchase new inventory and how fast it’s moving off the shelves. Those are businesses where having a partner like Fundera is great because financing will help get you through those initial years when you are moving your inventory so fast and you’re learning to keep up with demand and what that looks like.
Business owners need to understand that you can graduate into better loan products over time. Just because the first time you went and got a loan you were in a short-term product doesn’t mean that that’s all you’re ever going to be able to get. In fact, if you’re building your business and you’re starting to go up on those four metrics, over time you can potentially refinance that debt into a longer term loan. Also, when you’re building your credit, revenue, or cash flow over time, you’ll be able to scale up to a point where you could be eligible for an SBA.
Where to Start
Your local bank. I always say the best place to start if you have time is your local bank. If you can get a bank loan or a bank line of credit, you should absolutely get it. It’s going to be the cheapest cost of capital out there. But brace yourself that it could be a very long process, so even if you think you have time, be realistic about the amount of time. If you have two months, that still may not be enough time for a bank. I’ve had people tell me they’ve gone through six-month processes. But that’s where I always want people to start.
Online. If you have been denied by your bank, or you just know it’s not the right option for you, the next place is to go online. You will find, though, that when you Google “small business loans” or “business loans,” every lender is going to tell you they offer the same thing when in fact they don’t.
Fundera. Obviously, I’m a little bit biased here, but I think that starting with a service like Fundera is a great move because you know automatically you’re going to have access to the entire lending landscape by going to one site. It’s a service that is not any additional cost to you, so you’re able to get that clarity about what’s available to you immediately. It’s less work. There’s one application and one set of financial statements, or whatever is needed for the various applications. So there’s not only ease of the process and time savings, but also you now have a partner in the process.
When all of these offers are coming back, we can explain why you may not be eligible somewhere and see what’s holding you back. Is it your credit? Is it your time in business? Is it the fact that your partner has a bad credit score? We really provide transparency and clarity into the situation. We can explain the true cost of this, what it means, what you’re using it for, and then what’s most likely the best thing for you. It’s all about looking at it holistically and helping identify what’s going to work best long term for you. And then the benefit is, once you’ve found a loan through Fundera, the relationship continues. If there’s refinancing potential, we’ll help explore that with you.
We have a lot of people that come to us and they need money quickly, but they are very much SBA eligible. So we’ll help them go through a loan application with, say, one of our online long-term loan lenders and they can get funding very quickly, and then we will continue the SBA application with them and help them refinance out of that product. This saves them money and it also helps solve that quick need.
Similarly, say we know there’s something keeping you back from qualifying for something that’s lower cost. We have account managers that are here to help you with that, whether it’s building your credit up or understanding that it’s the way that you’ve been preparing your tax return. So you really feel empowered about the situation. You always have somebody to call.
Self-analysis. If Fundera is not right for you, then the first thing you need to do is a self-analysis. What is your revenue? What do your tax returns show? How are your bank statements? How is your credit? You can get a free credit score through Fundera, through annualcreditreport.com, or through Credit Karma. Check it and know your credit score. Obviously, you know how long you’ve been in business. Look at your ownership structure. Are you the only person or is there someone else who needs to look up their credit as well? It’s better to have all owners on board, prepared and ready to go. It will save you time throughout the process.
Research. Once you have those metrics in place, start researching lenders. I would say to start at the top of the funnel and work your way down. Start with SBA and see what their eligibility requirements are. Do you think you have a chance there? You can use our website to look up lenders. Next, go to that medium-term category. Look at their eligibility requirements. Do you think you fit there? Then go to things like short-term line of credit and short-term lenders. Do you think you fit there? Then you can look at the specialty lenders, and then you can look at the merchant cash advance.
So you’re doing a self-analysis throughout the process and you’ll start to get an idea of where you think you should focus. Then you can reach out and talk to each of those lenders to look at the reviews and see who you like working with. But the more research you can do throughout this process, the better. You will feel so much more empowered and in control in a lot of ways. If ever you see anything in the application or on an offer you don’t understand or you think you understand but you’re not sure, Google it. For instance, if you see something like a factor rate, really understand what that means in terms of pricing before you sign anything.
About Meredith Wood
Meredith Wood is the head of content and editor-in-chief at Fundera, an online marketplace for small business loans. Prior to Fundera, Meredith was the CCO at Funding Gates. Meredith manages financing columns on Inc, Entrepreneur, HuffPo and more, and her advice can be seen on Yahoo!, Daily Worth, Fox Business, Amex OPEN, Intuit, the SBA and many more.