The global economic downturn that began in the second half of 2007 impacted millions, if not billions, worldwide. As jobs were lost, mortgages were abandoned and companies floundered, access to financing became increasingly difficult. Consumer access to credit was one of the first targets as spending limits, loan amounts and mortgage sizes were all scrutinized. Farther down the spectrum were the businesses that themselves needed access to funding to help grow and expand.
As banks looked to protect their returns, they tightened their criteria in lending money to businesses that previously would have been prime applicants. As a result, approval percentages plummeted for applicants. While statistics on the overall approval percentages by banks vary (and aren’t published openly), a number of organizations have pointed to approval numbers below 15%. Cheryl Carner of Crystal Financial, a middle-market lender, suggests, "It will be more challenging for banks to do the transactions that they have historically done, so private equity firms and other middle market companies are going to have to continue to explore alternative lenders, whether that be credit opportunity funds, business development companies, or other entities that are non-regulated, as those lenders will have more flexibility to provide the capital solutions they're looking for." For business owners looking for funding from traditional sources, the climate became clearly inhospitable. From this vacuum came alternative funding sources for small business loans.
Understanding Alternative Lending
Key Area #1: Cashflow and Time in Business
This is perhaps the most important factor to understand about the alternative lending space. The lenders that operate in the small business arena want to know that a business is solid, strong and stable before giving them financing. For the most part, lenders use a combination of length of time in business, average sales volume, personal credit score and outstanding debt when making a decision. If a merchant cannot prove that they have been in business at least 6 months and are making at least $10,000 a month, then most lenders won’t lend to them. This isn’t just a byproduct of the lenders’ needs. It also reflects the needs of the merchants because repaying the loans could be tough if you haven’t proven sustainability (especially if you are a seasonal business).
Key Area #2: Types of Loan Product Offered.
Not all loans are equal. Much like how the loans in the housing market are all different (ex: 10-year FHA vs a 30-year traditional), these loans differ dramatically. The most popular form of financing in alternative lending right now is the merchant cash advance. This is where the lender will debit a small, pre-agreed upon amount from a merchant’s bank account consistently for the term of the loan. Lenders want to make sure a merchant can continue to grow their business while not requiring a large lump sum to repay. Again, this is really a two-way street. If the lender wants to take 10% of your daily receipts and you can’t afford it—don’t take the loan! Additionally, there are different types of loans in alternative lending (including asset-based loans and even credit lines) so don’t take something you don’t want. Obviously consult with a loan officer to understand all of your options.
Key Area #3: The Right Industry for The Right Loan.
We all know a restaurant and a rug store are different, but when you think about the mechanics of the two businesses, it is clear how truly different they are. Restaurants sell thousands of products a day and the register is busy—a high volume transaction business. A rug store hopes to move 7-10 nice rugs a week. The reality is there are industries that tend to thrive in this space because of their high cash flow and credit card processing capabilities. Make sure the deal is right for you. For example, Joe’s Pizza is running a strong business but Joe needs to buy a new pizza oven fast—his business can’t survive without it and his 20-year-old Blodgett double oven that he bought for $10,000 is fading. In order to get the funding he needs fast, he gets matched with a lender who is willing to give him $15,000 with repayments of $140 over 125 days. So basically for 7 months, Joe pays $140 bucks out of his credit card receipts and ends up paying a total of $17,500 total. This works out to about an 18% interest rate if all payments are made as scheduled (this is not an annualized rate)*. All this works for Joe because while he doesn’t have $15,000 on-hand, he can certainly afford $140 a day with his new oven cranking out pepperoni pies. The same may not be the case for the rug store owner. Be smart!
Loans aren’t for everyone. With more and more companies advertising alternative funding for merchants, it is important to know the limitations of the loan products available and more importantly, the limitations of your business.
Silver Rock Funding
Silver Rock Funding is a BBB-accredited business loan marketplace that connects merchants with the funding they need. Silver Rock Funding is based in Alexandria, Virginia.