One of the main reasons applying for a small business loan is seen as such a confusing, stressful process is the fact that every business lender is different. It’s not uncommon for a borrower to have to speak with multiple business lenders before being approved. After figuring out which type of small business loan makes sense for your specific needs (which is tedious enough), you have to find a business lender that offers your desired product for requirements you are able to meet.
Thus, it’s crucial to understand how to tell different business lenders apart based on the advantages and disadvantages they present.
In this guide, we’ll answer the following questions:
- What are the Different Types of Business Lenders?
- Which Business Lenders Have the Lowest Interest Rates?
- How Do You Qualify for Loans from Banks and Credit Unions?
- What are the Requirements for Peer-to-Peer Lenders?
- What are the Requirements for Online or Alternative Lenders?
- How are Traditional and Non-Traditional Lenders Different?
- How Do You Choose the Right Business Lender?
- What are the Signs of a Malicious Business Lender?
What are the Different Types of Business Lenders?
When someone mentions a “traditional” business lender, they are usually talking about banks and credit unions. Many credit unions can offer very similar products as banks, like business term loans and business lines of credit. However, only banks can offer SBA Loans. Banks can also distribute much higher amounts than credit unions. For example, while the average credit union can probably offer up to $250,000, banks can offer up to $10 million.
Funding Circle, Lending Club and StreetShares are known as peer-to-peer lenders, but these companies aren’t technically lenders themselves. The money doesn’t directly come from them. Instead, they act as a middleman between the borrower and individual investor or an institutional investor, like a hedge fund or investment bank. Peer-to-peer lenders offer business term loans, business lines of credit, and invoice/accounts receivable factoring. The maximum borrowing amount for most peer-to-peer lenders is $500,000.
Online lenders are sometimes called “alternative” lenders. Some of the most reputable online lenders include Kabbage, OnDeck, BlueVine, and Currency Capital. Between these options, you can get a business term loan, business line of credit, and invoice/accounts receivable factoring. Other online lenders, however, can offer additional products like merchant cash advance, equipment financing, working capital loans, revenue-based business loans, and even SBA Loans. While some online lenders can offer up to $250,000, others can offer up to $5 million or even $10 million.
Which Business Lenders Have the Lowest Interest Rates?
Banks and credit unions carry the lowest interest rates in the business lending industry. You can expect an interest rate of 4% to 10% on most bank loans. Interest rates for credit union products tend to range slightly higher or lower than banks, but generally within the same ballpark. These competitive rates stem from the fact that banks and credit unions prefer to loan higher amounts with longer terms, i.e. at least two years.
Interest rates for peer-to-peer lenders and online lenders have a much wider range. This is primarily because both of these options have significantly looser requirements than banks and credit unions. We’ll specify those requirements in just a bit. The terms for products from peer-to-peer lenders and online lenders can vary tremendously as well. Depending on the lender, you could get a ten-year business term loan or a three-month working capital loan.
Due to these factors, interest rates from peer-to-peer lenders and online lenders can range from 7% all the way up to 99%. Generally speaking, peer-to-peer lenders tend to offer lower rates than online lenders, but that also depends on the lender’s requirements.
How Do You Qualify for Loans from Banks and Credit Unions?
In the previous section, we noted that the products with the lowest interest rates and longest terms have the steepest requirements. We’ll start with banks, where the most important requirement is credit score. If your personal credit score is not well into the 700s, most banks won’t even look at the rest of your application. Banks heavily favor businesses that are at least two years old and are generating well over $100,000 in annual revenue.
What makes bank loans so difficult to qualify for is the often overlooked requirement of a massive bank balance. You may have heard that banks only lend to businesses that don’t actually “need” the money. Many bank loan applicants would likely say that this is 100% correct. In other words, your chances of approval are infinitely greater if you have enough money to finance your desired investment on your own. If you don’t think you can satisfy this requirement, you may still be able to get approved by providing collateral. Examples of items that can be offered as collateral include equipment, inventory, real estate, or accounts receivables. But even if you do have plenty of cash saved up, most banks usually require collateral from nearly all applicants.
In order to borrow from a credit union, you must live, work, worship, or attend school in a specified area, or be a member of a group such as a school, labor union, or homeowners’ association. As for general requirements, they aren’t much different than a bank, though many credit unions do not require collateral. Applicants for small to mid-sized loans may also be able to fall slightly short on some requirements, mainly because credit unions are non-profit.
What are the Requirements for Peer-to-Peer Lenders?
General requirements for most peer-to-peer lending products include at least one year in business, minimum personal credit score of 600, and annual revenue of at least $50,000. Different lenders may have additional requirements, like no previous bankruptcies.
What are the Requirements for Online or Alternative Business Lenders?
Online lenders have the loosest requirements in the industry, hence the higher interest rates and shorter terms. Some of their products don’t even have a minimum credit score requirement. And you usually don’t need collateral. For most products, applicants must have a minimum credit score of 585, at least six months in business, and at least $50,000 in annual revenue.
Unlike the other options, online lenders frequently work with borrowers with rocky cash flow. You might wonder how any lender could approve someone with bad credit, cash flow problems, and just six months in business.
There’s two main reasons. First off, it’s important to remember that banks have stockholders and credit unions have members. Traditional lenders must be conservative with their lending decisions because protecting their stockholders or members is a top priority. For online lenders, their top priority is their borrowers.
Secondly, banks and credit unions are mostly concerned with just a few metrics (i.e. credit score, revenue). Online lenders usually base their decisions on more specific aspects of the applicant’s finances. They dive deeper into the business’s history to gauge its potential for success.
Here’s what online lenders look for in clients with rocky cash flow and/or bad credit:
1. Proper Tracking of Income and Expenses
Virtually all businesses run into cash flow problems at some point. If a business fails, it’s often because the owner was completely unaware that these problems even existed. Maybe the owner didn’t stay up to date with important metrics, like profitability or monthly spend. Maybe they got caught up in vanity metrics, like revenue or number of customers.
If you don’t track your income and expenses, you don’t know if that revenue is translating into actual income for your business. You also don’t know if you’re applying for a business loan at the right time, or if you’re asking for the right amount. Tracking income and expenses is especially crucial for seasonal businesses, or industries that are naturally prone to tumultuous revenue.
For example, let’s say you are pursuing a business loan to cover monthly expenses during a historically slow period. Thus, your desired lender will want to know the precise times in which your slow season has started and ended in recent years.
2. Your Expenses Aren’t Too High
Do you pay for subscription services you don’t even use? Do you provide fancy employee perks you don’t really need? Younger businesses have a habit of accruing unnecessary expenses. For this reason, online lenders favor businesses that review their expenses before applying and make the appropriate cuts. Unnecessary expenses are an obstacle for growth. Business lenders want to see that nearly every investment you put into your business has a clear purpose.
3. Multiple Specific Goals
All successful entrepreneurs had clear visions for their businesses during their early stages. They knew they couldn’t succeed without achieving a certain profit margin, number of customers, number of employees, etc. If you are considering a business loan, your current goal is to earn enough revenue to pay off the debt without impacting cash flow. Business lenders want to see that you know exactly how to make that happen. They might ask questions like “How many sales do you expect to make over the next six months?” Someone with a clear vision would be able to answer that question without even thinking.
Your revenue goals also determine your capacity to make monthly payments. For example, let’s say you have an annual revenue goal of at least six figures. This tells the lender that you intend to earn a little more than $8,000 per month.
4. Pricing for Profit
Pricing for profit is among the greatest challenges of any small business. Your prices must be competitive and reasonable but not too low. If your prices are too low, business lenders may get the impression that you are attracting customers who don’t view your products or services as truly valuable and are therefore less likely to become loyal customers. If dangerously low prices are the only way you are able to draw a profit, business lenders might be hesitant to work with you.
Remember, quality is supposed to be what separates small businesses from their larger competitors. Thus, business lenders who specialize in smaller operations might not be as worried about higher prices as you might think.
How are Traditional and Non-Traditional Lenders Different?
The aforementioned requirements are far from the only differences between traditional and non-traditional lenders, i.e. peer-to-peer and online lenders. Below, we’ll go over additional factors that make the experience of applying for both options very different.
1. Traditional Lenders Do Not Prefer Smaller Loans
Earlier, we noted that banks prefer to distribute large sums, partially because larger loans are more profitable. Even if you offer your desired purchase as collateral (i.e. inventory), these items are usually harder to sell. Banks would rather you risk more expensive items like your house or your car.
In summary, smaller loans from banks are not easy to come by. Non-traditional lenders, on the other hand, regularly distribute smaller amounts. Most of their customers are smaller businesses, so they are used to distributing under $20,000.
2. Traditional Lenders Require Personal Guarantees
Traditional lenders are more likely to make borrowers sign a personal guarantee. This states that in the event of a default, the lender can seize your personal assets to recoup from the loss. Most SBA Loans, for instance, require personal guarantees. Some business owners might not be comfortable risking their personal assets, especially if their business is very young. Some peer-to-peer loans require personal guarantees as well.
3. Traditional Lenders Require Business Plans
Banks and credit unions often require business plans for larger loans. On the surface, the idea of composing a business plan doesn’t sound too intimidating. All you have to do is explain what your business does, how you plan on using the borrowed funds, and what your investment will do for your business over the coming years, right? If only it were so simple. Answering these questions is just one small part of what is actually a 12-15 page proposal. Composing a business plan could very well turn out to be the most tedious aspect of the entire application process.
In addition to those three questions, your business plan must include an executive summary, market analysis, outline of organizational and management structure, marketing strategy, and more. The third item refers to the borrower’s track record as a manager, since banks tend to favor applicants with significant experience. You must also explain the current and projected state of your industry, target demographic, and biggest competitors. As you can see, you have to do a lot more than describe why your cash flow is in good shape.
Most alternative lenders, on the other hand, do not require business plans. You might not even have to disclose how you intend to use the money.
4. Traditional Loans Often Feature Loan Covenants
When you sign a contract for a bank loan, the contract will most likely include what are known as “loan covenants.” These are conditions the borrower must obey, though they usually only take effect if you fall behind on loan payments. When that happens, loan covenants could force you to maintain a minimum amount of available capital until the debt is paid off in full. You might be prohibited from making purchases of a certain amount or signing leases without approval from the bank.
The threat of loan covenants is likely a big reason why many businesses that can qualify for bank loans are too afraid to pursue them. Having to pay back more money would be the least of their problems. Loan covenants are also why anyone thinking of signing a bank loan is strictly urged to have an accountant, lawyer, or financial advisor review the document before making any commitments.
5. Banks Have a Habit of Short Funding Borrowers
Over the past few years, an increasing amount of banks have loosened their requirements and minimized the application process for certain products. You don’t need collateral and the application can be completed very quickly. It could then take as little as 24 hours for funding to be distributed. This gives the impression that banks are finally becoming less risk-averse.
But there’s a catch. While banks might be opening their doors to more applicants, they are apparently resorting to another tactic to mitigate the heightened risk: short funding. Many recent bank loan applicants have reported to have received significantly less funding than they requested.
It appears that short funding is a somewhat “hidden” way for banks to entice more potential applicants. Other business lenders have been known to do the same thing. It seems like they are approving more applicants even though they aren’t approving the application that was originally filed. Odds are, what they are really doing is approving more applications just so they can say that they’ve raised their approval rate.
Accepting less money than your business requires is arguably more dangerous than accepting more money. Every major expense naturally creates several other expenses. This is why all borrowers are encouraged to ask for approximately 50% more money than they actually need.
The bank might also be hoping that this tactic persuades applicants to not accept the money they are offered. Their approval rate goes up, but they take on less risk. It’s a win-win. But not for the borrower.
6. For Banks, “Character” Just Means “Credit Score”
“Character” is one of the Five C’s of Credit. This makes sense because “character” denotes trustworthiness and reliability. Who would loan money to someone who doesn’t possess either quality? But when it comes to bank loans, this term doesn’t mean what you think it means.
Banks claim to be assessing your personal dependability when in reality, they are judging you almost entirely by your credit score. Yes, that’s the real meaning of “character.” It doesn’t matter if your credit issues were someone else’s fault or beyond your control.
This is one of the primary differences between traditional and non-traditional lenders. Many business owners have bad credit. But as online lenders will tell you, that doesn’t necessarily mean they don’t know how to run a business and pay off debt. Hence, credit score is not always an accurate reflection of the business’s cash flow or profitability. If you have bad credit but your business is alive and well, most online lenders will not hesitate to work with you.
7. Online Lenders Can Approve Loans in Under 24 Hours
The massive growth of online lenders has proven just how valuable convenience is to today’s borrowers. Online lenders are usually not the cheapest option but their accessibility and speed are virtually unrivaled. Borrowers can often be approved and funded in under 24 hours. If you’re looking for the lowest rates on the market, you’re probably going to have to compile a lot of paperwork and wait at least a couple of months to get funded.
8. Traditional Lenders Have Just One Repayment System
Another reason banks prioritize capitalization is the fact that they mostly deal in business term loans. They have one main product, so their borrowers must follow the same repayment system. You have to make fixed payments every month, regardless of the state of your cash flow. If you have lots of capital on-hand, unforeseen expenses won’t stop you from making monthly payments.
Many online lenders carry a variety of products. This allows them to assign repayment systems that are better suited for their borrowers’ cash flow cycles. Not every borrower has to make fixed payments every month, nor do these payments have to begin immediately after funding is distributed. With a merchant cash advance and business cash advance, for instance, your payments are based on the amount of sales you perform each month. A slow month means a smaller payment, and vice versa.
How Do You Choose the Right Business Lender?
At this point, you’ve probably figured out whether you’re better off pursuing a traditional or non-traditional lender. But there’s still so many options to choose from! When comparing business lenders with very similar products, here’s how to choose the right option for you needs:
1. Experience With Your Industry
You are much more likely to find terms that make sense for your cash flow situation if you work with a business lender with experience in your industry. Banks, for example, are traditionally biased against industries that are stereotyped as “risky” or “low growth.” They tend to favor “recession-proof” industries with high profit margins. If you work in an industry that is currently doing very well, you probably won’t have to look too far for a willing business lender. But other business lenders may have no problem working with industries that are known for cash flow issues, like retail stores or hotels. When shopping for business lenders, it’s wise to begin by asking about the potential lender’s experience with businesses of your industry and size.
2. Customer Service
For many borrowers, the decision of which business lender to work with came down to how comfortable and important each potential lender made them feel. These borrowers likely harbored several concerns about the repayment process, such as what would happen in the event of a financial emergency. They also likely wanted to speak with human beings, rather than leaving a game-changing investment in the hands of a computer algorithm. If you’d prefer a business lender who can offer crucial financial advice and negotiable terms, you might not want to simply choose the least expensive or least tedious option available.
3. Potential for Long-Term Partnerships
Odds are, this isn’t the only time you’ll need a business loan. Some industries are naturally prone to occasional dips in revenue, while others must continuously expand in order to survive. If this sounds like you, it would be a good idea to choose a business lender that is known for approving multiple rounds of funding and prioritizing long-term partnerships. As long as you repay the first loan without trouble, you will likely have no problem obtaining additional rounds of funding. These days, it is completely normal to take out five or six loans from the same online lender in just a few years.
4. Hidden Differences Between the Same Product
While two business lenders might offer similar products, the requirements and repayment systems for each option could be wildly different. One product might require a minimum personal credit score, while the other won’t even check your personal credit at all. One product might be technically classified as a “loan” and show up as “debt” on your balance sheet, while the other’s would not, making it easier to take on other forms of debt at the same time. One business lender might not care how you use the money while another might only approve applications for certain types of investments.
Certain programs, like a merchant cash advance or business line of credit, are especially prone to these little differences between business lenders. For example, the traditional merchant cash advance has no set due date or minimum monthly payment. Numerous business lenders offer products that appear to be just like a traditional merchant cash advance, but you have to pay back a specific amount by a specific time. With a business line of credit, paying off the debt in full usually allows you continue to draw from your credit line. But some business lenders give you that second round if you pay off as little as half of your original amount within a certain time frame. Almost every business lender has their own stipulations, and you probably won’t hear about them unless you ask.
What are the Signs of a Malicious Business Lender?
Unfortunately, the growth of online lending has opened a window for malicious business lenders who prey on inexperienced borrowers. These aren’t the scammers who take your money and don’t lend you anything. Instead, malicious business lenders give offers that are specifically designed to draw a quick profit. They don’t care if you bankrupt yourself to pay them back.
In other words, their business models are essentially hidden ways to rip people off. Here’s how to spot a malicious business lender:
1. They Offer Loans to Businesses That Don’t Need Them
Legitimate business lenders do not distribute loans to businesses that are not in the position to take on additional debt. If your business is too young or too fragile for a loan, they won’t offer you one. They won’t offer you a loan to pay for something you could safely cover with a business credit card.
Malicious lenders do the opposite. They don’t care if you can barely afford to keep your lights on. They don’t care if you have no prior experience paying off this much debt. Thus, if your cash flow is not stable enough to take on a loan but someone offers you one anyway, you should probably decline.
2. They Ask You to Pay More Than You Can Afford
Let’s say your business earns $100 per week. The business lender you are speaking to knows this but offers you a loan that will charge you $150 per week to pay it back. Taking out a small business loan is not likely leasing a car. The person you are doing business with knows exactly how much money you have and how much you can afford to pay in a given time frame. Yes, a business loan is supposed to increase revenue, but a legitimate business lender will present options that your current revenue is capable of supporting. There must be a valid, logical explanation for the proposed rates and terms.
3. They Offer Less or More Money Than You Requested
A common tactic for drawing a quick profit off an unsuspecting business is issuing loans that are substantially lower or higher than what the business actually needs. Sometimes, what the business needs is different from what has been requested by the applicant. It’s the business lender’s job to bring the applicant back to reality and only present loans that the business can afford to pay back and will give their cash flow the boost they are looking for. Trustworthy business lenders are realistic about costs as well as budgets. They’ll tell you how much money you’ll need to get through a slow season, or simply how much you’ll be able to pay each month without having to dip into operational funding.
4. They Pressure You to Accept Offers
Every veteran business owner knows that pressure and deceit go hand-in-hand. If a sales representative is clearly pressuring you to accept an offer, it’s probably an attempt to avoid answering questions that will instantly kill the deal. Taking out a small business loan is a huge decision. Hence, you should be able to take as much time as you want before accepting an offer. Such decisions should also be made when you are not in the middle of a typically hectic work day. When you aren’t in the right mental state, you could be lured in by a tempting feature, like “0% interest” or neglect to ask about crucial factors, like the subject of the next section:
5. They Don’t Disclose Their Fees
It is apparently acceptable for business lenders to only reveal their fees if the potential borrower asks about them. Potential borrowers are always advised to ask about fees. Still, a legitimate business lender does not deliberately gloss over basic fee policies. One example is prepayment fees, which are not uncommon but high prepayment fees can significantly increase the loan’s overall cost. Then same can be said about additional fees for refinancing or customizing an existing loan. If you wish to pay off your loan early or modify its terms, you should only be charged if you were previously informed about this policy.
6. They Don’t Get Back to You Promptly
Reliability is a key component of trust. The business lender you choose should therefore be available to talk and get back to you promptly. You shouldn’t only be able to speak with the institution during certain times of certain days. When you have a question, you shouldn’t have to wait several days for an answer. Alternative business lenders often speak with clients when it is most convenient for them, even after normal work hours. Business owners are notoriously busy, so the longer they have to wait for information, the more stressful their day becomes.
Business Lenders: Above All Else, Know Your Business
Choosing the right business lender is much easier when you truly understand your business. Different business lenders specialize with different types of businesses, and not just in regards to industry. You have to know your cash flow cycle, your busy periods, your financial goals, anything that could affect your capacity to repay debt. This will ultimately allow you to find a business lender that works with you, not against you.
Which factors were most important when you looked for business lenders? Share any thoughts or resources on our contact page!