Getting funding for your business is necessary, but that doesn’t mean it’s easy. Some of the obstacles you’ll face are high interest rates, extended underwriting time, origination fees and stringent approval standards.
Of course, these hurdles are contingent on the borrower. If you’ve got great credit, steady revenue and impressive sales, lenders are more willing to give you better rates and larger amounts. Startups that have been in business six months or less and whose borrowers have poor credit scores can expect more hurdles.
The following list of five funding options gives you a good sense of what’s available to you and your business.
- Bank loans
Bank loans have fallen out of popularity over the past decade. Their requirements for SMB loans became more stringent after the recession—they don’t want to risk their money with unstable or young ventures.
As a result, banks like Bank of America have gone the safe route and offer Small Business Association loans. These types of loans require intense scrutiny from underwriters, but if you’re approved, you’ll get interest rates below 10 percent and repayment periods of years and not months.
Despite the upside to these terms, most entrepreneurs favor using their own money or equity because there’s no processing time or underwriting. Plus, bank loans can take more than a month to process.
Factoring is a small business loan in which the interest rate is expressed not by percentages, but by the following formula: 1.1, 1.2, 1.3, etc. The lender will quote you a loan amount with a factor rate. While a 1.2 factor rate may seem innocuous (it’s not a percentage, per se), factor rates end up costing you significantly more than you think.
To understand how much you pay, multiply the factor rate by your loan amount, i.e.: 1.2 x $10,000 = $12,000. In this situation, you’re paying $2,000 in interest. On top of that, you can expect an origination fee of between 2.5 percent and 4 percent.
Using the previous example and a 2.5 percent origination fee, you can expect to pay $2,250 to borrow $10,000. That’s a 22.5 percent interest rate. But remember, these types of loans are often short-term: six months, especially on a smaller amount, is common. When you take that fee out over the course of the year, your APR is 45 percent, which is nearly predatory, by lending terms.
Related: 8 Funding Alternatives to Consider
- Business line of credit
A business line of credit is like a credit card, but with much higher rates. The lending company approves you for a certain amount of money, and you can withdraw from that amount whenever you’d like. You only pay interest on what you take out.
Most companies will sell you on their lines of credit by pushing supposedly low APRs—one company says they’ll get you money at 12.99 percent. However, these APRs are based on income, client base and credit scores. If you’re weak in those areas, expect to pay a significantly higher amount than what’s advertised.
Lending companies won’t usually charge you high origination fees for lines of credit, but they require you to make weekly payments. This is risk mitigation on their part; they want to pay and pay promptly.
- Merchant cash advances
These loans are similar to the factor loans we mentioned before, with one big difference: instead of paying your loan back weekly through a bank account, the lender will take a percentage of your credit card sales every day.
There’s a high markup for these types of loans (it’s common among non-bank lenders), but these cash advances can provide a quick influx of operating cash.
You’ve probably read the success stories of companies using crowdfunding to jump-start a product launch. Crowdfunding has its upside—you don’t have to deal with loan officers, venture capitalists or unscrupulous lenders. You get to reach out to friends, family and the masses to generate capital.
However, there are downsides. Companies with the best stories usually garner the most funding. If your company’s marketing team doesn’t have the chops to create a captivating narrative, crowdfunding could be a fruitless venture.
The Small Business Administration recommends hiring a lawyer and a CPA to review your finances and legal standing to make sure you minimize the risks of crowdfunding. There is a potential for lawsuits if you underestimate launch costs and can’t follow through on the perks and products you promise your investors.
Do your research before you decide
Today’s lenders can be split into two groups: bank and non-bank. Both of these groups have one goal, which is to minimize risk and make money. They’re going to accomplish that goal by using stringent underwriting that weeds out all but the highest-earning clients, or they’re going to hammer you with high interest rates and fees.
Unfortunately, we already know that sometimes you don’t have a choice regardless of how much you’ll be charged to borrow. Run some preliminary numbers with your bank and non-bank lenders to get a sense of what your loan amounts and rates will be. Then, consult your lawyer(s) and your CPA.
Once you feel like you have a good sense of how much it will cost you and what the advantages and disadvantages are for each option, make your decision. Your biggest mistake in this area will be a lack of research—hasty decisions result in high fees.