What are the advantages of short-term loans for small businesses compared to alternatives? What are the disadvantages?
At the end of the day, traditional banks will offer a business owner the best terms and the best deal. However, there are several advantages to short term loans.
Short term lenders leverage technology to offer convenience through online applications, fast loan decisions, and higher approval rates given consideration of non-traditional data sources. They also offer smaller loan sizes compared to traditional bank loans.
Generally, you want to match loan term and size to the use of funds, so short term loans expand the range of financing options available to businesses.
But this speed and flexibility come at a price. While competition in the alternative lending space has increased and rates have somewhat decreased, the cost of short term loans are generally higher than traditional bank financing.
When do short-term loans make the most sense? Are they better for certain types of businesses or certain situations?
You must have a clear plan on how you’ll be using the funds and repaying the debt. Short term loans are better for businesses with strong cash flow. They can be a valuable life line in emergency situations if equipment breaks down or bad weather slows down foot traffic in the store.
What are some things small businesses can invest in with a short-term loan?
Short term loans help to fill cash flow gaps and smooth out seasonality. They provide working capital to fill a big order or help you meet payroll when business is slow.
What should small businesses keep in mind when shopping for a short-term loan (e.g., interest rates, terms, lender reputation)?
Do your homework. Understand what you qualify for and avoid applying for options where you don’t meet the minimum requirements. Otherwise, it will have a negative impact on your credit score.
Pay attention to APR when considering different options - it allows for an apples-to-apples cost comparison of loan options offering different terms. However, APR isn’t perfect, especially when dealing with loan terms that are shorter than a year. Especially in times of crisis, it’s critical to look at absolute cost (interest, origination fees, prepayment penalties).
Make sure you have your profit margin is enough to cover the loan repayment. Also, while everyone hopes for the best case, understand what a downside would look like if your business were to slow down.
Don’t simply take the first option that says yes. If it sounds too good to be true, it probably is. Avoid stacking multiple short-term loans.
If a lender doesn’t approve you for the full amount you have applied for, that’s because your cash flow situation doesn’t support repayment of the loan amount. Be careful not to get stuck on a debt treadmill.
What do businesses need to have lined up in order to qualify for a short-term loan (e.g., good credit score, thorough business plan)? Why do lenders take these things into consideration?
At the end of the day, reputable lenders will approve your loan application based on your ability to repay. Each lender generally has minimum requirements for credit score, time in business, revenue, and profitability. Alternative lenders offer higher approval rates because they’re able to consider non-traditional data sources.
To speed up the process, make sure you know your numbers and have your supporting documents – typically your business/personal tax returns and business bank account statements and sometimes your credit card statements and your traditional business financial statements – handy.
What is the application process like for a short-term loan compared to alternatives? What can the borrower expect?
It depends on the lender. Generally, alternative lenders have online application processes that ask for self-reported information about your business to determine your eligibility to apply. If you are eligible, then you will be asked for supporting documentation (stated above) to verify the information you originally.
Borrowers will also receive phone calls from the lender to support you through the process and answer any questions you may have.
What other types of financing can small businesses consider to meet short-term needs?
Small businesses can consider lines of credit and credit cards to meet short-term needs. If you work with invoices, factoring is an option as well. At the end of the day, regardless of what option you take, make sure you have a clear and realistic path to repay any debt you take on.
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