Business Financing Options for Bad Credit
December 11, 2020
As a business owner, having bad credit (whether personal or for your company) is a catch-22. It’s hard to grow faster without financing, but it’s just as difficult to get approved because of your credit score. While bad credit financing is generally more expensive, there are some options that may help you get the capital infusion you need. Here are five types of financing to consider, along with the pros and cons of each one.
Short-Term Loans
Get a lump sum of working capital with a fast repayment time. This can help you grow your business credit while also borrowing a small amount to help you with near-term needs. Naleu’s network of online lenders offer easy online applications and fast approval times.
Pros:
- Get access to your funds quickly
- May find unsecured options
- Lower credit score minimums
- Fixed payments make it easy to budget repayment
Cons:
- Higher interest rates
- May have frequent, automatic payments (such as daily or weekly)
- May require personal guarantee and/or place lien on business
Business Line of Credit
Rather than receiving a lump sum of money, a business line of credit gives you access to an account you can draw on as you need extra funds for your company. You’re charged interest on your outstanding balance and pay down your debt just as you would with a credit card.
Pros:
- Only pay interest on what you owe
- Solve short-term cash flow problems
- Have emergency financing already available when you need it
Cons:
- High interest rates, especially for bad credit borrowers
- May lead to unnecessary debt if you draw on your line when you don’t really need it
- May have additional fees compared to other types of business financing
Merchant Cash Advance
With a merchant cash advance, your business receives an upfront payment and subsequently makes automatic payments as a percentage of your credit and debit card sales. Rather than interest, you’re charged a factor rate, which is a multiple of the amount you borrow.
Pros:
- Lenders use sales rather than credit to qualify borrowers
- Usually no collateral required
- Funding time is fast
Cons:
- Factor rates are extremely expensive
- Repayment can cause cash flow issues
- Won’t help establish business credit
- Only for businesses with credit card sales
Invoice Factoring
Invoice factoring is similar to merchant cash advances in that it’s based on future revenue. With this type of financing, however, you get an advance on a portion of your business’s outstanding invoices. The lender charges a service fee as well as interest until your clients pay the invoices. Then you receive the remaining funds.
Pros:
- Helps with cash flow while waiting for customer payments
- Low to no credit requirements
- May help you collect delinquent accounts
Cons:
- Interest charged daily or weekly
- Lender may take over your customer relations to collect invoices
- Does not help your business credit score
Equipment Financing
It’s possible to find equipment financing companies that work with small businesses who have bad credit. Part of the reason is because the equipment is used as collateral so if you default on the loan, the lender can simply repossess the property. You may also be able to find options available for new businesses.
Pros:
- Longer loan term spreads out equipment purchase costs
- The equipment serves as collateral, rather than other business or personal assets
- Options to buy or lease available
- May be able to roll in soft costs, such as delivery fees
Cons:
- Only for equipment — doesn’t add any working capital
- Equipment may be repossessed if you don’t pay
- May need large down payment to qualify
Even with bad credit, it’s possible to find lending opportunities for your company’s specific needs.
Explore small business financing solutions with Naleu.
During the initial phases of the COVID-19 pandemic, it became apparent that government intervention was needed to save a crashing American economy. To address the economic crises, the Trump administration signed the CARES Act into law, including the Paycheck Protection Program. However, with a program plagued with fraud and undercapitalized, a new program has been established. Below is a reminder of the original program and what has changed in the new. The Background The CARES Act: This $2 trillion program divides relief in the following ways: Individuals: ~$560 billion in the form of stimulus checks. Big corporations: ~$500 billion in the form of bailouts. Small businesses: ~$377 billion Other (mostly government programs): ~563 billion The Paycheck Protection Program (PPP) is a loan program designed to incentivize small businesses to continue to pay their employees as part of the CARES Act. What was Essential to Small Businesses? For small businesses, the most notable features of the Cares Act are as follows: The government defines small businesses as companies with 500 or fewer employees. $10 billion of grants are outlined in the bill. Individual companies are entitled to up to $10,000 in emergency grants to cover "intermediate operating costs." The bill outlined $350 billion for the Small Business Administration's Paycheck Protection Program. Individual companies are entitled to up to $10 million in loans. $17 billion was allocated to "cover six months of payments for small businesses already using SBA loans." Overall, the CARES act and the Paycheck Protection Program's incentive seems to be for the aid of small business employees. The legislation accomplishes this through forgivable loan payments to small businesses with continued employment as a condition. The CARES Act and Paycheck Protection Program also spell out specific changes in expenses and deduction rules to allow small businesses to have an easier time keeping workers on their payroll and staying open during the pandemic (NPR). According to the Small Business Administration (SBA), PPP loans have a 1% interest rate. Loans issued before June 5 have a maturity of 2 years, loans issued after June 5 have a maturity of 5 years, no collateral or personal guarantees required. CONGRESS APPROVES ANOTHER ROUND OF PPP On December 27, the US Federal Government approved a new $900 billion stimulus bill. About a third of the stimulus ($284 billion) will be allocated to small businesses in the form of forgivable loans - part of a revamping of the Paycheck Protection Program (PPP). The government on Monday was set to reopen its signature small business pandemic aid program with $284 billion in new funds and revamped rules that aim to get cash to the most needy businesses while stamping out fraud and abuse. Changes to the PPP PPP loan applications will officially be reopening after being closed since August. The funding in this round is significantly smaller than the CARES Act - a difference of over 300 billion. Key changes: A maximum loan amount of $2 million Businesses that received a PPP loan the first time can apply for a second loan under the new PPP, with certain restrictions. Employee maximum reduced from 500 to 300. Loans can now be used for software and COVID-19 protective equipment. Expansion of loan forgiveness up to $150,000, given 60% of the loan being used for payroll. Simplified application. 501(c)(6) non-profits now qualify for financing. Other Guidelines: Businesses that were initially unable to secure financing will be granted access to the application and select businesses that already received PPP financing through the CARES Act. An SMB's maximum loan amount can be calculated by multiplying your past year's average monthly payroll by 2.5. The total maximum is set at $2 million (compared to $10 million before). Borrowers can choose their covered period within the range of 8-24 weeks. PPP financing can be used for payroll, operations, supplies, rental and mortgage costs, and damages. Expenses paid with PPP loans are tax-deductible. Eligibility: To be eligible for the program, you must be a small business with fewer than 300 employees that experienced revenue losses of at least 25% from the first to the third quarter of 2020 compared to the same quarter of 2019. You must also continue to have workers on your payroll. In the Future: A Biden Presidency President-Elect, Joe Biden has noted essential changes in small business relief. The Biden administration plans to implement the following small-business-related measures under the "Make It Work" checklist: Implementation of a national work-sharing program for employers to utilize instead of laying off workers. Ensure equitable and speedy access to relief for all small businesses. Focusing substitute for small companies rather than large corporations and financial institutions. Establishing strong accountability and transparency policies. Establishing a CARES Act Implementation Office to ensure ease of access to knowledge about the government program. Begin work on a fourth stimulus package. See above, on the Joe Biden campaign website at https://joebiden.com/the-biden-make-it-work-checklist/ . Overall, it seems that the Biden administration intends to expand government relief, explicitly focusing on small businesses and other areas the previous package seemed to leave out. To date, the PPP has distributed $525 billion through more than 5 million loans.
A business loan could be just what you need to jumpstart your company. Getting your documents ready in advance can expedite the loan approval process. Read this list so you can take the next step in getting financed as soon as you’re ready. Loan Letter Oftentimes banks want business loan applicants to provide a formal letter stating what they intend to use the loan for. Try to be as specific as possible with this. Example questions your loan letter should answer might include: How large of a loan are you seeking? Why is the loan needed? What do you need to purchase? How much will it specifically cost? How do you anticipate the business loan helping your business in the long run? How fast do you anticipate being able to pay off the loan? Bank Statements Most lenders require your business’s bank statements, and this will likely be one of the first things requested. Loan officers do this to ensure your business can actually afford to take out a loan as well as make the corresponding payments. Bank statements can also show how well you manage your company’s cash. On average, lenders ask for four months of bank statements, but it depends on the loan and the business. Tax Returns Next, you’ll need both personal and business tax returns. If you’re going to have a cosigner, he or she will need to provide returns as well. Generally speaking, you need to provide at least two years of tax returns (for both you and your business). As with bank statements, tax returns are used to gauge your financial health as well as your ability to repay a loan. If you’ve been running your business for two years, you’ll have a much easier time getting a loan. If not, you still have options, but many lenders like to see two years of business tax returns before they approve a loan. Business Permit or License Before a lender gives you a loan for your business, they need to verify that you are legally allowed to be running your business. Requirements vary state by state, so just make sure you are compliant with all local and state laws. It’s highly likely you’ve already done all of this. Collateral You may need to provide proof of collateral to your lender, especially if you are applying for an SBA loan. Depending on the loan amount, you may be able to use your house, car, or any type of specialized equipment you’ve purchased for your business. Just know that if you default on the loan, that collateral can be seized by the lender. Balance Sheet Your business’s balance sheet is used to determine your assets and to ensure you have enough income to pay back your loan. You will likely be asked for a year-to-date balance sheet, as well as the previous two years of balance sheets. Lease If your business is entirely online, then you won’t have to worry about this; however, if you have a brick and mortar shop then you’ll need to provide a copy of the lease. This shows that you’re able to conduct business. Debt Lenders need to know what kind of debt you already have, as well as your current debt payoff schedule. This is used to determine if you can take on any additional debt. You’ll need to be below a certain threshold for the lender to approve the loan, which is determined by your cash flow and existing debt. Typically this is referred to as a debt service coverage ratio (DSCR). Accounts Receivable and Accounts Payable How fast do clients pay you? If your business isn’t efficient at collecting payments, a lender may not be overjoyed to lend to you even though on paper your business may be profitable. You also need to show that you’re good at paying invoices, too. If you have a lot of outstanding invoices, it won’t be a good sign that you’ll make payments on time. Legal Agreements and Contracts If your business has any existing legal contracts or agreements, you may need to disclose each to your lender. Commons ones include: Equipment purchase agreement Franchise agreement Sales agreement Commercial real estate purchase agreement This is done so the lender understands your business on a holistic level and can better gauge its complete situation. Every lender is different in their exact requirements for applying for a loan. Check multiple offers with just one streamlined application with Naleu.