It’s a growing problem: Small businesses are getting in over their heads with debt, often brought on by the use of online lenders that typically charge higher rates and can require shorter payback periods than banks and other alternatives.
Because traditional bank loans are difficult for many small businesses to quality for, more Florida business owners are turning to these non-bank online lenders, such as OnDeck, Lending Club, PayPal Working Capital and Kabbage, to name a few. And a recently released national survey of small businesses showed Florida was not alone.
The 3rd Quarter Small Business Credit Survey by 12 Federal Reserve Banks shows that 70% of small firms have outstanding debt. As many as 64% of small businesses are struggling financially, and say “credit availability” and “making payments on debt” are the reasons. To qualify for loans, 58% of small businesses put their personal assets on the line using personal guarantees, while 49% put down their business assets.
Nearly a third of borrowers are turning to online lenders. That’s a significant jump from the previous year when only 24% of small business owners sought funding from such institutions. The survey showed that medium and high-risk applicants were especially inclined to seek funds from these lenders that often have higher interest rates, whereas low credit-risk applicants rely on banks.
Indeed, small businesses are drawn to online lenders because their loans are easier to qualify for and small businesses can apply, get approved, and receive the funds in a matter of days or hours rather than months. But watch out. Even beyond the higher cost of the money, many of these loans are short term and require putting personal or business assets on the line. What’s more, the shorter loan terms can play havoc with cash flow, the lifeblood of a small business.
MAKE CHANGES IN YOUR BUSINESS FIRST
Consultants at Florida SBDC at FIU, the small business development center with FIU’s College of Business, have seen businesses getting into deep trouble.
Roberto Castellon, an SBDC at FIU consultant who specializes in finance and access to capital, says businesses can get into financial trouble when there is a shift in the market and they are losing money because of it, but they don’t make changes in their business model to adjust for it. Instead they start borrowing from a lender with high rates – and that doesn’t solve the underlying problems.
“I have seen crazy rates because they sell it to you like it is short term. Their terms are short, so they are meant to be like a bridge loan. But companies that are losing money can’t pay it when it is due and they have to borrow more to pay one off. So a company can be in debt into a tune of a half million dollars before the owner realizes he should should have changed the business model to make profit instead of losing money,” said Castellon, a former business bank officer who has also founded several companies.
“What we have here often is a mistake on the part of the business owner. Their overhead is too high, they have a sudden drop in sales, and a shift in marketplace in terms of pricing. They are borrowing short term to solve a long term problem.”
What should these businesses do instead? “The market place is ever changing, so you have to react to it and look inside the company. Look at your inventory, your suppliers, your expenses. How about cutting your salary?” Castellon said.
WHEN MIGHT HIGHER INTEREST RATES BE JUSTIFIED?
Obtaining high interest rate debt may be OK in some instances, such as if your company is making money and you have crunched the numbers and determined that you can leverage the borrowed funds enough to justify the high interest rate you are paying. “It is advisable under a very narrow band of conditions but people jump in like it is their savior,” Castellon said.
“I would only borrow if my business is highly profitable and I can afford the higher rate and I am a young business or a person with bad credit that can’t get a traditional loan – maybe,” he said. “It could be a potential solution to their problems if they have a very short, very defined downturn and they don’t have access to a line of credit at a bank. For instance, maybe they have a government contract that is about to start and need the coverage for a very short period of time.”
Still, it is always best to try to figure out internally how to react to the situation.
Ray Juncosa, also a consultant at SBDC at FIU specializing in access to capital, agrees.
These onlilne lenders are not necessarily predatory because their rates aren’t in the same lofty spaces as so-called payday companies and hard money lenders, both of which Juncosa always advises companies to stay away from. Online lenders are not in that category – but their rates are high.
MANAGE DEBT PRUDENTLY
Juncosa too believes a business needs to make sure they understand what the real problems are. “They also should understand the importance of credit repair and getting themselves to bankability. But if they have no other choice than to go for expensive financing, they need to manage the credit prudently. Your business and personal assets are at stake.”
It’s difficult to get a loan from a bank — that’s a reality. Banks typically won’t lend to businesses under two years old, or ones of any age with poor credit. Out of 10 small businesses, maybe two or three are bankable, said Juncosa, a former bank executive.
SBA loans offer attractive rates but the underwriting process is, well, a process, he said. But once you are able to get a loan, “you are able to create a very solid track record you can fall back on that demonstrated you were able to get a loan that is not that easy to get, “ Juncosa said. SBA lenders offer a number of loan programs for various uses.
Juncosa, Castellon as well as other SBDC at FIU consultants work with client companies to help them get bankable and establish a relationship with a banker.
“I do an evaluation and analyze their situation. What is the liquidity of the company? I look at solvency. If they can get to a debt-service ratio to 125 or north of that, a banker might take a look,” Juncosa said.
FINANCING OPTIONS
What are some other alternatives to traditional bank loans?
SBA 504 loan: If you need a loan for real estate your business will be occupying for or equipment, the SBA 504 may be a good option. If you are able to qualify, you can borrow up to 90%, freeing up cash to grow your business. (READ MORE HERE)
Community foundations and nonprofits: In South Florida, CDFI organizations including Bayside Foundation and Accion lend money to qualifying organizations. However the process is not quick and there are limits to how much they will lend. Bayside may lend up to $150,000 and Accion may go to $250,000 for qualifying businesses. (READ MORE HERE)
Factoring: It works like this. You sell your invoices at a discount to a factoring company in exchange for a lump sum of cash. The factoring company then owns the invoices and gets paid when it collects from your customers. This could be an avenue to take, if necessary, but you to be careful to select the right company.
Other alternative financing avenues such as online lenders, as discussed above, as well as credit card debt, Accounts Receivables financing or PO financing may be appropriate in some situations – but read the fine print.
There is no magic potion, said Juncosa. Some companies have high enough margins to sustain some of these more expensive options while they work on their issues.
“What we at SBDC do is we try to help small businesses get healthier so they can access much more reasonable financing.”
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