When small businesses need loans in economically difficult times
The current inflationary environment in the U.S. economy can put significant pressure on small business finances making continued business operations more difficult without additional capital from some type of lending source. This need typically arises when the cash flow from business operations is insufficient to meet some type of specific need [i.e. buying more raw material to make more saleable goods]. Or in anticipation of uncertain challenges.
Under these circumstances the business owner has to determine where this additional funding can be obtained and under what terms and costs. In this article we will survey the more common lending sources and discuss the pros and cons of each.
SBA Loans
These are actually SBA-backed loans made through commercial banks, some credit unions, and Community Development Corporations. There are several types of loan programs available to meet specific business needs. Detailed program information can be found on www.sba.gov and the lender can provide input regarding which program(s) might fit your specific situation.
Pros: Moderate cost structure and (typically) lenders are located in your community.
Cons: Defined program rules and lending policies, can take 2-3 months to obtain funding, may not fund if the loan application is deemed to be risky.
Economic Development Districts
These are nonprofit organizations which provide a variety of loan programs which are made available via federal agencies (i.e. Economic Development Administration, US Department of Agriculture — Rural Development, Department of Commerce, etc.) These loan programs are often referred to as “Gap” loans for those applicants who don’t otherwise qualify for conventional or other loan programs and are designed to assist small and emerging businesses in the retention and creation of employment. Loan funds can be used for real estate, working capital, inventory, equipment, refinancing existing debt, etc.
Pros: Loan rates and terms are determined based upon the purpose of the loan and risk level. Rates are typically slightly higher than conventional loan rates, but not exorbitant. Loan decisions are typically made at the local level.
Cons: Loan fund availability is sometimes limited based upon loan demand. The programs require full underwriting — not just based upon credit score.
SBA Certified Development Companies
SBA Certified Development Companies are economic development organizations which are licensed to underwrite, fund and service the SBA 504 program on behalf of the SBA. This loan program is limited to fixed asset financing (i.e. real estate, equipment, etc.) and are made in participation with a commercial lender. The rate on the SBA component of the loan is low as the program is funded via the sale of government backed bonds. Also, it assists the small business owner via the retention of working capital due to a lower down payment requirement.
Pros: Low down payment, fixed rate for the term of the loan, no interim maturity of the loan, etc.
Cons: Project development and loan underwriting is done at the local level, but the loan application must be approved by SBA which can add several weeks to the loan approval process. Loan applications must be fully underwritten.
Community Development Financial Institutions (CDFI)
These are private sector lenders who aggregate funds from various sources so they can make loans that help improve communities.
Pros: CDFI’s can have looser lending requirements than banks or credit unions. They can offer loans for down payments on other lender’s loans, can finance inventory or equipment. They can often make lending decisions faster than other organizations and can evaluate the borrower’s impact on the community as a reason for making a loan.
Cons: interest rates, fees, and ongoing loan servicing costs on CDFI loans will likely be higher than other loans and repayment terms may be shorter.
Non-Bank Lenders
These are private companies that offer loans to companies that cannot obtain other types of loans. They can have very flexible loan products to finance inventory, provide working capital, cash advances on receivables, and many other products.
Pros: flexibility of loan products, very quick lending decisions, able to collateralize parts of the business to make the loan.
Cons: potentially high lending costs because many of the loans carry significant risk to the lender.
Online Lenders
Online lenders like Kabbage, On Deck, and others can make substantial loans for various business purposes
Pros: will provide financing for a number of purposes, can provide significant levels of financing, can make lending decisions within days of application
Cons: the loans will have short terms which potentially can cause cash-flow problems in loan repayment, the effective lending rates can be high, they will often will take a percentage of sales dollars as part of the loan payoff. The effective costs of borrowing is typically much higher than other loan programs.
Private Lenders and Investors
Friends, family, and interested parties can be a source of funds to meet business needs.
Pros: decisions and funding can happen quickly and the terms of repayment can be creative and tailored to specific business ability to repay the loan. Some investors may offer money in return for an ownership stake in the business.
Cons: failure to repay any investment within the terms agreed to can strain relationships and destroy friendships. By all means, be a responsible borrower. When in doubt how to structure a loan or an equity position, consulting an attorney is a good idea.
Which lender does a business owner select?
It will truly depend on the circumstances of your specific situation. Do you need a quick decision? Are your business financials less than credit worthy for a commercial lender? Can you quickly generate cash through additional business to repay the loan?
In one case, a business startup did not have a good enough case to convince a commercial lender to make a loan. However, a different lender was eager to make the loan as they perceived the new business, a child daycare business, was truly needed in the community.
In another case, a commercial roofer was experiencing cash flow issues because jobs they did for various school systems were taking a long time to pay the final progress payment on several jobs. They successfully arraigned a significant loan from an online lender so they could start additional jobs. They repaid the online loan in about 90 days and were very satisfied with the experience.
The key to making these lending opportunities work, is to clearly understand your needs and objectives for borrowing, have a solid plan for repaying the borrowed funds and then stick to that plan. Your North Idaho Small Business Development Center at North Idaho College can help you work through all these issues to develop a borrowing plan to meet your needs and help you stay on track for successfully repaying your business loan. For more information, please visit our website https://nisbdc.com/ or email us at ISBDC@nic.edu or call us at 208-665-5085.
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Warren Mueller is in his sixth year as an SBDC Business Coach. He spent 25 years in international business development in the defense contracting and specialty chemical industries. He is also a consultant in Strategic Pricing and Pricing Management. In 2014, he published a book on Strategic Planning for small businesses and nonprofits.