Lending Library

While some debt is considered good debt for small business owners—debt that ultimately helps the borrower net more in savings or income—other debt is deemed “bad debt.”

The latter includes debt that can directly and negatively impact a business owner’s credit score, or that costs money or potentially limits their ability to secure financing in the future. Past-due debt, sometimes referred to as “delinquent debt,” falls into this category.

What is past due debt?

Past-due debt is the money owed on a missed debt payment.

For example, let’s say you receive a credit card bill of $1,000 with a minimum monthly payment of $50. If you don’t make that $50 payment on time (usually within a month), it will become past due.

This debt payment will often accrue late fees and additional interest if not paid—and continue to accrue fees for as long as it remains unpaid.

You don’t necessarily need to pay the full $1,000 at once—but you missed the required minimum payment, which caused a debt payment to become past due.

Past-due debt can arise from anything that requires regular payments—utilities, rent, credit cards, business loans, and invoices. Any required payment that goes unpaid becomes past due.

What is the difference between past due debt and delinquent debt?

The difference between past due debt and delinquent debt is simply semantics. Debt that is past-due is also considered delinquent.

However, while any unpaid payment is past due, there are differing levels of delinquency. Each level has its own penalties and risks to your financial reputation. Here are a few examples:

• Within 10 days: Many lenders have a grace period of a couple of weeks during which you can pay off the debt. During this time, there aren’t late fees or penalties as long as you pay off your debt. (This grace window varies by the lender—some will charge a fee if you miss the payment date by even a day.) 
• After 10 days: You may receive a late fee for your delayed payment, but the lender won’t take any action against your account. 
• After 30 days: If you skip a full billing cycle, your creditors will likely report this missed payment to the national credit bureaus. This report can impact your credit score and add delinquency to your credit history.   
• After 90 days: If you continue to miss payments, you’ll likely accrue more penalty fees and interest. Your interest rates may increase, and your credit will keep dropping. Eventually, your creditor will send your account to collections and freeze any services you receive.

The impact of past due debt on your business

If you’re contending with multiple sources of debt, start with your past-due accounts. Late payments and delinquent debt can linger on your credit report and negatively impact your credit score.

With a poor credit score, loans (of any kind) will become harder to get—you’ll have to battle less favorable terms and higher interest rates, assuming you can get a loan at all. Paying off your overdue debts first could prevent your account from going into collections and affecting your credit score. 

If possible, make the minimum payments on all of your accounts—even if you can’t pay off the full balance. Hitting these minimum payments proves to creditors that you’re still willing to pay what you owe and aren’t going to fall into delinquency.

If you are ever in a situation where you’re unable to make the minimum payment, contact your creditor ASAP. Some credit card companies offer hardship programs where you can pause payments for a few months. Your other lenders may be willing to accept partial payments in the short run.

How long do late payments stay on your credit report? 

Payment history is one of the biggest factors of your credit score. Your history lets lenders know how likely you are to miss a payment or become delinquent on the account.

Because of its high value, a missed payment will stay on your credit report for 7 years, whether the missed payment is 30- or 90-days late. 

However, a missed payment might not affect your credit score for the full 7 years. If you only miss a few payments, then your credit score might rebound in a couple of years. Multiple factors contribute to your credit score, and maintaining a good payment history is one of the best ways to keep it strong.

How to solve your past due debt

If you have an upcoming loan payment that you can’t afford, don’t panic. Below, we’ll show you a few tactics to keep your lenders satisfied and your cash flow flowing when paying off your debts isn't a readily available option.

Find short-term financing

It’s always scary to fight debt with debt, but sometimes it’s necessary. If you’re struggling to make your loan payments, consider one of these short-term financing options:

• Business Lines of Credit: Use a line of credit to cover practically any business expense: payroll, rent, debt payments, supplies—you name it! You can get funds in as little as 1 to 2 weeks, and then you’ll get immediate access to any funds you use as soon as you repay the amount used.
• Business Credit Cards: If you don't qualify for a line of credit, a business credit card is another great short-term financing option. You can make your necessary loan payments on your credit card and earn cashback and travel rewards while you're at it. Plus, you can score a card with a 0% interest period (sometimes as long as 18 months), meaning you can make lower monthly payments with fewer consequences.

Negotiate with your lenders

Your lenders don’t want you to default.

If you’re struggling to make payments, they may be willing to temporarily restructure your loan. This act could mean lower interest rates, payment deferments, and extended terms.

For example, Bank of America allows businesses to request deferments on loan payments without negative credit reporting.

Funding Circle provides forbearance, repayment flexibility, and even late fee forgiveness. 

Talk to your lender and see what help they’re willing to provide. It doesn’t hurt to ask, and you might be surprised with their leniency.

Set reminders for your minimum payments

While your lenders will likely remind you about upcoming bills, you can also set payment reminders to ensure that you at least make your minimum payments.

These reminders will help you avoid past-due debt, even if you still need time to pay off your full balance. Making these small payments will help to protect your credit and your future financial opportunities.

If you’re too busy to remember to make payments, you can also set up autopay options to draft from your account. Just make sure you have enough money to avoid overdraft fees.

Boost your cash flow

Improving your cash flow is probably one of the harder options, but it’s still possible. To boost your cash flow, you’ll need to increase sales or decrease expenses (or both). 

Consider areas where you can cut spending. Every dollar counts. And then look for where you can grow your sales. With the digital world as your oyster, there are endless possibilities for making revenue online.

Don't give up

If you can’t make your loan payments, don’t give up. There’s a way out—you’ll make it through this. Hold your head up high and fight for your business’s survival.

A variety of reasons support buying a commercial property for your business. One is that it can give you the flexibility to adapt the building to your needs or expand your operations. Another compelling argument in favor of purchasing a commercial property is that doing so can help you build equity, which is an obvious disadvantage to renting.

Considering whether to buy or rent a commercial space can be difficult, and it is worth noting that those who rent will always, in a sense (and cents), be at the mercy of their landlord. If you have an opportunity to buy commercial real estate with a fixed-rate loan, however, you can make your expenses easier to manage and avoid the risk of either having to pay more in rent or move your business elsewhere.

Purchasing a commercial property for your business could also offer you an array of potential tax benefits and deductions. This includes depreciation and the chance to deduct the interest portion of the mortgage payment. In addition, when you locate your business in the commercial real estate investment, you could potentially deduct the maintenance expenses from the business income. Also, there is a chance you could pay rent to yourself as the property owner, and the rent would be a deduction.

What is commercial real estate?

Commercial real estate refers to properties that are used for business purposes. This type of real estate includes spaces where businesses operate, whether they're retail stores, offices, warehouses, or other types of buildings that generate profit.

Types of commercial real estate.

• Multifamily - As the name implies, this refers to residential investment properties housing multiple families, such as apartment complexes, duplexes, triplexes, and even assisted living communities.
• Office - This refers to large, small, or medium-sized buildings capable of supporting a variety of businesses with a need for space, such as medical providers, attorneys, or accountants.
• Retail - This type of commercial real estate refers to a space that a consumer-facing business may be interested in, such as a coffee house, department store, or a suite in a strip mall.
• Industrial - This term refers to warehouses, production facilities, and distribution centers—basically any type of building a manufacturer may need.
• Hospitality - This area generally covers buildings that are either the current or former home of businesses in the service industry, such as restaurants, hotels, bars, or resorts.
• Special Purpose: Properties specifically designed for a particular business, like hotels, schools, or self-storage facilities.

Within the confines of commercial office real estate, there are three different types.

• Class A refers to commercial real estate of the highest possible quality. These are usually newer buildings in a prime location and in good condition.

• Class B refers to middle-range commercial properties that may be older and lower in price compared to Class A, making them a good target for renovation or restoration.

• Class C commercial real estate refers to older properties in a less-than-optimal location with extensive wear and tear.

How to buy commercial real estate for your business.

Consider the following elements when beginning the purchase process.

1. Identify property requirements.

Understanding your personal goals as a commercial real estate investor is essential, as your goals will influence the property requirements. Are you looking to build a brand or a retail establishment? How much foot traffic are you hoping to attract?

When looking into commercial real estate, consider the following:

• Budget: Know what you can afford before you start looking.
• Zoning Laws: Ensure the property is zoned for your type of business.
• Accessibility: Make sure the location is easily accessible for your customers and employees.
• Future Growth: Think about your future needs and whether the property can accommodate them.

2. Secure financing.

There are a variety of commercial real estate loans available with different terms and commercial mortgage rates. Bear in mind that, unlike a personal mortgage that may be able to cover up to 100% of the cost of the property, a commercial mortgage will typically cover only up to 75% to 80% of the cost of the property. 

Commercial mortgage

This refers to any sort of financing where the loan is secured by the value of the underlying commercial asset, which could include a warehouse, apartment complex, office building, shopping center, etc.

SBA 504 loan 

The SBA 504 loan is a loan program administered by the Small Business Administration (SBA), in which small business owners partner with Certified Development Companies (CDCs) to secure financing. Usually, a 504 loan will include a first mortgage for around 50% of the cost, from a third-party lender. The SBA will back a second mortgage, up to 40%. This would only leave the remaining 10% to the small business owner, allowing that individual to free up capital. The loan can be used to expand, buy real estate, or purchase equipment.  

Hard money loan 

This type of financing originates from private individuals or businesses, instead of traditional financial institutions. Generally, a hard money loan refers to a nonconforming loan that can be used to purchase a commercial or investment property, often with a much shorter duration and a higher interest rate compared to other options. A physical asset or property is usually required to serve as collateral for this type of loan. 

3. Enlist an experienced team.

Buying commercial real estate can be a complex process, so it's essential to have a team of experienced professionals to guide you. Here are the key people you should consider involving:

• Real Estate Agent/Broker: Specializes in commercial properties and helps you find suitable options. They can negotiate on your behalf and provide market insights.
• Attorney: A lawyer with expertise in commercial real estate can help you with contracts, zoning issues, and legal due diligence.
• Commercial Lender/Mortgage Broker: They can assist in exploring financing options and securing a commercial real estate loan that fits your needs.
• Accountant: Provides financial advice, helps with tax considerations, and aids in determining the property's financial viability.
• Property Inspector: Conducts a thorough inspection of the property to identify any structural or maintenance issues that need to be addressed.
• Appraiser: Offers an independent assessment of the property's value to ensure you're making a sound investment.
• Contractor: If the property requires renovations or modifications, a reputable contractor can estimate costs and manage the construction process.

4. Evaluate the value of the property.

Determining the value of a commercial property is a critical step in the purchasing process. Here's how you can approach it:

1. Comparable sales (Comps): Look at recent sales of similar properties in the same area. These comps provide a benchmark for the current market value.
2. Income approach: Evaluate the potential rental income the property could generate. This method involves calculating the net operating income (NOI) and dividing it by the capitalization rate to estimate value.
3. Cost approach: Consider the cost of replacing the building with a similar one, including the value of the land and the depreciation of the current property.
4. Professional appraisal: Hire a certified appraiser who specializes in commercial real estate. An appraisal will give you a detailed report on the property's value based on various factors, including location, condition, and market trends.
5. Future potential: Assess the property's potential for appreciation. Investigate local economic growth, infrastructure projects, and zoning changes that might affect the property's value over time.
6. Physical condition: Conduct a thorough inspection to identify maintenance or structural issues. Properties in better condition typically command higher prices.
7. Market conditions: Stay informed about the current real estate market trends and cycles. The value of commercial properties can fluctuate based on supply and demand dynamics.

5. Make an offer.

Once you've researched the property you'd like to purchase, you can begin the offer process.

1. Determine your offer price: Based on your evaluation of the property's value and your budget, decide on an initial offer price. Keep in mind that this price should be competitive but also leave room for negotiation.
2. Prepare a letter of intent (LOI): Draft a Letter of Intent outlining your proposed terms and conditions. The LOI should include the offer price, payment terms, due diligence period, and any contingencies such as financing or inspection results.
3. Submit the LOI: Present the Letter of Intent to the seller through your real estate agent or broker. This document serves as a formal expression of your interest and opens the door for negotiations.
4. Negotiate terms: Be prepared to negotiate with the seller. This may involve several rounds of counteroffers until both parties agree on the final terms. Your real estate agent or broker can be invaluable in guiding you through this process.
5. Draft the purchase agreement: Once both parties agree to the terms, have your attorney draft a formal purchase agreement. This legal document will outline all the specific details of the transaction, including contingencies, closing date, and any special conditions.
6. Due diligence period: After the offer is accepted, you'll enter the due diligence period. During this time, conduct thorough inspections, review financial records, verify zoning laws, and ensure there are no hidden issues with the property. This period allows you to confirm that the property meets your expectations before finalizing the purchase.
7. Secure financing: Work with your commercial lender or mortgage broker to finalize your financing arrangements. Ensure all necessary documents and approvals are in place to secure the loan.
8. Close the deal: If everything checks out during the due diligence period and your financing is secured, proceed to the closing. This stage involves signing all required documents, transferring funds, and obtaining the keys to the property.

Ready to start looking into financing for a commercial property? Learn more about commercial mortgages.

As a small business owner, you’re probably familiar with at least a few of the many loan products available. Many lenders require you to offer an asset to secure a debt. As time goes by, you might find yourself securing multiple loans with the same asset—a process called cross-collateralization.

Cross-collateralization is fairly common—“second mortgages” are a popular form of cross-collateralization, for example. There can be many benefits to taking advantage of cross-collateralization, but this process also increases the risk of losing assets, so it’s important to understand how cross-collateralization works before making any formal arrangement.

What to know about collateral.

There are two main types of loans: secured loans and unsecured loans. These loans differ in regard to collateral requirements. Collateral is an asset that a borrower offers up as a way to guarantee the amount of a loan. Common forms of collateral include cash deposits, real estate, or vehicles.

Secured loans require collateral, while unsecured loans do not. If you default on secured loans, the lender can seize the collateral as repayment for the loan amount. Lenders of unsecured loans, like credit cards, have no such recourse, but this usually causes the repayment terms of unsecured loans to be less favorable for the borrower.     

In many cases, a lender uses an asset to secure the loan for that very asset. This is common with home mortgages, car loans, and equipment financing. If you have a mortgage, your house is the collateral—so if you default on your mortgage, the lender can then collect the collateral and repossess your house.

What is cross-collateralization?

Cross collateralization refers to a situation where multiple loans are secured with the same asset.

In a second mortgage situation, your home serves as collateral for a mortgage. As you pay down your mortgage, you own more of your home. You can then use your home as collateral for a second loan, i.e., a second mortgage.

Cross collateralization also occurs if different types of financing are secured with the same asset. If you’re paying off a car loan, the car becomes collateral for this loan. If you use the car as collateral for another type of financing, like a credit card, this is cross-collateralization.

“Cross-collateral refers to a method that lenders use to utilize the collateral of a loan such as a car to secure a second loan that an individual may have with the lender,” explains Jason Gordon at The Business Professor. “When an asset is cross-collateralized, it brings up issues as to which secured party has priority to the asset in the event of default.”

Less commonly, cross-collateralization also refers to a situation when a lender requires multiple forms of collateral for a single loan.

How cross-collateralization works.

Understanding the workings of cross-collateralization is crucial for any business owner considering this route. Essentially, this process ties the value and security of one or more loans to the same collateral. This is advantageous in situations where you may not have enough separate assets to secure multiple loans. For example, if you have equity in your property, you can leverage it to secure not just a primary mortgage but also a business loan or line of credit.

When you enter into a cross-collateralization agreement, it's like you're giving the lender a broader safety net. In the event of a default on any of the loans secured by the same asset, the lender has the right to seize and sell that asset to cover your debt. This means the stakes are higher for you because failing to repay one loan could jeopardize the asset tied to all the loans.

One critical aspect to monitor with cross-collateralized loans is the loan-to-value (LTV) ratio. This ratio measures the loan amount against the value of the collateral securing it. A higher LTV ratio indicates more borrowing against the asset, which can be risky if the market value of the collateral decreases.

For businesses, cross-collateralization can open doors to additional funding that might not be available otherwise. However, it compounds the risk to your assets. Therefore, it's wise to carefully assess your financial stability and the implications of tying multiple debts to vital assets before proceeding with such arrangements.

Benefits and risks of cross-collateralization.

Cross-collateralization can be a double-edged sword for savvy business owners, meshing intriguing benefits with profound risks. It's like stepping into a strategic game where your assets are on the line, offering a chance to secure more funding while posing a significant risk if the tides turn. In this section, we'll unravel the perks and perils of cross-collateralization, aiming to provide a balanced view that helps you weigh its worthiness against your business strategy.

Benefits

• Increased loan access: Cross-collateralization can significantly enhance your borrowing power. By leveraging the same asset for multiple loans, businesses can access higher loan amounts or more favorable terms than might be available with unsecured financing.
• Flexibility in financing: This strategy offers flexibility, allowing businesses to tap into the equity of their assets, such as real estate or vehicles, for various financial needs, from expanding operations to covering unexpected expenses.
• Potential for better rates: Often, loans that are secured by collateral have lower interest rates compared to unsecured loans. Cross-collateralization might help negotiate lower rates due to the added security it provides lenders.

Risks

• Increased loss risk: The primary risk of cross-collateralization is the potential loss of valuable assets. If a business cannot meet its loan obligations, the asset securing multiple loans could be seized, having a more significant impact than defaulting on a single secured loan.
• Complexity in managing loans: Juggling multiple loans tied to the same collateral can lead to intricate financial management challenges. Keeping track of various terms, interest rates, and repayment schedules requires diligent oversight.
• Difficulty in switching lenders: Once an asset is cross-collateralized, it may be more challenging to refinance or obtain new loans with different lenders. The existing cross-collateral agreements might limit flexibility and negotiation power with potential lenders.

What is a cross-collateral loan?

A cross-collateral loan essentially links the collateral of multiple loans together. This means if you've borrowed money to purchase a car and later decide to take out a personal loan, the same car can act as the collateral for both loans if both are through the same lender. This strategy can be particularly appealing for borrowers looking to maximize their borrowing capacity without having to find new assets to secure each loan. 

However, it's essential to understand that cross-collateralizing your loans binds them together in a way that can complicate future financial moves. For instance, if you wanted to sell the car that's serving as collateral for your loans, you'd need to pay off or substantially pay down the debts to remove the lender's claim on your asset. This intertwining of debts and assets makes managing your finances a bit more complex but can be a powerful tool in the right circumstances.

Is cross-collateralization legal?

Cross-collateralization is legal and fairly common, but a lender is required to inform you that cross-collateralization is occurring.

If you take out multiple secured loans from the same lender, like a bank, it might use the same collateral, making your assets cross-collateralized. You must legally consent to this, but do your due diligence in reading over any loan agreement. Be especially aware of “dragnet clauses” where a lender can pursue your asset if you used it for collateral for any loan with the lender.“

Lenders cannot use your business’s property as collateral without your consent,” writes Shawn Grimsley in the Houston Chronicle. “Lenders obtain your consent to cross-collateralization through a dragnet clause, which may allow the lender to use the collateral for any loans or other obligations your business may owe the lender.”

Is cross-collateralization bad?

If you can make your loan repayments on time, you’ll probably have no issues with cross-collateralization. Trouble arises if you default, however. If an asset is cross-collateralized and you default on one of your loans, you will default on all of your loans, because the asset can no longer secure any of them.

Can banks cross-collateralize?

Banks cross-collateralize often, but cross-collateralization is even more common with credit unions. Cross-collateralization is especially conventional when you seek multiple loans from a single lender. With every loan you take out, read over the agreement and make sure you consent to how a loan is secured.

How do I get out of cross-collateralization?

The best way to untangle yourself from a bad cross-collateralization situation is to contact the lender and attempt to renegotiate your loan. You might, for example, be able to secure the remaining debt with other collateral, although the repayment terms might be worse.

Bad cross-collateralization situations usually end with the loss of the asset, even if you declare bankruptcy. Unfortunately, besides repayment, the only way to get out of cross-collateralization is by letting your lenders repossess the collateral.

Alternatives to a cross-collateral loan.

Exploring alternatives to a cross-collateral loan is important for any business owner seeking flexibility and minimal risk in financing options. One such alternative is seeking out unsecured loans. Although typically bearing higher interest rates due to the increased risk for the lender, unsecured loans do not tie down your assets, providing peace of mind and simpler asset management.

Another option could be asset-based lending, which focuses on the value of specific assets rather than intertwining them across loans. This method allows for targeted borrowing against inventory, receivables, or other business assets without cross-collateralization complications.

Crowdfunding or peer-to-peer lending platforms also present innovative financing avenues. These methods can offer more favorable terms and the opportunity to avoid traditional banking systems and their associated risks and constraints. Each alternative has its unique set of benefits and considerations, gearing towards providing a tailored solution that aligns with your business's financial strategy and growth objectives.

Navigating the complexities of cross-collateralization requires a delicate balance between leveraging your assets for financial gain and protecting them from undue risk. Whether you're a seasoned business owner or new to the entrepreneurial scene, understanding the intricacies of secured loans, including cross-collateral loans, is crucial.

By weighing the benefits against the potential drawbacks and considering viable alternatives, you can make informed decisions that align with your financial goals and risk tolerance. Remember, the key to successful financial management lies not only in securing the necessary funds but also in maintaining control over your assets and their future.

You may have decided to buy an existing business after it popped up on your radar. But more likely, you’ll have to look for a business that is for sale.

You can find businesses for sale via:

• Business brokers
• Networks and small business associations
• Your current employer
• Directory listings
• Advertisements

1. Hire a business broker.

A business broker is similar to a real estate agent. They know the ins and outs of which businesses are for sale (including which are a steal versus a money pit) and understand the nuances of specific industries. The broker will also help you throughout the negotiation process.

You may have to use a business broker with certain sellers who use intermediaries to protect their identity. Business owners sometimes keep their “for sale” activity secret to avoid provoking anxiety in suppliers, customers, and employees.

What to look for in a business broker.

Choosing the right business broker is crucial for a smooth transaction. Consider these key attributes:

• Experience and Industry Expertise: A broker with a solid track record in your business sector will better understand market conditions and potential pitfalls.
• Certifications and Professional Affiliations: Look for membership in the International Business Brokers Association (IBBA) or similar organizations to ensure professionalism.
• Reputation and Client Testimonials: Research reviews and ask for references to gauge client satisfaction and success stories.
• Network and Reach: A well-connected broker with extensive industry contacts can offer more opportunities and access to potential buyers or sellers.
• Fees and Contract Terms: Discuss upfront to ensure there are no hidden charges and both parties are clear on expectations and deliverables.

You’ll pay a fee to use a business broker, but it can be worth it to avoid surprises during the purchase process.

How to find a small business broker.

Places to find a small business broker include:

• Business broker associations
• Your professional network
• Ask other for-sale businesses

Business Broker Associations

Business brokers are like the rest of us. They often belong to professional organizations to stay current with industry trends, boost their visibility, and increase networking opportunities. Most business broker associations list their members on their websites.

Two well-known business brokers’ associations to review are:

• International Business Brokers Association (IBBA)
• National Association of Business Brokers (NABB)

Your network

Your professional network, including your attorney, accountant, or business peers, may be able to recommend a business broker. Don’t forget to check with your local SCORE chapter or small business development centers.

Ask for recommendations from for-sale businesses.

Do you know a business for sale that you aren’t targeting for purchase? Ask them if they are using a business broker that they’d recommend.

2. Ask your network.

This is the perfect time to tap into your professional network and small business associations. Often, they know what companies are on the market or are open to a conversation about selling.

Using your network to find businesses for sale offers several significant advantages. Firstly, there’s an inherent level of trust and credibility because you're often dealing with established relationships. This trust can streamline negotiations and provide access to information that might not be publicly available.

Secondly, your network can offer deeper insights and firsthand experiences about potential businesses, helping you make a more informed decision.

Additionally, leveraging your network can lead to more discreet inquiries, which is crucial in preserving confidentiality during your search. Finally, using your network can save both time and resources by tapping into a pool of pre-vetted opportunities, compared to cold-search methods.

3. Check with your employer.

Depending on your employment situation, perhaps you could buy your current employer’s business. You don’t want to appear to be staging a takeover, so start the conversation by asking what their succession plan is. That could lead to deeper discussion, including your interest in purchasing the business.

4. Explore directory listings.

Internet searches and directory listings such as BizBuySell.com, Bizquest.com, and LoopNet.com are also great sources for finding businesses for sale. 

These sites allow you to filter your search by location, industry, and business size. They also provide detailed information on the business’s financials, such as revenue and cash flow. However, keep in mind that many of these directories charge a fee for listing businesses for sale, so not all companies may be represented.

5. Look for advertisements.

Finally, don’t overlook traditional methods like newspaper or online ads. Local publications often feature businesses for sale in their classifieds section.

A business owner planning a DIY sale may accept a lower purchase price since business broker fees will be eliminated. Finding the best small business to buy takes time but will pay off in dividends down the road. When you are ready to take the leap, remember that Lendio can walk you through the steps to secure a business acquisition loan.

The availability of dependable cash flow can have a big impact on the success of a small business. Yet a 2021 report from the Federal Reserve shows that, when businesses applied for financing, nearly 60% of applicants were either outright denied or able to borrow only a portion of the money they needed. 

It’s tempting to look at the bank as the bad guy in this scenario. Yet it’s important to understand that smaller commercial loans aren’t always a good fit for large traditional lenders. From a processing and profit standpoint, issuing smaller commercial loans might not be practical for some lending institutions. 

So, what options do small business owners have in this situation? For many small business owners who are stunned to learn how hard it is to get a business loan, the answer is to consider alternative business loans.

What are alternative business loans?

Alternative business loans are business loans, lines of credit or other forms of business financing offered by lenders other than through traditional banks. They are also often called online loans because they are accessible through online applications and platforms.

Alternative business loans vs. traditional business loans.

Traditional business loans are generally associated with banks and credit unions, where the application process can be lengthy and requires extensive documentation, such as financial records and business plans. Interest rates might be lower, but qualifying for these loans is often a challenge for small businesses without a strong credit history or significant collateral.

On the flip side, alternative business loans, accessible through online lenders, provide a more streamlined application process, often with less stringent requirements for credit scores and documentation. They can be a boon for businesses needing quick cash flow solutions, as approval times are significantly shorter, sometimes even within the same day. However, this convenience can come at a cost, with potentially higher interest rates and fees than traditional loans.

What are my alternative financing options?

Here are some examples of alternative financing options available to small businesses.

Business term loans.

Business term loans are what many people think of when they think of business financing. Term loans often feature fixed interest rates, fixed monthly payments, and a fixed number of monthly payments (aka repayment period). Depending on the lender, you may be able to use the funds you borrow for a variety of purposes, from equipment needs to cash flow support to expansion.

Short term loans.

Short term loans earn their title because they typically feature a shorter repayment period. With this type of alternative business loan, you might have to repay your loan within a year or less, though terms can vary. These loans sometimes come with weekly or even daily payments as well.

This loan option could be helpful if your business needs to access funds in a hurry (provided you’re working with a reputable alternative lender). However, you should make sure the loan offer makes sense for your business and that you can manage an expedited repayment schedule. A business owner might consider this type of loan to address a financial slump, manage a seasonal downturn, finance short-term projects, and more.

Equipment financing

Equipment financing is a type of loan that can help you finance essential tools and equipment for your business to operate. The equipment itself typically serves as collateral for the loan. As a result, you may be able to lock in a better rate for this type of financing, compared to other borrowing options. Depending on the lender, however, you may also need to provide a down payment.

SBA loan

Although you can apply for SBA loans with traditional banks, some online lenders offer them as well. Loans backed by the U.S. Small Business Administration can be a great fit for small businesses, since they often feature affordable rates, high loan amounts, and lengthy repayment terms.

On the other hand, the approval criteria for SBA loans tends to be on the stricter side. For example, with SBA 7(a) loans, you’ll need a minimum FICO® SBSS Score of 155 to qualify. SBA loans also tend to feature slower funding periods with loan processes that often take weeks or even months to complete.

Business credit card.

Business credit cards are a flexible financing option that may be available to established businesses and startups alike. However, you may need good personal credit to qualify. The interest rates on business credit cards (and credit cards in general) are often high. So, it’s best to use this form of financing for short-term cash flow support—never borrowing more than you can afford to pay off in a given billing cycle. When you revolve a balance from one month to the next, interest charges generally apply.

Many business credit cards come with the potential to help you build good business credit for your company as well. And if you open a business rewards credit card, you might earn valuable points, miles, or cash back on purchases that your business already needed to make.

Business line of credit.

A business line of credit is another flexible way to borrow money for your business. When you open a line of credit you receive a credit limit—the maximum amount your business can borrow on the account. As you use the line of credit, your available credit shrinks. But when you repay some (or all) of the money you borrowed, you should be free to borrow again against the same credit line.

Business lines of credit often feature revolving interest rates (like credit cards). These revolving interest rates can range from affordable to high, depending on the lender you choose, your creditworthiness, and other factors. Yet you pay interest only on the money you borrow, not the overall credit line. So, you have a bit more control over the process than you would with a traditional business loan.

Business cash advance.

A business cash advance (also called a merchant cash advance) lets your company borrow against money it will make in the future. In general, the cash advance provider will base the amount your business is eligible to borrow on its credit card sales volume.

As you collect future credit card payments, the cash advance company may take a portion of your daily sales to repay the borrowed funds, plus a “factor rate.” Factor rates can be high, making merchant cash advances a potentially expensive financing option. So, it’s important to review your company’s finances and make sure it can handle the expense and repayment schedule before you move forward.

Accounts receivable financing.

Accounts receivable financing—also called invoice financing—offers small business owners another way to borrow against future earnings. If your business invoices its customers and has to wait to receive payment, you might be eligible for this funding solution.

In general, you don’t need good personal or business credit to qualify for accounts receivable financing. Rather, financing companies will consider the creditworthiness and payment capability of your customers (aka debtors) instead.

Peer-to-peer lending.

Peer-to-peer lending (P2P lending) has emerged as a popular alternative financing option for small business owners. Unlike traditional loans issued by banks or financial institutions, P2P lending allows businesses to obtain capital directly from individual investors. This occurs on online platforms specifically designed to facilitate these types of transactions.

For borrowers, the appeal of P2P lending lies in its potentially lower interest rates, flexible terms, and the ease of application and quick funding times. For investors, it offers an opportunity to earn higher returns on their investment compared to traditional savings or investment products. However, it's important for business owners to understand that while P2P lending can be less stringent in terms of creditworthiness requirements, the rates and terms vary widely based on the platform and the borrower's credit profile.

Who are alternative lenders?

Since 2012, more than 100 participants have entered the alternative lending industry.  These companies offer a variety of alternative financing options, from term loans to cash advances. The flexibility that alternative business loans offer can make these funding solutions an excellent resource for small business owners.

See our full collection of best business loans.

Pros and cons of alternative lending.

Pros

Below are some of the benefits that alternative business loans have to offer.

Online applications

Most alternative lenders have embraced technology and provide applicants with simple loan applications that take just a few minutes to fill out. By comparison, some business loan applications can take hours or more to complete, given their sometimes heavy documentation requirements. With a simplified loan application process, alternative lenders free small business owners up to focus on what really matters—running their businesses.

Less stringent requirements.

Traditional lenders will consider a variety of factors when you apply for a business loan. A business lender may review your personal credit score, business credit score, time in business, annual revenue, collateral, and more to determine whether or not to approve your application for financing and what terms to offer you if you qualify.

Alternative lenders tend to be more lenient where business loan requirements are concerned. You might be able to get an alternative business loan with less-than-perfect credit, lower annual revenue numbers, etc. There are even first-time small business loans from alternative lenders for eligible startups.

Faster funding speed.

Another potential perk of using alternative business loans has to do with funding speed. When you work with a traditional lender, you might have to wait days or even weeks after qualification to receive your business loan proceeds. The SBA loan process, for example, is reported to sometimes take several months to complete.

With alternative financing, on the other hand, some lenders offer same-day or next-day funding. This can give small business owners faster access to the capital they need in a hurry to manage cash flow, cover expenses, order inventory, invest in growth opportunities, and more.

Credit building potential.

The potential to establish credit for your business is a valuable benefit. Many alternative business lenders also offer their customers the opportunity to build business credit, just like traditional lenders. If you want to establish business credit, you should look for an alternative lender that reports to one or more of the business credit reporting agencies.

Of course, how you manage your alternative business loan matters most where your business credit is concerned. If you have an alternative business loan that appears on one or more of your business credit reports, it’s essential to pay on time every month. (Tip: Some business credit scoring models may reward you more if you pay early.) If you make late payments on your business credit obligations, however, those negative notations have the potential to damage your business credit scores.

Flexible usage of funding.

Some alternative business loans offer business owners more flexibility when it comes to how they use the money they borrow. If you need to secure financing that your business may need to cover a variety of different expenses or investments, having less restrictive rules around how you use the funds you borrow can be useful.

More financing options.

When you apply for business financing from a traditional lender, you might not have a lot of different funding choices available. Alternative lenders, by comparison, offer a variety of financing options, such as those outlined below.

Cons

While alternative lending offers a plethora of advantages, it's important to approach them with a balanced perspective by considering the possible downsides.

Higher costs

One significant drawback of alternative lending is the potentially higher cost of borrowing. Interest rates and fees may be considerably higher than those offered by traditional lenders, especially for businesses with less-than-stellar credit histories. This can significantly increase the overall cost of financing, affecting your business's financial health in the long term.

Shorter repayment terms.

Many alternative loans come with shorter repayment terms compared to traditional bank loans. This can result in higher monthly payments, which might strain your business's cash flow. It's crucial to assess whether your business can comfortably manage these payments before proceeding.

Risk of unreliable lenders.

The alternative lending space, though innovative, can also attract lenders who are less than scrupulous. Due diligence is essential to ensure you're dealing with a reputable lender. Look for reviews, testimonials, and any possible red flags before you commit to a loan.

Potential for debt cycle.

Because of their accessibility and speed, there's a risk of becoming reliant on alternative lending for regular cash flow needs. This can lead to a cycle of debt that is difficult to escape, especially if the business uses new loans to pay off existing debts.

May not report to credit bureaus.

Some alternative lenders do not report to credit bureaus, which means these loans won't help build your business's credit profile. If building credit is one of your goals, verify with the lender whether they report to the major credit bureaus before you apply.

Less personalized service.

While not always the case, alternative lenders might offer less personalized service compared to a traditional bank where you might have a dedicated relationship manager. This can make it more challenging to negotiate terms or receive guidance based on your specific business needs.

The bottom line.

Navigating the world of business financing can be complex, but understanding your options with alternative lending is a crucial step towards finding a solution that aligns with your company's needs and goals. Whether you're seeking to manage cash flow, expand operations, or simply get through a rough patch, alternative loans offer a range of solutions that might be suitable. Remember, the key is to consider both the immediate benefits and the long-term implications of any financial decision.

Before making a decision, assess your business's financial health, project future cash flows, and consider how the loan fits into your broader business strategy. It's also prudent to consult with a financial advisor to understand the full impact of taking on new debt. Ultimately, by doing your due diligence and thoroughly weighing the pros and cons, you can choose a financing option that helps your business grow while maintaining its financial health.

Alternative lending can be a vital resource for businesses that might not qualify for traditional bank loans. However, it's essential to approach this option with caution, understanding the terms, the lender's credibility, and how the loan fits into your overall financial strategy. With careful planning and strategic decision-making, alternative lending can provide the financial support your business needs to thrive.

Small Business Administration (SBA) loans are some of the most desirable and sought-after financing options available for small business owners. SBA loans are known for affordable interest rates and generous repayment terms that can help small businesses grow and reach their financial goals. At the same time, SBA loans are also somewhat notorious for featuring tedious application processes and slow funding speeds. 

If you plan to apply for an SBA loan, it’s important to have realistic expectations regarding the overall timeline for these financial products. The SBA loan process can take much longer than traditional and online business loans. Often, it takes weeks to apply for an SBA loan, and the underwriting and funding process for an SBA loan can last as long as 60 to 90 days.The guide below will walk you through the steps borrowers need to take to get various types of SBA loans. You’ll discover how to find an SBA lender, the documentation you need to gather for your loan application, and other important details about each loan option.

The SBA loan process.

Applying for an SBA loan can seem overwhelming at first glance, but understanding each step can make the process more manageable. Here are the key stages of the SBA loan process, from initial preparation to final funding, so you can navigate it with confidence. Knowing what to expect and how to prepare will help you streamline your application and improve your chances of securing the loan your business needs.

Getting matched with a lender: 2 days.

The federal government guarantees a portion (up to 75%) of SBA loans. However, the Small Business Administration itself does not issue loans to business owners. Instead, SBA loans come from the same lenders you would seek out for traditional business loans. 

If you’re interested in applying for an SBA loan, the first step you’ll need to complete is getting matched with an SBA lender that’s capable of meeting your needs. You can complete this step online via the U.S. Small Business Administration’s lender match tool. 

The lender match process requires you to complete a brief questionnaire. After you do so, it could take a few days for the system to locate a lender match for your business (though sometimes the process is faster).

Gathering documentation and applying for the loan: Up to 30 days.

The next step in the SBA loan application process is typically the lengthiest and the most difficult for you, the business owner, to complete. SBA loans feature extensive paperwork and documentation requirements. Below is a sample—though certainly not a comprehensive list—of items your lender may want you to include with your SBA loan application. 

• Business licenses
• Detailed list of debts
• Current income statement
• Personal income tax returns (previous three years)
• Business income tax returns (previous three years)
• Business financial statements (profit and loss statements, cash flow projections, etc.)
• Loan application history
• Resumes for principal owners
• Real estate appraisals (collateral)
• Lease agreements (collateral)
• Franchise, asset purchase, real estate purchase, or other purchase agreements (based on loan purpose) 

Depending on the loan purpose and your business’ record-keeping habits, this step might take anywhere from a few days to an entire month. 

Underwriting: As little as 2 weeks up to 3 months.

Once the application is complete and submitted with all required documents, the loan enters the underwriting phase. This is when the lender reviews all the information and documents you provided to determine your eligibility. The underwriting process for an SBA loan can range significantly in duration. Some lenders are able to expedite their review and make a decision within as little as two weeks. However, for more complex applications or during times of high demand, this process can extend up to three months.

During underwriting, the lender assesses the risk of lending to your business, which includes evaluating your financial statements, credit history, business plan, and the collateral you’ve offered. To improve your chances of a favorable outcome and possibly expedite this process, ensure all documentation is accurate, comprehensive, and well-organized.

Waiting for a loan decision: 1-3 weeks.

Once you submit your loan application, it can take several weeks for a lender to review your documents and underwrite your loan. During the application review and underwriting process, the lender will analyze your creditworthiness (aka your likelihood to repay debts) and your capacity to repay (aka whether you can afford additional debt). 

Other details a lender may evaluate include:

• Value of collateral provided
• Business revenue
• Credit history (personal and business)
• Credit scores (personal and business) 
• Personal and business debts

If your application passes through the underwriting process and a lender approves your application, the next step will be to schedule a loan closing date. 

Receiving your loan proceeds: 1-2 weeks (sometimes up to 90 days).

Once a lender approves your application for an SBA loan, it will put together some paperwork to finalize your loan agreement. This process also takes time. (Note: For commercial real estate transactions, you might also have to hire an attorney to facilitate appraisals and title work, and process other legal documents that could add more complexity and time to this process.)

It’s common for an SBA lender to need several weeks to prepare the paperwork you will need to review and sign before you can receive your loan proceeds. That time frame can easily be doubled, tripled, or more with commercial real estate transactions. And some banks warn that the loan closing process for SBA loans could take up to three months.

How long each loan type takes.

Every SBA loan type has its own unique timeline, shaped by varying application requirements and review processes. Understanding these differences can help you better plan for the future and set realistic expectations for the funding your business needs. Here's a brief overview of how long you might expect to wait for some of the most common SBA loan types.

SBA 7(a) loans: 60-90 days.

The SBA’s most common loan program is the SBA 7(a) loan. This general purpose loan can provide borrowers with up to $5 million in funding. Eligible business owners can use SBA 7(a) loan proceeds for a variety of business expenses, including the purchase of commercial real estate, working capital, business supplies, furniture, and fixtures, and to refinance existing business debt. 

SBA 7(a) loans are popular due to their versatility and the substantial loan amounts they offer. However, these loans also tend to take the longest of all SBA loan types. From start to finish, it's common for an SBA 7(a) loan application and funding process to last between 60 and 90 days.

Additionally, SBA 7(a) loan terms are generally favourable, with repayment periods of up to 25 years for real estate and up to 10 years for other uses such as working capital or equipment purchases. This long-term financing can help businesses manage their monthly payments more effectively. Furthermore, these loans often come with lower interest rates compared to traditional business loans, making them an attractive option for small business owners seeking affordable financing solutions.

SBA Express loans: 30-60 days.

Another popular Small Business Administration loan program is the SBA Express loan. With the SBA Express Program, qualified borrowers can receive up to $500,000 worth of funding for their businesses. And for loans of $50,000 and under, lenders do not have to require collateral from borrowers. 

After you complete your application for an SBA Express Loan, you can expect to receive a response from the Small Business Administration within 36 hours. However, the lender makes the final eligibility decision. From application to funding, the entire SBA Express Loan process could potentially take as little as 30 days. 

It is important to note that the federal government guarantees only up to 50% of SBA Express loans. By comparison, the SBA 7(a) loan features a 75% guarantee that lenders can rely on in the event of a default. As a result, SBA Express loans are riskier for SBA lenders to issue. So, they might not be as easy to qualify for, depending on the details of your loan application.

SBA 504 loan: 60-90 days.

SBA 504 loans can be a helpful financing option for small business owners who need affordable financing options for certain types of commercial real estate purchases, machinery, or equipment. Eligible borrowers may receive up to $5 million in funding. For certain energy projects, the maximum loan amount may extend to $5.5 million.  

504 loans are backed (in part) by the SBA and made available through Certified Development Companies, also called CDCs. These are nonprofit corporations that aim to promote economic development in local communities. Around 50% of the total project is typically financed through a private business lender as well, along with at least a 10% down payment from the business owner (sometimes up to 20% down). The SBA-backed portion of the loan comes in the form of a second mortgage for up to 40% of the eligible project costs.  

You can start the application process for a CDC/504 Loan by searching for a local CDC on the SBA’s website. In general, SBA 504 loans can take several months to process. Most borrowers will wait at least two to three months from the time they submit their initial loan application before they receive their loan proceeds (assuming all goes well and they qualify for funding).

Note that you cannot use a 504 loan for working capital, inventory, consolidating or refinancing debt, or investing in rental properties. However, these SBA loans may work well for purchase of real estate assets or equipment that can promote job creation or business growth. Companies that will use funding to improve or modernize existing facilities, land, streets, landscaping, etc., may also be eligible for this SBA loan program.

SBA microloan: 30-90 days.

Small business owners can use the SBA microloan program to borrow up to $50,000 to cover eligible business expenses. The average size of an SBA microloan is $13,000. Even though most microloans feature smaller loan amounts, the intermediary lenders that issue the loans (typically nonprofit community-based organizations) may require collateral, plus a personal guarantee from the business owner. 

Although lenders issue microloans for smaller amounts, the loan process can still be slow. If your small business qualifies for funding, it’s common for it to take between 30 and 90 days between the initial loan application and the receipt of your loan proceeds. Remember, both the SBA and an intermediary lender will have to approve your loan application.

Eligible microloan borrowers can use the funding they receive to support their small business in a variety of ways including to purchase inventory, equipment, supplies, machinery, furniture, and to provide essential working capital. However, business owners cannot use SBA microloan funds to purchase real estate or consolidate existing debts.

Factors that affect SBA loan processing times.

Several factors can impact the processing time of SBA loans, making some applications move faster or slower through the pipeline. Understanding these factors can help applicants set realistic expectations and better prepare for the application process. Key elements that affect SBA loan processing times include:

• Business readiness: The more prepared a business is with its financial statements, business plans, and required documentation, the faster the application process can proceed. Incomplete applications or missing documents can significantly delay the process.
• Lender experience: Working with a lender that has extensive experience with SBA loans can also affect processing time. SBA Preferred Lenders, for example, have the authority to process, underwrite, and finalize most SBA loans without direct SBA review, which can speed up the approval and funding process.
• Loan complexity: Larger loan amounts, or loans used for more complex projects (such as purchasing real estate or starting new construction), may require additional documentation and verification, extending the processing time.
• Time of year: Application volume can vary throughout the year, impacting processing times. Periods of high demand can slow down the process, as lenders and the SBA manage a larger queue of applications.
• Accuracy of information: Inaccuracies in the application or documentation can lead to delays as these issues are identified and corrected. Thoroughly reviewing all information before submission can prevent unnecessary setbacks.
• Economic and policy environment: External factors, such as changes in government policy or economic conditions, can influence processing times. For example, during economic downturns or following natural disasters, the volume of applications may increase, slowing down the process for all applicants.

By being aware of these factors, applicants can take proactive steps to mitigate potential delays, such as choosing an experienced lender, ensuring their documentation is complete and accurate, and applying during lower-demand periods when possible.

How to speed up SBA loan processing times.

While the SBA loan process can be lengthy, there are several strategies you can employ to help expedite your application:

1. Get prequalified: Before you formally apply, some lenders offer a prequalification process that can give you an idea of your eligibility and the potential loan terms. This can help you identify and resolve issues that might slow down the full application process.
2. Organize your documents: Ensuring that all your financial documents, business plans, and personal credit histories are in order before you apply can save valuable time. Missing paperwork or unclear details can cause delays, so it's vital to prepare everything meticulously.
3. Work with SBA Preferred Lenders: Choosing to work with SBA Preferred Lenders can significantly speed up your loan processing time. These lenders have demonstrated their proficiency in processing SBA loans and have earned the authority to underwrite and finalize most SBA loans without needing to direct SBA review. This streamlined process can reduce delays and help you receive your funds faster.
4. Clear communication: Maintain open lines of communication with your lender. Promptly respond to any requests for additional information or clarification to avoid bottlenecks.
5. Hire a professional: Sometimes, hiring a loan consultant who specializes in SBA loans can be worth the investment. They can help you navigate the application process smoothly and identify and address potential issues before they become obstacles.
6. Consider smaller loan amounts: If possible, apply for only the amount you need. Smaller loans often require less documentation and can be approved more quickly than larger, more complex loans.

By following these tips, you can enhance your chances of a swift and smooth SBA loan approval process, helping you secure the funding your business needs with as little delay as possible.

SBA loans vs. other small business loan types.

When deciding on the best financing option for your small business, it’s vital to compare SBA loans with other available loan types. This evaluation can help you determine which loan will best meet the needs of your business, considering factors like interest rates, repayment terms, and application complexity.

Traditional business loans.

Traditional business loans, offered by banks and credit unions, are a common choice for many business owners. These loans typically provide funding quickly once approved, often within a few weeks. However, the requirements for obtaining a traditional business loan can be stringent. Lenders usually look for strong credit scores, a solid business history, and substantial collateral. Interest rates can be higher compared to SBA loans, especially for businesses deemed risky.

Merchant cash advances.

Merchant cash advances (MCAs) provide small businesses with an advance on their future credit card sales. They are typically easier to qualify for than SBA loans, making them an appealing option for businesses with less than stellar credit. However, MCAs come with higher costs, including elevated interest rates and fees, which can make them more expensive in the long run. Repayment is usually tied to daily credit card transactions, potentially straining cash flow.

Business lines of credit.

A business line of credit operates much like a credit card, offering flexible access to funds up to a certain limit. Once established, you can draw from the line of credit as needed and repay it over time. This type of financing is ideal for managing cash flow or handling unexpected expenses. While the application process for a business line of credit can be quicker than for an SBA loan, interest rates may be higher, and the repayment terms could be less favorable.

Equipment financing

Equipment financing is specifically designed for purchasing machinery or other business-related equipment. The equipment itself often serves as collateral, making it easier to qualify for this type of loan. Interest rates and terms can be more favorable compared to other forms of financing. However, this type of loan can only be used to purchase equipment, limiting its flexibility compared to an SBA loan.

Invoice factoring

Invoice factoring, or financing, allows businesses to sell their unpaid invoices at a discount in exchange for immediate cash. This type of financing can be quick and relatively easy to obtain, making it a good option for businesses that need to improve cash flow quickly. The downside is that it typically comes with higher fees and interest rates, and relying too heavily on this type of financing can become expensive over time.

In summary, while SBA loans often come with lower interest rates and favorable terms, the application process can be lengthy and complex. In contrast, other small business loan types may offer quicker access to funds or be easier to qualify for, though they often come with higher costs or more rigid usage restrictions. Evaluating your specific business needs and financial situation carefully will help you choose the most suitable loan option for your circumstances.

The bottom line.

The U.S. Small Business Administration provides many attractive financing options to support small business owners throughout the country. And when it comes to the cost of the loan and loan terms, SBA loans tend to be generous in both areas.

With a proprietary application platform that makes uploading documents fast and easy and a dedicated SBA team on call to answer any questions you have and assist you throughout the funding process, we’ve made it as easy as possible for business owners to access an SBA loan. Learn more about applying for an SBA loan.

Lenders use the debt-service coverage ratio (DSCR) to determine whether your business qualifies for a loan and under what terms. This is just one metric that financial teams consider (along with factors like your credit score and tax returns), but it is vital because it helps you get a fair rate and approval for your request. 

Your DSCR highlights any existing debt you may have and if you can realistically pay it off. Learn more about this concept and what it means for your loan application chances.

What is the debt-service coverage ratio (DSCR)?

The debt-service coverage ratio (DSCR) is essentially a numerical figure that represents your business's ability to repay its debts. It's calculated by dividing your business's net operating income by its total debt service obligations over a specific period, usually a year. A simpler way to think about it is comparing the money your business makes to the money it owes. If your DSCR is 1.00, that means your net income exactly covers your debt payments. Most lenders look for a DSCR higher than 1.00, indicating you have more income than debt and can comfortably manage additional loan payments. A lower DSCR, on the other hand, signals potential risk to lenders, as it suggests your business might struggle to meet its debt obligations.

How do you calculate your DSCR?

You can easily calculate your DSCR once you have your ledgers balanced and have developed a clear picture of the financial risks associated with your business. 

This is the formula to track your debt-service coverage ratio:

Net Operating Income / Debt Service

For example, if you took out a $20,000 loan and have a net operating income of $30,000 for the year, your DSCR is 1.5 ($30,000/$20,000).

Once you calculate your DSCR, you can evaluate whether your income and proposed debt are proportionate or if you need to make changes to become profitable. Here is how you read the ratio:

• If your DSCR is greater than 1.00, you have the operating income necessary to pay off the debt.  
• If your DSCR equals 1.00, you have just enough operating income to cover your debt.  
• If your DSCR is less than 1.00, you do not have the operating income you need to cover your debt. 

Continuing the example, if your business has to close for 6 months and you only have an operating income of $15,000, a $20,000 loan would place your DSCR at 0.75.  

Most lenders prefer applicants to have a DSCR of at least 1.25. This creates a safe cushion in the event that a company’s net operating income decreases unexpectedly.

What is net operating income?

As you learn about the debt-service coverage ratio, you may want to take a step back and learn about net operating income—an important term to help you calculate your DSCR. 

Net operating income tracks a company’s ability to generate a positive cash flow. It is calculated by subtracting your operating expenses from your gross operating income (or revenue). 

For example, someone who owns a real-estate rental property might collect $1,000 each month in rent and $75 monthly in fees for internet and utilities. The landlord would have $1,075 in gross operating income. The operating expenses would include taxes, home insurance, and upkeep like a lawn service. If these expenses cost $475 total, the landlord’s net operating income would be $600.

Why does DSCR matter?

Understanding your debt-service coverage ratio (DSCR) isn't just about getting through the door with lenders—it's about financial health and strategy for your business. It matters because it provides both you and potential financial partners with a clear, quantitative measure of your company's ability to manage and service its debt with the income it generates.

In a real sense, DSCR is a litmus test for financial stability. A strong DSCR indicates to lenders that your business has a healthy cash flow, making it a lower-risk investment. For you, it's a signal that your business operations are generating enough profit to comfortably handle your current debt obligations, plus some. This can give you the confidence to pursue expansion or improvement projects, knowing that your fundamental finances are solid.

Furthermore, understanding and improving your DSCR can open doors to better loan terms, including lower interest rates, more favorable repayment schedules, and higher borrowing limits. In contrast, a lower DSCR might prompt a reassessment of your business strategies and financial management practices to bolster your operating income or reduce debt, protecting your business from over-leveraging and financial distress.

Remember, lenders and financial analysts see the DSCR as a direct reflection of your business's financial health and its future prospects. That's why paying attention to this ratio isn't just about securing loans—it's about securing your business's future.

What is a good DSCR?

A "good" DSCR is somewhat subjective and can vary by industry, but as a rule of thumb, lenders typically look for a ratio of 1.25 or higher. This benchmark indicates that a business has enough income to cover its debt obligations with a little room to spare, which in turn suggests financial resilience. Specifically, for businesses operating in sectors with more predictable cash flows, such as manufacturing or retail, a DSCR closer to 1.00 might still be acceptable because their income streams are more consistent. On the other hand, industries subject to seasonal variations or cyclical demands, like agriculture or construction, might need a higher DSCR to account for periods of reduced income.

It's crucial to understand that a higher DSCR not only improves your chances of loan approval but also may result in more favorable loan terms. This is because lenders perceive a lower risk when a business demonstrates a strong ability to generate profit in excess of its debt obligations. Conversely, a DSCR below 1.00 is a red flag, signaling potential difficulties in meeting debt payments which might necessitate immediate financial restructuring or strategic adjustments to improve profitability.

In essence, while the "ideal" DSCR can vary, aiming for a ratio that comfortably exceeds your lender's minimum requirement is a wise strategy. It positions your business as a sound investment and provides you with leverage during negotiations, potentially saving your business significant amounts in interest and fees over time.

What do lenders learn from your DSCR?

The DSCR is an indicator of risk for your business loan. If you have a low DSCR (or a ratio that is close to 1.00), you are more likely to default on your loan. You may have to miss payments if you don’t maintain your net operating income or you may require additional loans to cover your costs.  

A low DSCR can also cost your business money. Not only are you more at risk for a loan denial because of this ratio, but your lender may charge higher interest levels and have fewer forgiveness options if you get approved. 

You could end up paying more fees and extra expenses to the lender in order to pay off the loan. Your lender might also require you to pay off the loan faster, limiting your other business investment opportunities.

How to improve your DSCR.

There are multiple steps you can take to improve your DSCR, but few offer easy solutions. You may need to make significant adjustments to your business to improve your financial standing. A few options include:

• Decreasing your operating expenses. (Lower payroll costs by adjusting your staff, cancel a few non-essential services.)
• Pay off some of your existing debt. (Wait a few months until your debt is lower to apply.)
• Decrease your borrowing amount. (Take out a smaller loan and apply again after you pay that one back.)
• Increase your net operating income. (Find ways to grow your sales without driving up costs.)

Each solution will have its own benefits for business owners. Some will find it easier to lower their borrowing amount, while others will want to cut expenses to get the funds immediately.

Know your DSCR before you apply for a loan.

You can reduce your risk of loan rejection by calculating your DSCR beforehand. You can understand how likely it is that your loan will get denied based on this score. A higher DSCR isn’t a guarantee for approval, but it can make your loan application look better.

Get to know some of the loan options through Lendio’s comparison guide. You can get an idea of the amount of funding you need and the flexibility required to spend the money how you want. Find what works for you today.

In the fast-paced world of business, maintaining a steady cash flow is crucial for survival and growth. However, even the most well-run businesses can hit a rough patch or find themselves in need of quick capital to seize a growth opportunity. This is where cash flow loans come into play. Think of them as a financial lifeline, designed specifically to keep your business afloat during precarious moments, helping you navigate temporary cash crunches or seize golden opportunities. Whether you're looking to cover operational costs, invest in new equipment, or simply need a cushion during a slow season, understanding how cash flow loans work could be the key to unlocking your business's potential.

What are cash flow loans?

Cash flow loans, in simple terms, are based on the future cash flows of a business. Rather than focusing on the hard assets of the company, lenders evaluate the projected revenue and cash generation capabilities when deciding to fund. This makes cash flow loans particularly appealing for businesses that may not have substantial physical assets, but have strong revenues and profit margins. Essentially, it’s about borrowing from your future self—using tomorrow’s earnings to fuel today’s growth and operations. These loans can be flexible, offering businesses the necessary breathing room to manage expenses, invest in new projects, or expand operations without the immediate burden of traditional asset-based lending requirements.

How do cash flow loans work?

Cash flow loans typically work by allowing businesses to borrow based on their projected cash flows. This is calculated using the business's current financial situation, including income and expenses, to estimate future earnings. Lenders utilize this forecast to determine how much money they can safely lend, ensuring that the business can repay the loan from future income. The process usually involves detailed financial analysis, including a review of the business’s sales history, profit margins, and cash flow statements.

The repayment terms for cash flow loans can vary significantly depending on the lender and the financial health of the business. Generally, these terms include a fixed interest rate and a repayment schedule that may span months or a year. Importantly, because the loan is unsecured, lenders may charge a higher interest rate than traditional secured loans. This higher cost reflects the increased risk the lender takes on by not requiring collateral.

For businesses, managing a cash flow loan responsibly means closely monitoring cash flow projections and making adjustments as needed to ensure the loan does not become a financial burden. It's essential for businesses to consider their ability to manage the loan's repayment schedule, especially during periods where income is lower than expected.

Cash flow loans vs. traditional loans.

When comparing cash flow loans to traditional loans, the key difference lies in the collateral. Traditional loans typically require physical assets as collateral, such as real estate or equipment, making it a challenge for businesses that lack substantial assets but are cash-rich.

Another notable difference lies in the application and approval process. Cash flow loans often boast a faster approval process since the evaluation is heavily based on financial projections and revenue performance, not the valuation of physical assets. This can be particularly beneficial for businesses needing quick funding to capitalize on immediate opportunities or to address sudden financial shortfalls.

However, the trade-off for the convenience and accessibility of cash flow loans is usually a higher interest rate compared to traditional loans, due to the higher risk lenders assume by not requiring collateral. Businesses should weigh these costs against the benefits, considering their cash flow stability, growth prospects, and ability to manage the loan repayment under varying economic conditions.

Ultimately, the choice between a cash flow loan and a traditional loan depends on the specific needs, circumstances, and financial health of the business. Each financing option offers unique advantages and challenges, making it crucial for business owners to carefully assess their situations and future financial projections before making a decision.

Types of cash flow loans.

Cash flow loans come in several types, making them a flexible financing option for many businesses. The types include:

1. Merchant cash advances: Merchant cash advances are a form of financing where a lender provides a lump sum payment to a business in exchange for a percentage of the business’ daily credit card sales.
2. Business cash advances: A business cash advance is another type of financing where a company receives a lump sum of cash from a lender. This amount is then repaid over time via a fixed percentage of the business’ daily sales.
3. Unsecured line of credit: An unsecured line of credit allows businesses to access funds as needed, without putting up any collateral. These credit lines can be helpful for managing cash flow fluctuations or unexpected expenses.
4. Invoice financing: Invoice financing is a form of funding where businesses can borrow money against the amounts due from customers. This option provides immediate cash flow by allowing businesses to turn their outstanding invoices into immediate capital. It’s particularly useful for businesses with long invoice payment cycles, enabling them to maintain operations and growth without waiting for clients to pay.

Pros and cons of cash flow loans.

Before we delve into the advantages and disadvantages of cash flow loans, let’s remember that every business is unique. What works best for one may not necessarily be the right choice for another. It’s crucial to understand your own business needs and circumstances to make an informed decision. Now, let’s get started with the pros and cons.

Pros of cash flow loans

• Fast access to cash. Unlike traditional lending, which can take weeks or months due to the requirement of extensive documentation and collateral valuation, cash flow loans allow businesses to access needed funds in a matter of days. This rapid turnaround can be crucial for covering immediate expenses or capitalizing on timely opportunities.
• Lower credit score requirements on some loans. Since lenders focus more on the projected revenue and cash flows rather than the creditworthiness of the borrower, businesses with less-than-perfect credit can often still qualify. This makes cash flow loans an attractive option for newer businesses or those that have encountered financial difficulties in the past.
• No collateral required in the traditional sense. Cash flow loans do not necessitate physical assets as security, making them more accessible to businesses without significant tangible assets. This characteristic is particularly useful for service-oriented or tech companies, which might not have the equipment or real estate typically required for traditional loans.

Cons of cash flow loans

• Can be more expensive than other forms of financing. Because cash flow loans often come with higher interest rates and fees due to the lack of physical collateral and the perceived higher risk by lenders, they can be more costly over time compared to traditional loans.
• Relies on business generating enough cash flow to repay the loan. A critical consideration for cash flow loans is the dependency on the business's ability to generate sufficient cash flow to meet repayment obligations. Since these loans are based on future earnings projections, any shortfall in revenue can pose a significant repayment challenge, potentially leading to financial strain or impacting the business's credit.
• Riskier for businesses with unstable or unpredictable revenue streams. Businesses that experience significant fluctuations in sales or operate in highly volatile markets may find cash flow loans especially risky. Since repayment depends largely on consistent revenue, periods of low income can lead to difficulties in meeting loan obligations, potentially exacerbating financial instability.

How to get a cash flow loan.

Navigating the process of obtaining a cash flow loan can seem daunting, but with the right approach, it can be streamlined and successful. Here's a step-by-step guide to get you started:

1. Evaluate your financial health: Before applying, assess your business's current financial status. This includes reviewing your cash flow statements, profit and loss accounts, and future financial projections. Understanding these will help you determine how much you need to borrow and can afford to repay.
2. Research potential lenders: Not all lenders offer the same terms for cash flow loans. Spend time researching to find those that cater to your business type and offer terms that align with your needs and repayment ability.
3. Prepare necessary documentation: While cash flow loans may not require collateral, lenders will still expect a comprehensive view of your business's finances. This typically includes financial statements, tax returns, cash flow projections, and a business plan that outlines how the loan will be used.
4. Apply for the loan: Once you have gathered all necessary documents, fill out and submit your loan application. Be prepared to answer additional questions about your business and financial projections.
5. Carefully consider the terms of your loan agreement: Carefully examine the terms outlined in your loan agreement. Pay close attention to the interest rate, repayment schedule, and any fees or penalties for early repayment or late payments. If there are points or terms that are unclear, don't hesitate to reach out to the lender for clarification. Making an informed decision now can prevent misunderstandings or financial strain in the future.

Remember, transparency with your lender about your business's financial health and clear communication can significantly enhance your chances of success in obtaining and managing a cash flow loan.

Exploring alternatives to cash flow loans.

While cash flow loans can be an excellent solution for many businesses, they’re not the only option. Other financing alternatives may be more fitting, depending on your business’ specific needs. Let’s take a look at a few:

1. Invoice factoring: One alternative to cash flow loans is invoice factoring. This method involves selling your unpaid invoices to a third party (i.e. ‘factor’) at a discounted rate. The factor then collects payments directly from your customers, allowing you to get immediate cash. It’s an excellent choice for businesses that have to wait for long periods to receive payments from their customers.
2. SBA loans: SBA loans are backed by the Small Business Administration (SBA) and often come with lower interest rates and more favorable terms. However, they can take time to process and may require more paperwork.
3. Term loans: Term loans are traditional business loans where a lender provides upfront money, repaid over a specified period with interest. They are used for capital investments like equipment or real estate. While term loans have lower interest rates than cash flow loans, collateral and a solid credit history are usually required.

Remember, the best financing option for your business depends on various factors, including your business’ size, its stage in the business lifecycle, its financial stability, and your specific needs. Weigh your options carefully and consider seeking advice from a financial advisor to make an informed decision.

Cash flow loans can be a versatile and valuable solution for businesses requiring extra cash. They provide flexibility and easy access to funds. However, as with any financial decision, it’s important to carefully consider the potential risks. Understanding the nature of these loans—as well as the differences between them and their asset-based counterparts—is crucial for making informed and beneficial financial decisions.