Financing for Small Business: Should You Risk Capital Loans?
This is a sponsored post to help new businesses with alternative financing from my friends at Small Business Loans Australia. Enjoy!
A great number of promising companies fail because they run out of money. Loans seem like a solution that should prevent this. However, only 48% of small businesses manage to meet their financing needs. Being a new business with no credit score means your chances of getting a good business loan are minimal. Therefore, you have to look for riskier solutions, like capital financing.
If you choose to go that route, you need to understand the pros and cons of capital loans and prepare adequately. Use this type of financing very responsibly and only if you are ready to deal with its potential pitfalls.
Capital Financing Vs. Traditional Business Loans
A traditional loan, offered by a bank, has a great number of highly specific requirements. At the minimum, a business aiming to get this type of financing must provide a solid business plan that proves it can be profitable. The applicant also must have a good credit score and, preferably, offer some collateral.
Of course, the majority of new and struggling businesses won’t have all those things. Capital loans are your way to work around those requirements as they are offered by private lenders with less stringent terms. However, when you look into capital financing explained, you’ll see that these loans are extremely varied. Every lender has their own unique set of requirements, so it’s possible for nearly all businesses to find some solution.
In theory, capital financing should be based on the amount of money your business makes on average. This means that the lender studies that data and determines the maximum size of the loan based on it. For example, PayPal Working Capital allows you to borrow up to 35% of your annual PayPal sales. However, there are additional requirements such as the minimum total amount of sales, their frequency, etc.
Private lenders are usually more flexible. What’s more important, they are often willing to renegotiate their general terms for individual clients. For example, if you have some collateral to offer, the interest rate on a capital loan might be reduced. It’s different for every lender, so you’ll need to study each available option closely.
Capital Financing: Pros and Cons
Capital financing is versatile, which is its main advantage by default. This enables every business to find some kind of solution for their immediate money problems. Other advantages of these loans also include:
- Capital loans are easy to get even if your company is completely new and you have no collateral or other guarantees to offer.
- Lenders offering these loans are often willing to work with businesses that have a poor credit rating.
- You get the money fast, so this loan can be used to deal with immediate cashflow issues.
All these things make capital financing appear as the miracle solution for all business’ problems. However, these advantages come at a price, that’s often too steep for small businesses to pay.
- Capital loans have much higher interest rates than banks.
The worse your company’s situation is, the higher the rate would be. Therefore, if you can’t offer any collateral and have a bad credit rating, the loan might be impossible because even if your business does good work, all the money you make will pay off the interest.
- Capital financing is often treated as a type of personal financing and tied to the business owner’s credit score.
This means that if you default on a loan, your personal credit rating will suffer as your business collapses.
When Should You Risk Taking a Capital Loan?
As you can see, the risks of capital financing are as big as its advantages. Therefore, you need to consider your situation very carefully. Also, you have to be realistic when you evaluate your ability to pay off the debt. Defaulting on alternate loans means trouble and can cost you your business and personal bankruptcy.
To avoid this, you should only take out this type of loan if:
- You need the capital to use short-term.
You have to be sure that you’ll get some money back in order to pay off the loan fast and minimize the interest payments. Please note that you need to study the loan’s terms very carefully and only use the one that allows for early repayment.
- You are confident that you’ll be able to pay off the loan fast.
You need to be as sure as possible that this infusion of capital will provide results. At the least, you have to be sure that you have something big enough to sell in order to pay off the loan.
- You only need some cash to tide you over before loan approval.
This kind of financing might be a good short-term measure if you are sure that a bank will grant you a loan with better terms. You’ll be able to use part of that business loan to pay off the short-term on with high interest.
Capital financing seems great and it can be a true lifesaver for small businesses in some situations. However, you should never forget that these loans are extremely expensive and they can put you out of business fast. Therefore, only use them when your situation is dire.
Read Next For Financing for Small Business: