As smart as the average small business owner is, it’s impossible to anticipate and prepare for every need. Plus, what a start-up might see as a crisis, an older business might not. With that in mind, let’s talk about the pitfalls of taking a reactionary approach to meeting a company’s debt capital needs, some of the options and approaches to consider if you find yourself in a situation that requires cash flow now, and a more strategic approach to prevent you from needing a crisis loan in the first place.
Emergency loans can be expensive
The coronavirus pandemic and the Paycheck Protection Program (PPP) have been great options that have helped millions of small business owners overcome the challenges associated with the pandemic. The SBA offered very liberal qualifying criteria, but there were still millions of other small business borrowers who simply couldn’t meet the eligibility requirements and were unable to access this potentially free funding. to help them weather the storm.
Maybe they didn’t pass the credit check because they had bad credit, or didn’t have the basic financial block and equipment in place to provide audited payroll records, or a balance sheet. which showed that they were a profitable business before the crisis — some did not even have a professional bank account. That’s not to say that they weren’t all able to find borrowed capital, but they had to look to alternative (and often much more expensive) sources of capital and paid an annual percentage rate ( APR) well above the potential of 0%. interest rate offered by the federal government as part of the SBA’s P3 forgiveness program.
In addition, many lenders normally present in the market have either significantly reduced their lending operations or have withdrawn from the market altogether for a period of time. Including some of the more easily qualified traditional sources of capital such as business credit cards; or any other short-term financing that is less dependent on a business owner’s personal credit rating and more reliant on their business cash flow and income (which was non-existent for many business owners in the past. the time). This essentially meant that the available alternative financing became very expensive as lenders had to charge high interest rates to mitigate the risks associated with lending in this environment.
How can you better prepare for the next crisis?
Using P3 as a guide, he taught us that there are a handful of things you can start doing today that will help you, should something like this (or any other urgent need for funding) happen again. And keep in mind that it likely will, as business cycles come and go regularly. I have personally experienced a number of recessions throughout my career.
Here is a list of four things to help you prepare so that you can access borrowed capital when you need quick emergency funds to get you through a business crisis:
- Have a professional bank account: Crisis or not, many commercial lenders won’t even consider your loan application if you don’t have a business bank account. Banks that work with the SBA are no different. If you don’t have a business checking account, make it a priority.
- Make sure your financial records are up to date: I agree that most small business owners don’t start a business because they are excited about the accounting process. But most lenders, especially those who give loans in times of financial difficulty or when you need quick financing to deal with some sort of crisis, want to see your balance sheet, income statement, and accounts. results are all in order. Plus, they’ll likely want electronic access to your business bank account to confirm that you have the income and cash flow to make the periodic payments.
- Show a profit on your balance sheet: It is common for many small business owners to do a little financial gymnastics to reduce their tax burden at the end of the year by posting a loss rather than a profit. It’s understandable, but a lot of companies just couldn’t qualify for the P3 because they didn’t have the financial records to show they were a profitable business in 2019.
- Pay attention to your personal and professional credit profile: Your business credit history is important. Your personal credit score too. For example, if your personal credit score is below 650, you have options, but they will come with higher interest rates and stricter repayment terms. If you don’t know your current credit situation, you can view your personal credit score and business credit for free on Nav.
Quick financing options when your business is struggling
Because we can’t always predict when a crisis will strike or when you might need quick access to extra cash, here are some options to consider:
- Business line of credit: I am a huge fan of the line of credit. It gives you access to emergency capital when you need it. You can use it, pay it off, and use it again the next time you need extra cash to cover a crisis or take advantage of an opportunity. And you only pay interest on what you use. This requires that you plan ahead and have the line of credit in place before you need to draw on it and you will need to make sure that you can meet the qualifying criteria before going through the application process. Fortunately, they are also widely available from traditional financial institutions as well as online lenders. So, depending on your situation, you may be offered a business line of credit.
- Business credit cards: There are a number of reasons to love business credit cards, but like a business line of credit, you need to apply before you actually need to access cash. Fortunately, if you’re a start-up business with no long credit history, most credit card providers primarily look at your personal credit history to make an approval decision. So if you have a good personal credit score, you will likely be approved.
- Online lenders: There are more loan options today than ever before, including short-term loans to meet an emerging need. Unlike many traditional lenders like a bank or a credit union, online lenders offer loans for small amounts that you would likely need to meet unforeseen expenses like repairing essential equipment, resolving problems. a plumbing problem or any other need for quick cash. . While interest rates are likely higher, the loan application process is faster and easier, approvals can be the same day, and you might even have money in your bank account the next business day. Be aware, however, that you probably won’t be looking at monthly payments, but rather a daily or weekly withdrawal from your business bank account.
- Cash advance financing: This type of funding comes in many forms. A cash advance is not really a loan. A merchant cash advance or MCA is more like a credit card cash advance. The MCA provider grants you an advance based on your daily credit card receipts going through your merchant account. A business cash advance is an advance based on your cash flow. This type of financing is readily available, relatively easy to obtain, and you can access it quickly, but it is expensive. Depending on the provider, the costs associated with a cash advance can be much higher than the other types of financing mentioned above. In addition, since these providers generally do not express their costs as an annual percentage, it can be difficult to compare them to other types of financing. This Nav Calculator will help you determine the APR for a cash advance.
When I talk about strategic borrowing, I’m talking about anticipating needs and ensuring that a business is proactive in meeting them – when borrowing can be anticipated. I understand that many entrepreneurs tend to make a lot of decisions on the fly. Due to the costs involved, I don’t think this should be one of them.
Sitting down to plan and anticipate the ebbs and flows of the coming year, taking the time to consider initiatives that might require additional capital, and honestly assessing the ability to successfully apply for a loan is the first step. A more reactionary approach could mean the rejection of a loan application and a lost opportunity and potentially increased costs
Abraham Lincoln is credited with saying, “If I only had an hour to fell a tree, I would spend the first 45 minutes sharpening my ax.
Strategic borrowing involves sharpening the ax.
This doesn’t mean that you will always be able to anticipate when you will need financing, which is why some of these other options are available. That being said, the more strategic you can be in how you prepare and anticipate your business financing needs, the better able you will be to find the best loan with the right costs and the most favorable terms.
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