3 questions to ask yourself before you look for a small business loan

Photo courtesy of Morguefile user Dodgerton Skillhause

Photo courtesy of Morguefile user Dodgerton Skillhause

There was a time when banks were the primary source of capital for small business. We’ve discussed how the market is changing before, but even traditional voices like former SBA administrator Karen Mills is discussing the change in small business finance and identifies alternative lenders as the change agents. “Alternative players have the potential to fundamentally change the way in which small businesses access capital,” she writes in the final installment of a four-part series on the availability of bank capital for small business for the Harvard Business School.

Although alternatives to the bank have been around in one form or another, Mills identifies a number of factors that contribute to the growth of the segment in today’s market:

  1. Institutional debt and equity investors have been attracted by the relatively high rate of returns available in the lending market
  2. Alternative lenders are simplifying the process and making it more convenient for small business borrowers—many applications can be completed in as little as 30 minutes
  3. Alternative lenders look at risk differently—they use predictive modeling, data aggregation, and electronic payment technology to assess the health of a business

I’m convinced the day when the average small business owner could go into the bank and get a “general purpose” type loan are over. The specialized nature and higher cost of alternative financing make it more important than ever before that small business owners go into the process more informed about available options, costs, and with more understanding regarding what’s happening within their businesses. With that in mind, here are three things to consider when taking advantage of the opportunities to secure capital with alternative lenders:

1. Do you know how you’re going to use the capital?
Despite what you might think, this is not a silly question. I can’t count the number of times I’ve spoken to a small business borrower who can’t articulate what he or she plans to do with the loan proceeds they’re asking for. Most of the capital available through non-bank, alternative lenders, is designed to address short-term needs and shouldn’t be considered a long-term solution for cash flow or financing growth (at least that’s my opinion). For example, some time ago I spoke with a small business owner who had just won a fairly substantial contract from the federal government and needed capital to ramp up. He was looking for a short-term loan to get his company through the first 60 days to accommodate the government’s pay cycle.

He was turned down at his local bank, but Lendio was able to connect him with an alternative lender willing to offer him a short-term loan to get over the hurdle of ramping up staff and equipment. Because he was able to access the capital quickly, paying the premium was a smart decision because he would have otherwise not been able to service the contract.

2. Will the extra capital have a positive impact on the business?
My father believed if borrowed capital wasn’t going to have a positive impact on the business and wasn’t used to facilitate an essential business need, he didn’t borrow. If it wasn’t critical to the bottom line, he would do without until he could invest either cash flow or savings.

That’s not to say he never borrowed, he did. He just made sure it was going to add value to his company’s bottom line. This approach is even more important as the cost of borrowed capital increases.

I’m surprised at how many people when asked, “How much are you looking for,” respond with, “How much can I get.” It’s like going into the car dealership looking for a used Chevy sedan and leaving with a brand new Corvette. The burden associated with borrowed capital is significant enough that a small business owner should probably be thinking more about the smallest loan amount that will accomplish the objective—in other words, being happy with the used sedan.

3. Do you know the numbers?
It’s critical to know what the financial reports are telling a small business owner about his or her business. I understand that most Main Street business owners don’t go into business because they’re jazzed about becoming a financial analyst, but if a business owner can’t read and understand a financial statement, a profit and loss report, or the other financial reports a bookkeeper or accountant would create, it becomes difficult to determine whether or not the business is even capable of servicing any debt.

Any CPA or accountant should be able to explain in detail (so you can understand it) what the reports are telling you. If they can’t or are unwilling to spend the time to make sure you understand, you have the wrong person.

If you can answer these three questions, you may be in a good position to leverage financing from an alternative lender to help your business grow and thrive.

Is your small business looking for a loan? Did this article help? Let us know what you think by leaving a comment below or by reaching out to us on Facebook or Twitter.

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