Bank drive-thru

What You Need to Know About Small Business Loans

I’ve been with my local bank since I was a teen. While opening a bank account isn’t too exciting, the exciting part was the thought of being able to write checks to pay for things. (Not anymore!) Recently, I emailed my bank contact to request a debit card who sent a friendly reply. After a little back and forth, she said she knew of me. How? I lived an hour away from the bank, so all my transactions were online or by mail.

It turned out that Theresa knew my mom. We had a nice email conversation as she took an interest in my background and asked questions. I enjoyed the conversation and appreciated her personal service. Once upon a time, small business owners had a similar relationship with their local banks. When it was time to grow business or request financing, owners drove to the bank where they most likely knew someone.

They probably knew each other through their kids who attended the same school or played on a team together. Maybe they crossed paths at the grocery store or a restaurant. This personal relationship led to a trusted financial partnership. That’s why I stuck with my bank all these years regardless of where I lived.

Yet, when my family visited our neighborhood bank, no one had a clue who we were. And we once had an incident that required a lot of interaction. They still didn’t remember us nor we them. Today, many business owners don’t know a soul at their local bank. They can no longer count on them for help.

Although there’s been a slight improvement in recent years, big bank lending to small businesses has barely budged. Small banks tend to be a better option, but bigger banks have swallowed up the community banks and many went out of business. Skip going to a bank. You’ll save yourself a lot of time and headaches. Instead, read on for alternative financing options.

Why small businesses loans remain low

Like everything else, small business lending took a hit during the recession. It’s slowly recovering. Still, the chances of approval remain low. According to Biz2Credit Small Business Lending Index, banks deny 80 percent of the small business loan requests.

Here are three reasons why big banks avoid loaning to small businesses.

1. Less profit on smaller loans

Banks are in the business to make money. To get a better chance of business loan approval from a big bank, small businesses need to think big in the amount they ask for in a loan. Like $1 million big. The transaction costs for small loans isn’t much less than those for a big loan. Thus, big loans make more money.

Considering the median U.S. Small Business Association (SBA) loan size is $130k to $140k with the highest being $250k, most small businesses don’t come close to the amount that big banks want to see.

2. More regulation

The financial recession of 2008 has forced banks to tighten their loan requirements and take fewer risks. Banks know that working with a small businesses involves more risk than working with large businesses. They want to limit risks.

Banks need assurance that a small business can survive any potential downturn. Global capital requirements have grown more complicated. U.S. regulators are enforcing more control over whether banks can issue a business loan.

3. Fewer community banks

Community banks have a higher approval rate on small business loan than large banks do. Unfortunately, the number of community banks has declined since the savings and loan crisis in the 1980s followed by the financial crisis of 2008. Partly due to the Dodd-Frank Act, their share of U.S. banking assets and lending markets has dropped to 20 percent. Since the law passed in 2010, community banks’ shrinking assets have doubled.

Alternative lending options

What are other sources of funding? That’s where alternative lenders can help. Because these lenders aren’t banks, they don’t have the same strict rules and restrictions that banks do. Many of these alternative lenders are online.

But be careful. Some don’t list all their fees up front. When you ask questions to lenders, inquire about their fees. Find out all of them. A client had a hard time cutting ties with a merchant cash advance provider because of their exorbitant fees.

Invoice financing — also referred to as accounts receivables financing and factoring — is a flexible financing solution that can help your business be more competitive while improving your cash flow, credit rating, and supplier discounts.

Unlike traditional bank financing or merchant cash advances, invoice factoring relies on the financial strength and credit worthiness of customers, not the business owner. Unlike most loan options, this isn’t a loan. This is money your clients owe you. This option can help you get the money faster.

SBA loans are loans facilitated by the SBA. The SBA doesn’t provide the loan. Rather, it acts as a guarantor and connects small business owners with third party lenders through its loan programs. The organization simplifies the process, guarantees a bond, and provides financial assistance programs through surety bonds, debt financing, and private investment funds.

Merchant cash advance (MCA) providers advance a loan based on future credit card or debit card sales. The MCA provider gains access to a company’s credit card or debit card account to take a percentage for itself. Since B2B companies often don’t have credit card or debit card sales, the MCA provider will access their bank or PayPal account.

Because they get their money from future sales, merchant cash advances aren’t loans. This makes them exempt from usury laws that prevent lenders from charging high interest rates and fees. If you work with an MCA provider, find out all the fees up front. Ask what happens if your business slows down and doesn’t bring in enough money to make the payment.

Also beware that it’s not always easy to identify an MCA company. Some refer to their financing program as business cash advance or small business loans.

Instead of driving to the nearest bank, small business owners have other avenues for business financing. Research, ask lots of questions, and do your due diligence. There are lenders who care about the businesses. They’ll go out of their way to help you grow just like Theresa helps me when I need something.

Image credit: Mike Davis

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