The Small Business Owner’s Guide to Short-Term Business Loans
Short-term loans can act as a bridge between a liquidity crisis and long-term financing. Read on to find out when they’re useful and how you can get one.
Business is unpredictable. You can go months without running out of cash and then suddenly two customers don’t pay on time when you need to buy inventory in bulk and you start to scramble.
At a time like this, it makes no sense to commit to a long-term loan that will keep you paying interest for years. Let’s see how to get a short term loan for your business.
Overview: What is a short-term business loan?
Short-term small business loans are intended for one-time liquidity crises. It can be a time gap between a loan maturing and closing a new loan to pay it off. The use of the loan is generally either to pay off an existing loan or to use working capital as needed.
Short Term Loan Eligibility Requirements
The following items are often required to qualify for short term loans for your business.
Short term loans are often unsecured and the short term lender will require a personal guarantee to reduce risk. This means that if the loan is in default, you will be personally liable, even if your business is an LLC.
Lenders will go one of two directions. Either they will do a full underwriting of your business, which would require financial statements, a business plan, and other miscellaneous documents, or they will run your business through an algorithm to get a quick decision.
If they do a full underwriting, it will be a little different from a normal term loan. Usually the bank wants to see if your income can support loan repayments. With a short-term loan, you often only make interest payments or no payments until the full amount is due. Thus, the bank will examine your working capital position and analyze whether you will have the necessary cash to repay the loan when it comes due.
The best short-term business loans, at least in terms of ease of application, use an algorithm to score your business. One of the banks I worked for had a hybrid model, where we managed small potential loans through a software model, and then still did a mini-underwriting.
If the lender you are applying to uses only an algorithm, it will likely be based primarily on your personal credit score and your business credit score. Your personal credit score matters the most.
Years of studies on failed loans have led lenders to believe in the effectiveness of personal credit scores for business loans. If your score is lagging, work to pay off revolving balances and deal with existing judgments or derogating accounts.
Benefits of Short Term Business Loans
Here are the benefits of getting a short term loan.
Most traditional home loans end with a lump sum payment. The bank structures the loan to have a monthly payment based on a 20-year term, but after 10 years the balance is due. A lot can happen in 10 years, and it can be difficult to find financing to pay off the balance, especially because the first 10 years of payments won’t be enough to pay half the principal balance.
If you’re stuck in underwriting or even trying to sell the place, you may be able to get a short-term loan to pay off the note until you can pay it off in full.
Seasonal businesses often struggle to meet payroll or other fixed expenses during off-peak months. It’s easy when the money is flowing, but once the customers stop, you have to be disciplined to keep the lights on. Short-term loans can help pay operating expenses until you start making sales again.
Economies of scale
Larger companies can reduce their inventory costs by purchasing a (sometimes literal) ton of inventory at once. This helps suppliers better clear their existing stock and budget better. Small businesses often cannot make these same large purchases.
However, if you know you’ll be able to quickly turn over inventory with a one-off sale or by selling at a conference, it might definitely be a good idea to seek out a short-term loan to make a large purchase if you can get a hold of it. discount.
The two things to keep in mind are the likelihood of returning inventory – you don’t want to lose money with inventory burning a hole in your warehouse for three years – and whether the cost of the loan is in fact lower than the discount on the purchase.
Disadvantages of short-term business loans
Here’s where you can go wrong with getting a short-term loan.
Short-term loans carry higher risk than long-term loans, and lenders compensate for this by charging higher interest rates and fees. Pay attention to the annual rate. If you get an 8% rate on a four month loan, that’s an annualized rate of 24%.
Amount of the loan
Another way for lenders to reduce risk is to take out a large number of small, short-term loans. Lenders often have a policy stating the highest amount they will accept for loans that meet certain risk characteristics.
If you need to buy real estate or major equipment, you’d better try to find a loan term that matches the duration of the purchase.
It’s theoretically possible to keep continuously refinancing short-term loans with other short-term loans forever, especially if you’re using a lender that underwrites with an algorithm and doesn’t care about product usage.
Don’t fall into this trap. If you have a bunch of floating short-term loans with high rates, consider applying for an SBA loan to refinance them all into one note.
How to find and apply for short-term business loans
If you need a short-term loan, here’s how to get there.
1. Start with your bank
The best option is to get a loan from your existing bank. If you have a good relationship with a community bank, they’ll probably be willing to make an exception to the policy to provide a short-term loan that they normally wouldn’t.
Bank loans will have lower interest rates, lower fees, and more capable relationship managers.
2. Think about credit cards
If you already have business credit cards, consider maxing them out before hiring a new lender. This will reduce your overall fees and you will likely earn reward points. You can also contact your credit card provider if they can usually make short-term notes and if they already have information about your business.
3. Online lenders
I don’t have much experience with online lenders, but I do know that the rates for short-term business loans from an online lender will generally be higher than what you would get from a bank. This is because online lenders usually only have one product and cannot make a profit from other sources of fees, such as deposit accounts or cash management.
If you do end up going through an online lender, take the time to research the company first to make sure they are reputable and that you won’t be surprised by any hidden fees.
Ready, ready, ready
There are endless types of loans, but they are all taken out the same way: Can you make the payment(s) on time? Likewise, the process of finding a loan and budgeting will be essentially the same no matter what type of loan you are looking for.
Remember to take the time to consider your options and avoid loans with high interest rates and fees when you can.