Merchants Services

As a small business owner, you need access to capital to fund your business. One way to access capital is through a small business loan. Small business loans are typically used to fund startups or grow an existing business, help buy inventory or furniture, pay for marketing or strengthen the financial foundation of your business. However, accessing credit can be difficult for small businesses, especially those whose owners have bad credit.

According to the 2016 Small Business Credit Survey, or SBCS, released by the Federal Reserve, 45 percent of small businesses applied for some form of financing in 2016. Of those that applied for financing, 76 percent of applicants received at least some financing, but only 40 percent of applicants received the full amount sought.

A lack of affordable capital can negatively affect a business. Fifteen percent of new businesses (under the age of two) and 7 percent of older businesses (16 years or older) reported insufficient financing caused a decline in profits, according to a 2017 U.S. Small Business Administration Office of Advocacy report.

For business owners with bad credit, getting a traditional bank loan can be very difficult. However, there are alternative lenders who offer multiple funding options for those with bad credit. Some have no credit score requirements and consider additional factors including business revenue or how long the business has been established.

In this guide, you’ll learn how small business loans work and how you can find the best loan from an alternative lender to start or expand your small business, even if you have bad credit.

What Is Bad Credit?

The term “bad credit” refers to a poor credit score, usually a FICO scores lower than 640. Your credit score is a numerical representation of your creditworthiness, or how reliable you are at repaying debts. If you have a poor history of repaying debts, you will have a bad credit score.

While credit score ranges can go as low as 300, you typically need at least a FICO score of 600 to qualify for a bad credit loan. Each lender will look at your score to determine what level of risk it is willing to bear.

There are several credit scoring models in use today, but the most common is the FICO score. A second type of credit scoring model, the Vantage Score, is becoming more common.

The FICO credit score range is defined as:

  • Exceptional (800-850)
  • Very good (740-799)
  • Good (670-739)
  • Fair (580-669)
  • Poor (300-579)

The Vantage Score follows a similar model to the FICO score and its range is defined as:

  • Excellent (750-850)
  • Good (700-749)
  • Fair (650-699)
  • Poor (550-649)
  • Very poor (300-549)

When a business loan or any other credit product is marketed for bad credit, it is generally aimed at those with a credit score lower than “good” on the FICO scale. Because they have little creditworthiness in the eyes of lenders, people with a credit score in the range of 300 to 669 can find it very hard to get approval for a small business loan from a traditional bank lender.

Receiving approval for a small business loan is always easier when the applicant has strong credit and steady business revenue, because loan approvals factor in three main criteria: cash flow, credit history and collateral coverage, explains Jay Desmarais, head of regional commercial specialty segments at TD Bank.

“When a business owner has poor or unsteady cash flow, banks and lenders often focus more on the company’s documented financial history and assets,” says Desmarais. “In the current interest rate environment, those with poor credit scores may struggle with their loan approval.”

In addition to your personal credit score, your business credit score may be a deciding factor in receiving financing, particularly from traditional lenders. Just like with personal credit scores, there are many different business scores, with different scoring ranges and intents. Your business credit score reflects your payment history on accounts associated with your business. However, your personal credit history will be used exclusively if your business has no credit history, such as a startup business.

It’s a good idea to work on improving your personal and business credit so you’ll have more options for funding. With good business credit, you may be able to qualify for U.S. Small Business Administration, or SBA, loans, traditional bank loans and other small business loans without having to rely on your personal credit.

How Alternative Lending Works

Alternative lending refers to the broad range of loan options available to both consumers and business owners outside of traditional bank loans. They fill the gap in funding options by offering loans to people and businesses that many traditional banks won’t. Usually, alternative lenders offer loans online and may not have a brick-and-mortar presence like most banks.

According to the 2016 SBCS, small businesses that generate annual revenues of $1 million or less are typically more successful at securing financing from small banks and online lenders than large banks. There is a 60 percent success rate for small businesses that earn under $1 million seeking funding from small banks, and a 59 percent success rate with online lenders.

Startups in business for five years or less that have a medium or high credit risk are likely to see better approval odds with online lenders. They are more successful at securing financing from online lenders, with 45 percent receiving at least some financing. Among the same group, 26 percent received financing from large banks and 35 percent from small banks.

There are two main categories of alternative lenders:

1. Direct lenders: Usually geared toward small to midsize businesses,direct lenders are finance companies that fund your loan while cutting out intermediaries such as a private equity firm, broker or investment bank.

However, while when you work with direct lenders you don’t deal with an in-between, many direct lenders now have financial backing by banks.

2. Peer-to-peer lenders: Through an online marketplace, peer-to-peer, or P2P, lending directly connects borrowers with investors who typically fund small chunks of a diversified loan portfolio.

Advantages

  • Lower approval requirements: While alternative lenders might not offer the best low-interest business loan opportunities, lending criteria tend to be lower than at traditional brick-and-mortar banks.
  • Faster access to capital: Alternative lenders typically has a shorter application process and quicker turnaround times for receiving access to funding.

Disadvantages

  • Personal guarantees: Alternative lending typically requires you to personally guarantee the loan, so your personal credit and assets are at risk if you miss multiple payments, the business fails, or you default on the loan.
  • Higher interest rates: With less stringent lending criteria, alternative lenders take higher risks with borrowers. With higher risk, there are higher interest rates. Interest rates vary, but alternative loan products typically have annual rates starting at 15 percent for a 36-month P2P loan, and up to 45 percent for a four-month institutionally backed loan.

Types of Small Business Financing

Small business loans work like any other loan, with the condition that the funds be used for business-related purposes. Some loans can be used for working capital with looser spending requirements, while others must be used for very specific expenses, such as a commercial mortgage, invoicing or for new equipment.

Types of small business loans typically offered by alternative lenders include:

Term Loans

Term loans are lump-sum loans that provide businesses with a sum of capital. Businesses agree to repay a term loan over a fixed amount of time with a set payment schedule. Each payment you send to the lender includes the principal amount, plus the interest you owe on the loan for that period.

Business Lines of Credit

Business lines of credit are very similar to credit cards. With a business line of credit, a lender approves you for a pool of funds, otherwise known as a revolving line of credit. Like credit cards, there’s a cap as to how much you can borrow. With a business line of credit, you’ll be charged interest only for money you draw, not on the maximum limit.

You can access your line of credit for any business-related needs, whether it’s to expand your business, fill in gaps from cash flow issues, or to purchase inventory or equipment. If you make the minimum payments and don’t go over your limit, you can use your line of credit and repay what you borrowed for as long as you need it. When you’ve repaid the lender in full, you have access to your full line of credit. Borrowers with poor credit are likely to receive business lines of credit with higher interest rates and lower maximum limits.

Equipment Loans

With equipment loans, lenders typically finance 80 to 100 percent of the cost of your needed equipment. The equipment itself can acts as collateral for the loan. While traditional lenders may be reluctant to offer equipment loans to small business owners with poor credit, alternative lenders are more likely to do so.

Invoice Financing

If your small business struggles with ongoing cash flow issues because you’re waiting on outstanding invoices to be cleared, invoice financing (also known as factoring) is an option. While not a loan, with invoice factoring, you sell your unpaid invoices to a lender at a discount. The lender pays you most of the amount owed on the invoice upfront and keeps a portion of the outstanding amount (usually 20 percent) until the invoice is paid.

Invoice financing can be a risky choice. There is a factoring fee based on a percentage of the invoice, plus interest charged on the cash advance. The fees can quickly add up, and small business owners should carefully weigh the costs when considering invoice financing.

Merchant Cash Advances

For small business owners who need speedy access to capital, a merchant cash advance, or MCA, is a financing option. With an MCA, the lender provides you with a lump-sum of cash for a percentage of your anticipated sales.

You repay the advance plus fees with either a portion of your future credit and debit card sales, or with fixed daily or weekly transfers from your bank account. Your fee is determined by a risk assessment. Lower-risk borrowers will have lower fees and more favorable borrowing terms.

Borrowers should beware of the long-term financial implications of merchant cash advances.” It’s almost liked a drug,” says Kevin Monahan, area director for the Florida Small Business Development Center at the University of North Florida. “Small business owners need the money desperately, resort to paying high interest rates, and find themselves with less and less money.”

Merchant cash advances are often a poor choice for businesses. They typically have high interest rates, which can hit triple digits.

Small Business Loan Costs

Keeping loan costs minimal allows you to invest profits back into your business, so the lower your fees, the better. Small business loan costs typically include:

  • Annual percentage rate: The APR is the interest charged on your loan every year. The difference between an APR and the interest rate is that the APR includes all loan fees and associated costs. If you have poor credit, you will typically have a higher APR than small business owners with strong credit.
  • Down payment: In some cases, the down payment for your small business loan is covered by collateral.
  • According to the 2016 SBCS, “Personal guarantees are the most common means of securing debt across smaller- and larger-revenue firms.”
  • Other small business loans require an equity investment. Down payment requirements vary, but you typically will need to invest about 25 percent of your own capital when taking out a loan. However, the more you put down as a down payment, the less risky you are to lenders. If you have poor credit, you may need to give a larger down payment.
  • Factor rate: A factor rate is typically used for merchant cash advances to determine how much the borrower will owe in interest.
  • Instead of a percentage, the interest rate for invoice factoring is expressed in decimal form. The average factor rate is 1.1 to 1.4, Fit Small Business reports. For example, if a small business takes out a $10,000 loan with a 1.4 factor rate, and the term of the loan is one year, it will pay a total of $14,000 on the loan.
  • Your factor rate is determined by your industry, years in business, business stability and average monthly sales, which can be in the form of credit cards of other types of payment.
  • Origination fee: This fee is for processing a new small business loan. Some alternativelenders incorporate the origination fee into the total loan balance or the interest rate. Other lenders don’t charge an origination fee at all. With poor credit and a higher risk, you may likely be subject to paying a higher origination fee.
  • Underwriting fees: These fees are charged by underwriters to review and verify the provided documentation in your loan application and prepare the loan.
  • Closing costs: These fees are any other costs tied to closing the loan, such as filing and recording fees, a loan-packaging fee, business valuation or commercial real estate appraisal.
  • Additional fees: Other fees associated with a small business loan include late payment fees, check processing fees and prepayment fees, which are sometimes charged if you make early payments.

How to Get a Small Business Loan

Before You Apply

Applying for a small business loan requires preparation, especially if you have poor credit. You can increase your chances of approval and secure the best terms by improving your credit and creating a business plan that will make lenders more confident in your business.

  • Improve your personal credit. If you’re planning to start a new business, prepare several months to a year in advance to present your personal finances as attractively as possible, recommends S. Michael Surry, lecturer of finance at the University of Texas at Austin. Order a credit report and check your score. Often, you can get your credit score for free from banks, credit card issuers and free credit monitoring services. You can purchase your FICO score at myFICO.com. The FICO score is the most common score used by lenders. Improve your personal credit score by making on-time payments, dealing with delinquencies and paying down large balances when possible.
  • Some errors, such as incorrect outstanding balances, may negatively impact your credit score. By disputing these errors, you may be able to improve your score.
  • Build your business credit score. Businesses that have a separate credit profile may not have to solely rely on the owner’s personal credit history when obtaining financing, points out Desmarais. This can give your business a stronger credit picture and increase your chances of loan approval. If you want to build your business score, consider getting a business credit card or opening a line of credit. Set a maximum limit you’re comfortable with and make on-time payments.
  • If you already have a business credit score and want to improve it, rebuilding a business credit score is like improving a personal credit score, explains Rod Griffin, director of public education at Experian, one of the three major consumer credit bureaus. Catch up on any late loan payments and make sure your vendors are paid either within or ahead of terms to help improve your business credit score.
  • Write a solid business plan. Surry recommends a well-thought-out business plan with a well-formulated mission, strategy and plan for execution to boost your odds of securing financing through a lender. Your business plan should include projected financial statements constructed under various realistic scenarios, such as conservative, moderate and aggressive.
  • Find other ways to boost your creditworthiness. If you have bad credit, you can boost your creditworthiness by asking for letters of reference from personal and business creditors and vendors that you’ve worked with. The letters should indicate that you have a history of making on-time payments. If you have a strong management team, you can highlight the background, experience and creditworthiness of the team, says Surry. Having a business partner with strong credit as a guarantor on the loan can boost your odds of getting approved.

When applying for a small business loan, there is a significant amount of documentation involved. To ensure the application process goes smoothly and you get approved for money and terms you need, have the following information and documents on hand:

  • Personal information
  • Resume
  • Business plan
  • Income tax returns
  • Loan application history
  • Bank statements
  • Collateral
  • Use of loan
  • Debt schedule
  • Legal documents

For in-depth information on the loan application process, read the U.S. News Small Business Loans guide.

Choosing a Loan

When choosing an alternative lender for your small business, you should pay close attention to the lender’s eligibility requirements, loan options, costs and reputation. Keeping these things in mind will aid you in finding a lender with a higher chance of approving your loan and offer you solid customer service and the best terms possible with reasonable costs.

Eligibility Requirements

  • Minimum personal credit score
  • Minimum years in business
  • Minimum annual revenue

Loan Options

Loan types: During your search, look for a lender that offers the type of loan you’re looking for (i.e., a line of credit, invoice financing, term loan). To make sure you get approved for enough funding to start or expand your business venture, before you start your search, draft a detailed, thorough business plan and zero in on the type of funding you need.

“The business plan should present in clear and concise terms: your company’s unique value proposition, the current revenue and profit model, current cash flows, the burn rate, and how new cash infusions into the company will be used,” says Surry.

Loan limits: If the lender doesn’t extend financing in the amount you need, do your best to find one who will. If you have bad credit, you could consider lowering the amount you need or turning to creative sources of funding.

Loan term: Your loan’s term is the amount of time you must make payments on the loan. Note that if you take a loan with a shorter length, it will have higher monthly payments, but you may pay less in total interest on the loan. If you take out a loan with a longer term, your monthly payments may be lower, but you may have to pay more in total interest over the life of the loan. For small business owners with bad credit, there may be fewer options and less flexibility with your loan term, so beware of taking on a loan with repayment terms you won’t be able to manage.

Costs

Look for a lender with the lowest costs, including:

  • APR
  • Down payment
  • Factor rate
  • Origination fee
  • Underwriting fees
  • Closing costs
  • Additional fees

Reputation

You should read reviews to find out how businesses rate the service and products offered by each lender. Two good review sources for alternative lenders are Trustpilot, which rates companies based on an aggregate of customer reviews, andthe Better Business Bureau.

Best Bad Credit Small Business Loans of 2018

U.S. News conducted an in-depth review of the leading bad credit small business loan companies. The top 25 most active alternative lenders were researched for data on key factors U.S. News conducted an in-depth review of the leading bad credit small business loan companies. The leading alternative business lenders were researched for data on key factors including customer service ratings, qualification requirements and loan options.

While there is no loan that is perfect for every business, U.S. News recommends the top performers based on their strengths in key areas. These recommendations can support your research by showing you the loan most likely to meet your needs. They are a good starting point for most small businesses, but you should thoroughly research each option yourself.

Top Lender for Large Invoices


Blue Vine

Founded in 2013 in Redwood City, California, Blue Vine offers invoice financing and lines of credit to small businesses. Blue Vine recently expanded its new debt financing to $200 million and rolled out a 12-month business line of credit with monthly payments.

Best features: Blue Vine has a high limit for invoice factoring at $5 million. Small business owners can get speedy access to cash with an average application turnaround time of 24 hours and funds deposited hours after your request.

Drawbacks: The one- to 13-week term limits for Blue Vine’s invoice financing are short. Businesses that may have trouble with repaying their loan in such a short window of time should reconsider this type of funding. The starting APR rates are high.

Best for Businesses That:

  • Want a quick turnaround on the application process
  • Need fast cash
  • Have unpaid invoices

Highlights:

  • Loan types: Invoice financing, line of credit (six-month or 12-month)
  • Minimum credit score: 530 invoice factoring, 600 six-month term line of credit
  • Minimum years in business: Three months invoice factoring, six months for six-month term line of credit
  • Minimum annual revenue: $100,000 invoice factoring, $120,000 six-month term line of credit
  • Origination fee: None
  • Customer satisfaction ratings:
    • BBB rating: A+
    • Trustpilot score: Excellent

Top Lender for Medium-Term Loans


Funding Circle

Headquartered in London, Funding Circle is a P2P lender that has extended $7 billion in funds to businesses worldwide since its founding in 2010.

Best Features:
Funding Circle offers six-month to five-year term loans. Funding Circle extends loans globally and boasts an A+ score from the BBB. Small business owners can be funded in as few as 5 days.

Drawbacks:
Funding Circle is not a good choice for new businesses. While Funding Circle requires a small business to be established for a minimum of two years, it typically lends to businesses established for an average of 10 years.

Best for Businesses That:

  • Want a long repayment term
  • Have been established for at least two years
  • Want fast access to funding

Highlights:

  • Loan types: Term loans
  • Minimum credit score: 620
  • Minimum years in business: Two
  • Minimum annual revenue: Zero
  • Origination fee: 0.99 to 6.99 percent
  • Customer satisfaction ratings:
    • BBB rating: A+
    • Trustpilot score: Excellent

Top Lender for Very Small Businesses


Kabbage

Based in Atlanta, Kabbage has extended more than $4 billion in financing to small businesses around the world since 2009. Using an automated lending platform, there’s a quick application process.

Best features: With a $50,000 minimum revenue requirement, very small businesses can get lines of credit with Kabbage. This is one of the lowest revenue requirements among alternative lenders. Business lines of credit have a wide range from $2,000 to $250,000.

Drawbacks: Kabbage has a monthly fee of 1 to 10 percent for every month you carry a balance.

Best for Businesses That:

  • Have revenues of at least $50,000
  • Want a quick, simplified application process
  • Want a short repayment period


Highlights:

  • Loan types: Line of credit
  • Minimum credit score: No minimum
  • Minimum years in business: One
  • Minimum annual revenue: $50,000
  • Origination fee: None
  • Customer satisfaction ratings:
    • BBB rating: A+
    • Trustpilot score: Excellent

Top Lender for Lines of Credit


New Merchants Capital

Based in New York City and founded in 2007, New Merchants Capital extends lines of credit and term loans to small business owners. New Merchants Capital has facilitated more than $10 billion in financing.

Best features: New Merchants Capital offers up to $500,000 in lines of credit and has some of the lowest minimum credit score requirements available. Small business owners need a minimum FICO score of 500 for term loans. Term loans are available for up to 36 months.

Drawbacks: While New Merchants Capital doesn’t require personal assets as collateral, it does take a blanket lien on all business assets. You’ll be required to commit to either a fixed daily or weekly payment schedule, and there’s a 2.4 to 4 percent origination fee for first term loans.

Best for Businesses That:

  • Want a robust line of credit
  • Want a long-term length
  • Are comfortable making daily or weekly payments

Highlights:

  • Loan types: Term loans, lines of credit
  • Minimum credit score: 500 for term loans
  • Minimum years in business: One
  • Minimum annual revenue: $100,000
  • Origination fee: 2.4 to 4 percent on first term loans
  • Customer satisfaction ratings:
    • BBB rating: A+
    • Trustpilot score: Excellent

What to Do If You’re Denied a Small Business Loan

If you’re denied a small business loan or can’t secure enough financing due to poor credit, there are some things you can do to get the capital you need:

  • Lower the amount of capital you need. You may need to work with less financing than you initially anticipated, explains P. Simon Mahler, a certified business mentor with SCORE, a nonprofit organization that offers free mentorship and education to small businesses. Reassess your business plan and look for areas where you can lower expenses by bootstrapping, finding lower-cost alternatives or cutting certain expenses entirely for the time being.
  • “With all the tools and resources that are out there, you can build your own website, or market yourself on social media at no cost,” says Mahler. “You can use the city library for free Wi-Fi and spend very little money on a brochure to market your business.”
  • Add business partners. Adding business partners can strengthen the creditworthiness of your business. Lenders may consider the total personal income and collateral of all owners of the business, so adding more business partners means you’ll have more income and collateral for the lender to calculate against your funding needs. It’s best to choose partners with good credit and income, and ideally, experience in your industry.
  • Seek creative funding. As only 31 percent of new businesses typically receive the full amount of funding they seek, many have to get creative. Consider asking friends, family, private investors and potential customers to invest in your business. You can seek funding through a crowdfunding campaign such as Indiegogo, Kickstarter or GoFundMe.
  • It’s important not to be idle while waiting to hear back from lenders on the status of your application. “There’s an opportunity cost when you’re waiting to hear back from the lender,” says Mahler. “As a small business owner, you can’t take your foot off the pedal. During that time, you could be marketing your business and finding new customers.”

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