Updated July 19, 2021
Having a low credit rating can make borrowing difficult. As a small business owner, there are times you need to access capital quickly to pay rent or staff. In other situations, you may just want to renovate your storefront or expand but don’t have the cash on hand.
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For every business owner with a low credit score, the notion of a bad credit business loan immediately invokes the reality of a high-interest rate or application rejection. In many cases, that’s the reality. However, as the economy moves to the post-Covid era, understanding where to look for a business loan or capital funding; and what to look for can take away some of the fear in getting working capital funding.
The cost of capital is likely to continue to rise with inflation in the year ahead. How to still make that work for your business will be a challenge. In this article we’ll discuss the benefits and downsides of borrowing with a weak credit profile. On the positive side, there are lots of options that you may not be aware of. Alternatively, there are risks involved and you may wish to avoid these risks by looking at alternatives. In either case, understanding the details will help you make the right decisions.
More Than Half of US Small Businesses Are Experiencing Financial Hardship
Let’s be clear from the outset if you have a poor credit score and your company is experiencing financial distress, the cost of borrowing will be higher. If that’s you, you will be among the millions of business owners seeking a bad credit business loan.
OK, so once you get past that reality, what next? First, take some comfort in knowing that the majority of small businesses are experiencing financial hardships as a result of the pandemic. With government subsidies drawing to a close, most small businesses are scrambling to restart their operations and need capital to do it.
The business funding industry is very much aware of this fact and they are launching programs to deal with the issues facing small business owners. In particular, many funding companies are launching funding programs specifically to address the segment we are calling bad credit business loans. This is a new reality for both borrower and those companies providing the funding.
Understanding the Cost and Benefit of Money
As we discussed above, a bad credit business loan will carry higher costs, sometimes much higher. It’s important to understand whether it is wise to take funding at higher rates and repayment terms. The top things to remember when taking any kind of funding are:
- What are your alternatives to a bad credit business loan?
- Can you repay the principle and financing fees on-time or at all?
- Taking into account the cost of financing, does it make sense financially?
- How much borrowing is too much or too little?
A bad credit business loan is certainly not right for every business owner. In fact, if you are even unsure about any of the above bullet points, this type of funding may not be right for you.
What Alternatives Do You Have to Get Funding for Your Small Business?
This may seem like an obvious question, but often the stress of financial hardship can create distractions and lead to making rash decisions. Talk to your attorney or accountant and ask about ways to get financing.
If you are seeking capital to pay for goods or services for your business, talk to your vendors and ask for payment terms or extended payment terms. Many companies are in a similar position. If you have long-standing relationships with vendors, negotiating more time to pay is likely to have a positive result.
Unfortunately, purchasing materials is only a small part of the problem facing business owners today. Restarting sales and marketing, hiring workers and supply-chain disruptions are major challenges.
Re-Starting or Implementing Cost-Cutting Measures
According to a PwC survey in June 2021, many companies are dealing with the effects of the pandemic by cutting cost. For many small business owners who operate on small margins, this may not be possible. However, rethinking your business model may help to alleviate financial burdens.
For a small business, this may mean starting all over and re-inventing your business. This is not easy, but it could mean the difference between surviving as a company or closing your doors. So, what does that mean? For some companies, that could mean giving-up an office or warehouse and returning to the humble beginnings of working from home or in a shared space. Many states still have legislation in place for tenants to break their lease agreements without penalty. Alternatively, you may be able to re-negotiate lease terms with your landlord or ask for a few months of “rent forgiveness” while you get your business up and running again.
Streamlining services or product offerings are another way to cut costs. If you are a manufacturer, a restaurant or other goods manufacturer, that may mean that you limit the number of items you offer. When streamlining your organization, you may consider selling equipment or even a part of your business as you consolidate.
Finally, you may consider offering discounts to your customers for early or upfront cash payments as a way to generate immediate capital.
Seek Alternative Sources of Capital
Reaching-out to family and friends is a time-honored way to raise capital and if they have the means and are willing benefactors, then by all means, this is a time to go down that path. However, it’s becoming more common to get financing from business partners. Like asking for extended payment terms as discussed earlier, reaching-out to business partners such as vendors could be a viable source of financing.
Approaching a vendor with a promise of buying exclusivity from them may be an incentive for them to help you stay in business. If your company has the potential to continue to drive significant sales for your vendor, you may find them a willing partner. In fact, this could be an opportunity to strike deeper relationships with business partners.
If you are a business that processes lots of sales via credit cards, you may also wish to explore a merchant cash advance (MCA) type financing plan.
Thinking creatively and with an open mind is critical for small business owners in the post-Covid economic era. So, take a moment and break-down your situation into simple terms, speak with trusted partners and weigh your options. You will be amazed at the options you may discover.
What is Your Ability to Repay Borrowed Funds?
Taking a bad credit business loan should be a last resort, but if all else fails then educating yourself is critical. The first thing you need to ask yourself is, “will my business be able to repay a loan and associated fees?”
This is a difficult one for many business owners. At times it may seem like the only alternative is to borrow money to survive. Doing some simple math, you should be able to determine if you can repay your financing and repayment obligations. The key here is to not let your hopes and dreams (emotions) enter the equation. Be honest and overestimate your costs and be conservative on your sales projections.
It’s strongly advised that you consult an accountant to put together a balance-sheet to track your recurring monthly expenses and project incidental expenses as accurately as possible. If you don’t have an accountant then using an accounting software like Quickbooks is very helpful. The Quickbooks application also has payment applications to help you collect payments from customers quickly.
Starting a new business using a bad credit business loan carries a very high level of risk and should be avoided for many reasons. The main reason is the uncertainty of business success. Keep in mind that many businesses don’t make it past a year or two.
Reasons to Take a Bad Credit Business Loan
OK, if you are not completely scared-off by all of risks and you have decided to push ahead in getting a loan with less-than-perfect credit let’s discuss some reasons you should consider higher-cost financing.
Perhaps the most important reason to finance your company is that you need capital to stay in business. However, there are some solid justifications for acquiring additional working capital even if it comes with higher costs.
Ensuring Your Supply-Chain
Even as the global disruption from Covid-19 is receding, global supply chains will remain backlogged for years to come. A visit to a home improvement store will reveal just how widespread this issue is as you will encounter an unprecedented number of empty shelves.
The shortage of materials globally is affecting nearly every industry and many experts predict that supply chain shortages may worsen into 2022. If you cannot purchase material you sell or use in manufacturing, you will not last long.
Consider the US spirits distilling industry; a global shortage of glass bottles has sent costs skyrocketing and, in some cases, distillers have had to stop production because of delays and unavailability of bottles. That has led to many distillers stockpiling months of empty bottles for future use. For others without the resources to buy in bulk, it has resulted in the failure of the distillery.
This is a textbook case where a manufacturer has steady or growing demand that would justify financing at higher rates. Even if that results in a higher cost of goods sold, it is much like an insurance policy where the cost of financing can be seen as an insurance premium.
Justifying Business Expansion
Other cases where it may be advisable to take a bad credit business loan is among industries that are experiencing hyper-inflation. The construction industry, trucking and hospitality are good examples. Industries that offer business owners high/growing profit margins make the decision to finance at higher rates more reasonable. For example, if a $10,000 investment will yield a $45,000 return, what would you be willing to pay for that $10,000? Put another way, if you have a construction project that requires a piece of machinery that costs $10,000 to finish a job that will turn a $45,000 profit, would you finance it if you did not have the cash to pay for it outright? The answer would likely be yes most of the time. The question that remains is how much is that capital worth?
This is not to say that business owners should not consider the cost of financing, they absolutely should consider it carefully. However, as a last resort, that consideration should be made without emotion and based on a sound profit/loss evaluation.
As we said in the beginning, bad credit business loans will almost always carry higher finance costs. Lenders are taking a higher risk and will put a premium on the capital they give to businesses. If businesses look at capital like goods and services they purchase, they will likely make better business decisions.
The point here is that many business owners will be faced with higher finance costs in the short-to-medium term. Brace yourself for a bit of “sticker shock” in finance costs if you have a weak credit profile. However, do not let sticker shock turn into emotional stress. Do your homework, shop around and decide whether the higher cost of financing works for you.
How much borrowing is too much or too little?
One of the most common issues when financing your business operations is deciding how much to borrow. This is not easy to determine. However, as a rule of thumb, you will want to consider taking a higher amount versus too little.
If you are applying for financing with a weak credit profile, chances are that if approved, you will not likely get another chance to finance for a while or until you pay-off the current amount. So, it’s important that you get as much as you can and need. It is more common that business owners borrow too little in these situations. Again, refer to the section above that discusses determining how much you can afford to pay back from your business.