Businesses can have bad credit for any number of reasons, from a long-ago missed loan payment to simply being a newly-formed company. But bad credit can be particularly harmful during the holiday season when many businesses are experiencing their greatest traffic and highest sales. Fortunately, there are several types of funding that businesses with poor credit can use in order to maintain sufficient cash flow when they need it most.
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What is Bad Credit?
First things first. What, exactly, does it mean for a business to have bad credit?
A business’s credit is determined by a multitude of factors. In most cases, these factors are boiled down into empirical numbers by credit bureaus. These credit bureaus – Experian, Equifax, and Dun & Bradstreet – look over the many data points that make up your credit score and provide a report showing how your business stacks up. These data points can include:
Company demographics. How big is your company? How long has it been in business? A company with tons of employees and a long history is more stable – and thus more likely to repay its debts – than a startup company with just a few people on the team. Some lenders won’t even consider lending to companies with just a few months in business.
Payment history. In order to determine how likely you’ll be to pay off future debts, lenders want to know how successful you’ve been in paying off your past debts. Major red flags include missed payments and any loans you’ve defaulted on.
Credit utilization. If you have existing lines of credit, how much of that credit limit have you used? If you’ve got a high rate of utilization, lenders may determine that you’re likely to find it difficult to make payments on new debt.
Existing debts. If you’ve got an excessive amount of existing debt, lenders may determine that your business is unlikely to pay them off.
Inherent Risk. Some industries are riskier than others. A medical office loan is very likely to be repaid, while a loan for a cannabis dispensary is much riskier. This industry-dependent risk is factored into your credit report.
Each credit bureau’s score looks a little different, and some bureaus issue multiple scores to indicate a company’s history in comparison to its current likelihood to repay a debt.
But in general, if your company fits into the less-than-ideal end of any of the above categories, you may find that your business credit score is on the lower end. You’ve got bad credit, and business financing might prove to be a bit more expensive or complicated than you’d like.
Bad Credit Businesses During the Holidays
The holidays are one of the most important parts of the calendar for many companies. Companies with poor credit can see it as a particularly powerful opportunity. That’s because the increase in sales and traffic that comes with the holidays presents an opportunity to build credit by making progress on the issues that harm credit.
A boost in traffic might require a boost in hiring. With a larger team, you’re showing lenders that you’re a larger company.
If you’ve got a debt that needs to be paid off, the increased holiday revenue can help bring that debt to heel.
Why Do Businesses Need Funding During the Holiday Season?
Because the holidays make up such a significant portion of many retailers’ sales, there are several increased or specific expenses that come along with those months. In particular:
Inventory. If you want to make more sales during the holidays, you’re going to need more things to sell. Regardless of whether you’ve got good credit, you’re going to need to boost your inventory during the holiday season.
Hiring. You may need extra personnel to help your company move all of that increased inventory during the holidays.
Advertising. A smart, targeted marketing campaign can compound on the boost most businesses get in the holiday season. However, advertising can be pricy.
Cashflow. No matter what else you’re spending money on, cash flow is key. You need to deal with unexpected expenses. You also want to have the ability to take advantage of opportunities as they arise.
How Does Bad Credit Hurt Businesses Near the Holidays?
While seeking out funding during the holidays can seem counterintuitive – you are, in fact, adding debt to your ledger, after all – going without additional funding while you’ve got bad credit can lead to missed opportunities.
Your poor credit can lead to a major squeeze in cash flow during the time you want it most. You might struggle to make payments on existing debts, utilities, rent, or even payroll. If an opportunity comes up that can create growth for your business, insufficient cash flow and bad credit can lead to that opportunity slipping through your fingers.
If you’ve got poor credit and the holidays are approaching, finding a reasonable loan option to help with your holiday expenses can be a huge help.
Lenders want to lend money to borrowers who are likely to repay the loan with interest. A bad credit score means that based on available data, that particular business may be less likely to make those payments. There are several strategies lenders use to protect themselves from the possibility of losing too much money:
Higher interest rates and smaller loans. Look at it like this: the longer a borrower is in possession of loaned money, the more likely it is that some circumstance can lead to default. A lot can happen in the course of the decades it can take to pay back a multi-million-dollar real-estate loan. To protect themselves from that risk, lenders offer smaller loans to companies with poor credit. That way, they’d lose a small amount of money in the case of default. And on top of that, they boost the interest, ensuring that they’re making enough money on these small loans to justify the risk.
Collateral requirements. In an ideal world for borrowers, every loan offer would be for an unsecured loan: that is, a loan with no collateral requirements. However, if you’ve got bad credit, lenders may require that you put up some kind of significant assets as collateral. Whether that’s real estate, inventory, or even your personal vehicle, these lenders can require that you put real skin in the game. If your company defaults, the lender can take possession of (and sell) that collateral to cover the loss.
Short repayment terms. As we noted before, it’s risky to lenders when borrowers have money for an extended period. So lenders may require these loans to be repaid within a few months instead of the multiple years that are allowed for larger loans to better-qualified borrowers.
Unusual repayment cadence. Most loans are repaid with monthly payments. However, some small businesses with bad credit might be required to make repayments more often than that. These more frequent payments assure lenders that the cash is still coming.
Types of Holiday Loans for Businesses with Bad Credit
While lenders must protect themselves against risk, there are still funding options available for businesses with bad credit in order to help take advantage of consumers’ holiday spending.
Revolving Lines of Credit
A revolving line of credit is a line of credit that can be paid down and then borrowed again. There are two main forms of revolving credit that small business owners should be aware of that can be a huge boon during the holiday season.
Business Lines of Credit
A line of credit is a loan in which the lender makes a certain amount of funds available to the borrower. They function much like business credit cards (more on those in a moment), but often come with lower interest rates and a bit more flexibility of use.
A business line of credit’s biggest benefit is that, unlike a regular loan, borrowers only need to make payments and pay interest on the money they borrow under that limit. These lines of credit are often paid out directly into your company’s checking account, meaning that they can be used for equipment repairs, utility payments, even wages.
For that reason, many businesses take out a line of credit when times are fine and only draw on the line in cases of emergency or opportunity. If a vital piece of equipment breaks down, a line of credit allows you to replace or repair it immediately. If a vendor presents an opportunity to stock up on a significant amount of inventory at a discount, a line of credit means you’re able to take advantage without seeking out other funding.
Business Credit Cards
Business credit cards, on the other hand, function much like personal credit cards. You’ll have a credit limit and a card used to make purchases, but they often come with much higher interest rates in comparison to lines of credit.
Much like personal credit cards, business credit cards also typically accrue points or rewards. So if your business requires extensive travel, you might consider a business credit card where the issuer helps you build airline or hotel rewards.
Term Loans
Traditional loans are available to most companies, despite poor creditworthiness. But lenders do take steps to protect themselves from losing money on those loans.
A basic term loan is a loan for which you make regular monthly payments to a lender in exchange for an upfront deposit to your bank account. It’s a loan in its simplest form. However, term loans for companies with bad credit typically use one or more strategies to protect the lender from losing money on a borrower’s default:
Smaller loan amounts. First and foremost, if a borrower is less likely to repay a loan, lenders are going to lend them less money.
Higher interest rates. Lower interest rates on large loans make sense because a small percentage of a large number is often a large number in and of itself. Charging that same interest rate on a small loan leads to the lender making very little money on a risky loan. That’s why loans to bad credit businesses often come with high interest rates: they must be worth the lender’s while.
Collateral requirements. Lenders may require bad-credit borrowers to put up significant business or personal assets. If the borrower is unable to pay back the loan, the lender will take possession of those assets and sell them.
Shorter repayment terms. By insisting that the borrower repay a loan quickly (otherwise known as a short-term loan), the lender’s money is only in the hands of a risky company for a short time, lessening the odds that the borrower defaults.
Personal Loans
If your business credit isn’t doing particularly well but you’ve got fair or excellent credit as an individual, you could consider a personal loan to cover any gaps in cash flow. There are obvious risks to using your personal credit to fund business expenses, and some businesses won’t be eligible for this option at all.
As with all loans, the lending financial institution might impose restrictions on ways that the loan can be used. If you acquire a personal loan and use it for business purposes when that’s explicitly prohibited, the lender can demand immediate repayment in full, and you’ll pay interest, too.
If you’re comfortable with being personally responsible for the repayment of business debt, using a personal loan to cover costs can be helpful. Just be sure that you’re permitted to do so by the lender and understand the consequences of default.
Alternative Financing: MCAs and Invoice Factoring
MCAs
Merchant cash advances, or MCAs, are a form of business funding in which a cash advance provider pays upfront for a percentage of a company’s future credit and debit card sales. Because they’re by definition not loans, MCAs function very differently and are subject to entirely separate laws and regulations.
When your company receives a merchant cash advance, it makes payments by setting aside a certain percentage of each and every card-based transaction, typically around 10% of the total. The more card transactions your business processes, the more you pay.
That means in slow times, you’ll make smaller and fewer payments. The opposite is also true. When business is booming, you’ll make extra large payments to an MCA provider.
Unfortunately, there’s no advantage to quick repayment. MCA providers make money by charging a factor rate, typically a number between 1 and 2. Multiply the factor rate by the size of the MCA, and you’ll find the amount of money the MCA provider is owed in total.
For example, if you receive an MCA of $5,000 at a factor rate of 1.2, you’ll repay 5000×1.2, or $6,000.
Paying back an MCA quickly can lead to effective annual percentage rates (APRs) in the triple digits, so seek an MCA to fund your holiday expenses only if it’s absolutely necessary. But they may be your best option with bad credit. Because repayment depends on the volume of your transactions, your credit history is of less interest to MCA providers than it is to traditional lenders.
On top of that, the application process and funding of an MCA is typically very fast. You can typically receive an offer within a single business day.
Invoice Factoring
Like a merchant cash advance, invoice factoring involves a purchase instead of a loan. Instead of buying a portion of your company’s future transactions, invoice factoring (as its name implies) involves buying your company’s unpaid invoices.
If you’ve got a large amount of money in accounts receivable, invoice factoring providers may be willing to purchase a significant portion of the total. For example, if you’ve got $15,000 in outstanding invoices, the factoring company might pay you $14,250 upfront – or 95% of their total value. The factoring company then takes over the collection of the invoices.
You receive fast, short-term funding. There are no monthly payments and no extended terms. Instead, you give up a bit of money off the top.
You do, however, give up control of your customers’ payment experiences. While most invoice factoring companies are professional and courteous, you no longer have power over the way your customers make payments. If they have bad experiences, you may find yourself losing customers you had no power over.
