When small businesses need loans in tough economic times

The current inflationary environment in the US economy can put significant pressure on small business finances, making it more difficult to continue business operations without additional capital from some type of lending source. This need usually arises when cash flow from business operations is insufficient to meet a specific type of need. [i.e. buying more raw material to make more saleable goods]. Or in anticipation of uncertain challenges.

In these circumstances, the business owner must determine where this additional financing can be obtained and under what conditions and at what costs. In this article, we’ll review the most common loan sources and discuss the pros and cons of each.

SBA Loans

These are actually SBA-backed loans made through commercial banks, some credit unions, and community development corporations. There are several types of loan programs available to meet specific business needs. Detailed information about the program can be found at www.sba.gov and the lender can provide information about the program(s) that might fit your specific situation.

Pros: Moderate cost structure and (usually) lenders are located in your community.

Cons: Defined program rules and lending policies, obtaining funding may take 2-3 months, may not be funded if loan application is deemed risky.

Economic development neighborhoods

These are nonprofit organizations that offer a variety of loan programs that are made available by federal agencies (i.e. Economic Development Administration, U.S. Department of Agriculture – Rural Development , Department of Commerce, etc.) loans for applicants who do not otherwise qualify for conventional or other loan programs and are designed to help small and emerging businesses retain and create jobs. Loan funds can be used for real estate, working capital, inventory, equipment, refinancing existing debt, etc.

Pros: Loan rates and terms are determined based on the purpose of the loan and the level of risk. Rates are usually slightly higher than conventional loan rates, but not exorbitant. Lending decisions are usually made locally.

Disadvantages: The availability of loan funds is sometimes limited depending on loan demand. Programs require full subscription – not just based on credit score.

SBA Certified Development Companies

SBA Certified Development Companies are economic development organizations authorized to underwrite, fund, and administer the SBA 504 program on behalf of the SBA. This loan program is limited to capital financing (i.e. real estate, equipment, etc.) and is done in joint venture with a commercial lender. The rate for the SBA component of the loan is low because the program is funded by the sale of government guaranteed bonds. Also, it helps the small business owner via retention of working capital due to lower down payment requirement.

Advantages: Low down payment, fixed rate for the term of the loan, no intermediate loan term, etc.

Cons: Project development and loan underwriting are done locally, but the loan application must be approved by the SBA, which can add several weeks to the loan approval process. Loan applications must be fully subscribed.

Community Development Financial Institutions (CDFIs)

They are private sector lenders who pool funds from a variety of sources so they can make loans that help improve communities.

Advantages: CDFIs may have more flexible loan requirements than banks or credit unions. They may offer loans for down payments on loans from other lenders, may finance inventory or equipment. They can often make loan decisions faster than other organizations and can assess the borrower’s impact on the community as a reason for granting a loan.

Disadvantages: Interest rates, fees, and outstanding loan servicing fees on CDFI loans will likely be higher than other loans, and repayment times may be shorter.

Non-bank lenders

These are private companies that provide business loans that cannot obtain other types of loans. They may have very flexible loan products to finance inventory, provide working capital, cash advances on receivables, and many other products.

Advantages: flexibility of loan products, very fast loan decisions, ability to guarantee parts of the company to grant the loan.

Cons: Potentially high loan costs, as many loans carry significant risk for the lender.

Online lenders

Online lenders like Kabbage, On Deck and others can provide substantial loans for various business purposes

Pros: Will provide funding for multiple purposes, can provide significant levels of funding, can make loan decisions within days of application

Disadvantages: Loans will have short tenors which can potentially cause cash flow issues when repaying the loan, effective loan rates can be high, they will often take a percentage of sales dollars as part of loan repayment. The actual costs of borrowing are generally much higher than those of other loan programs.

Private lenders and investors

Friends, family and interested parties can be a source of funding to meet business needs.

Pros: Decisions and financing can happen quickly and repayment terms can be creative and tailored to the specific business ability to repay the loan. Some investors may offer cash in exchange for an equity stake in the business.

Disadvantages: Failure to repay any investment under the agreed terms can strain relationships and destroy friendships. By all means, be a responsible borrower. If in doubt about how to structure a loan or equity investment, consulting a lawyer is a good idea.

Which lender does a business owner choose?

It will really depend on the circumstances of your specific situation. Do you need a quick decision? Are your business finances less creditworthy to a commercial lender? Can you quickly generate cash through additional activities to repay the loan?

In one case, a start-up business did not have a strong enough case to convince a commercial lender to provide a loan. However, another lender was eager to provide the loan because he felt the new business, a daycare center, was badly needed in the community.

In another case, a commercial roofer was having cash flow problems because jobs he was doing for various school systems were taking a long time to pay the final installment payment across multiple jobs. They managed to get a large loan from an online lender so they could start additional jobs. They repaid the loan online in about 90 days and were very happy with the experience.

The key to making these loan opportunities work is to fully understand your borrowing needs and goals, have a solid plan for repaying the borrowed funds, and then stick to that plan. Your North Idaho Small Business Development Center at North Idaho College can help you work through all of these issues to develop a borrowing plan that meets your needs and help you stay on track to successfully repay your business loan. For more information, please visit our website https://nisbdc.com/ or email us at [email protected] or call us at 208-665-5085.

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Warren Mueller is in his sixth year as an SBDC business coach. He has spent 25 years in international business development in the defense contracting and specialty chemicals industries. He is also a consultant in strategic pricing and price management. In 2014 he published a book on strategic planning for small businesses and nonprofits.

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