High risk business loans are business loans that are offered to individuals or businesses with poor or little credit. Lenders determine the risk of the loan from the business’s credit history as well as the average daily cash balance in its bank account.
Do you need financing for your seasonal business or to battle an unexpected decline in sales? Are you facing short-term credit crunch caused by late-paying customers? If you own a high risk business with poor credit history, you will need to figure out your best options for obtaining credit.
Borrowers that are considered ‘high risk’ usually receive smaller loan amounts at greater interest rates. Since the applicants have problems with their credit scores, many traditional lenders such as banks usually do not offer loans to them.
Other factors that determine whether the loans are considered as high risk business loans are the industry type and the age of the company. Companies that are comparatively new, unusual or branded as a ‘high risk high return’ business are deemed high-risk.
The terms and rates of high risk business loans reflect the risk taken by the lender – higher the risk; higher will be the rates and shorter the loan terms.
The loan terms for high risk business loans range from three and six months to 12 months. The factor rates range from 1.18 to 1.60, while interest rates range from 18% to 36% or higher.
Some businesses and industries deemed as high-risk include mining (51.3%), manufacturing (48.4%), services (47.6%), wholesaling and agriculture (47.4%), retailing (41.1%), finance, insurance, and real estate (39.6%), transportation, communications, and utilities (39.4%) and construction (36.4%).
Many alternative lenders serve this niche. The choice of alternative lenders will be determined by the characteristics and credit history of the borrowing business or individual. Evaluate your needs and options thoroughly, and you can still get the financing you need when the bank says no.
Let’s take a look at some of the options:
- Offering collateral
A popular way to obtain funding despite less-than-perfect credit is to secure the loan by offering collateral such as inventory, equipment, auto titles and other forms of property. Downside: If you default on the loan, you risk losing them. - Peer-to-peer lending
Another popular option to find funding in this digital age is to post your requirement in the online social lending marketplace that offers peer-to-peer lending. A peer lender is an individual who invests in the companies he/she likes. You can post your requirement on certain websites, where potential lenders or investors bid on the requested loan at a given interest rate. You can opt for the lowest rate with the best repayment terms. However, you do not know your lender and your loan requirements are now public knowledge.
Not just strangers, peer-to-peer lenders may also include family and friends. The benefits of this type of loan are that you can get quick access to cash and the repayment terms are flexible. The downside is that loans from family and friends may come with expectations of discounted products or positions in your business. - Find a co-signer
Your application for funding may be approved by banks and traditional lenders if a person with good credit guarantees your high risk business loan. You can ask a friend or family member who has faith in you and your business to co-sign the loan and take on the risk. - Credit unions
Credit unions are similar to traditional lenders in some ways, but they can still be a good option for businesses with less-than-ideal credit. If you manage to find a credit union that serves business in your industry category, you have an increased chance of loan approval. - Alternative Lenders
Some lenders often use non-traditional methods of reviewing applicants to determine a business owner’s creditworthiness. These alternative lenders may consider and approve your high risk business loan even if your credit score is less-than-perfect. For example, hedge fund lenders often offer loans to high risk businesses, such as technology-based companies. The quality of the pitch made by the borrower influences the size of the loans. Hedge fund loans usually offer greater flexibility than those given by conventional lenders and the access to funds is relatively quick. The downside is high borrowing costs and prepayment penalties. - Convertible debt instruments
These are asset-backed high risk business loans. If the lender wishes to convert the debt to an equity position in the business, the business owner may need to give up some future equity. The lender is taking on less risk in making this type of loan as compared to a straight equity investment. On the downside, the owner may be required to pay back unconverted debt if the company is performing below budget. If the company does well, the borrower may lose future equity. - Credit cards
Many small business owners turn to credit cards for funding. If your credit score isn’t good, you might have to rely only on secured credit cards, which have higher fees than regular credit cards. Do keep in mind that credit cards are an expensive way of financing a small business, especially if you have bad credit. They are also subject to huge rate penalties for delayed or missed payments on outstanding bills.
