What You Should Know About High Risk Business Loans
High-risk business loans have two defining qualities of being high risk and centered around businesses. These businesses are typically startups, based in volatile industries, or have poor or no credit. The loans themselves have high costs and short-term agreements.
Every business, no matter how successful they are today, needs funding for the initial launch.
Entrepreneurs lean on business loans to get them off the ground to earn revenue.
It’s incredibly risky for a lender to give a loan to a business with poor or no credit. Therefore, most business owners turn to private online lenders as opposed to large or small banks.
According to a Federal Reserve study, application rates for online lenders has increased by 13% over the past two years.
What Makes a Business Loan High Risk?
Although they are useful for entrepreneurs, high-risk business loans are usually a last resort. Business attorney Neal Salisian says, “high-risk business loans are ones with high-interest rates, large payments or frequent payment requirements.”
Salisian says that high-risk loans should be used as tools to, “get a business back from the brink,” but not as a long-term financing solution.
While these are the general characteristics, there are multiple types of high-risk business loans. Jared Weitz, CEO of United Capital Source, says include angel investing, business credit cards and asset-based loans are common financing alternatives.
Every business needs funding, but each business operates differently. It’s important to research your options and ensure you’re avoiding scammers. The Better Business Bureau and Federal Trade Commission revealed that marketplace scams accounted for $50 billion nationally in 2016.
What Are the Benefits of High-Risk Business Loans?
With that being said, there are a few benefits that make these loans worthwhile. Despite the risk, they do the job of being an easily accessible source of money for entrepreneurs.
Rob Misheloff, CEO of SmarterFinance USA, admits that, “when a business can make enough profit to justify the high cost of funds and cannot access capital any other way, high-risk loans make good business sense.”
If you take the high-risk loan road, it’s crucial to honestly predict future earnings in depth to avoid financial problems.
There are even a few benefits for lenders. High-risk lenders carefully vet all potential borrowers and plan for possible losses. The work may pay off when it’s time to collect; the investment return could be significantly higher than a traditional loan.
Who are High-Risk Lenders?
High-risk lenders are private institutions specializing in subprime loans (300 – 599 credit score). To offset the risk, these lenders require strict repayment terms. For example, a business may have to pay large installment payments or high-interest rates or agree to provide collateral.
Lenders stockpile reserves in case of an unexpected loss. “Lenders will establish a borrowing base, where the line of credit is provided based on the level of accounts receivable and inventory,” says Weitz. “This will be set up so the borrowed amount is aligned to the assets needed to be converted to cash in order to repay.”
How to finance a business is an important decision not to be made lightly. Analyze your options and tread carefully for future success.