How Small Businesses Can Deal With a Cash Flow Shortage
Did you know that a cash flow problem is the number one reason that businesses are forced to close their doors forever? A lack of cash flow can lead to some sleepless nights for a small business owner.
You need a quick influx of cash. You know you can only afford to pay your expenses and your staff for so much longer. You need to find viable small business funding options quickly, or drastic measures will have to be taken… And soon!
The good news is that there are options aimed at helping small business owners like you survive these cash flow droughts. None of them is a one-size-fits-all solution. However, there is likely one that is perfect for your business. Some take more time than others and others have more favorable repayment terms.
Here are some of the most popular.
1. Merchant Cash Advances
A lot of small business owners find that merchant funding solutions have a great balance of fast turnaround times and reasonable payment terms. They are designed specifically for entrepreneurs and business owners who need fast cash.
First and foremost, a merchant cash advance is not a loan. It’s a form of funding. This means that it’s not subject to the same stringent regulations as bank loans or SBA loans. But, more on that later.
An MCA can get you up to $500,000 if your business has been operating for over 6 months and you can show more than $10,000 per month in transactions. Unlike some of the other options we will explore, our funding process won’t focus on your business plan, your credit history, or your business’ equity and assets.
The turnaround time is also incredibly fast. You can apply online any time, day or night, and have an answer within 24 hours. This makes this a great option if your cash flow shortage came up rather suddenly due to unexpected circumstances, such as building or equipment damage.
How Does Repaying a Merchant Cash Advance Work?
Because this is not a loan, you won’t be dealing with interest rates. MCAs use a factor rate, which is a number that is based on risk assessment by your provider. The higher the factor rate, the higher the cost of borrowing.
Your factor rate will usually be between 1.2 to 1.5, which you multiply by the amount of your advance to get your repayment amount. For example:
An MCA for $50,000 x a factor rate of 1.4 = A total repayment amount of $70,000
You’re paying back your advance through remitting daily or weekly debits from your bank account through Automated Clearing House (ACH) withdrawals. The nice thing about this is that your payments are a percentage of your transactions. This means that when business is slow, you will be remitting smaller amounts.
2. Bank Loans and SBA Loans
Maybe you’re thinking about a more traditional loan to add some cash into your business.
This is a very popular and viable solution to a cash flow problem. However, it should most likely only be considered if:
- You’re not in an urgent hurry to get the money
- You have a great credit history, and/or a great relationship with your lender or bank
The turnaround time for either of these methods can easily stretch out over a month or more. If you’re looking at emergency repairs that need to be made ASAP, this will probably not be the best option for you.
Bank loans and Small Business Association (SBA) loans are in high demand because they typically offer a low cost of borrowing. However, those low costs mean a high bar for lending parameters.
To qualify for either, you’re most likely going to need:
- Annual business revenue over $180,000
- A minimum credit score of 680
- To be in business a minimum of four years
- Equity near $1 for every $4 of the loan amount
Meeting those standards also does not guarantee your application will be approved. In fact, most applications are rejected. A recent survey of over 10,000 business loan applicants in the U.S. revealed that 82% were denied financing by their bank. Meanwhile, only about half of SBA loans are getting approved these days.
These numbers do not include the number of small business owners who don’t even bother applying because they know it will be a waste of their time.
What’s the Difference Between an SBA Loan and Bank Loan?
Simply put, a bank loan is a loan agreement between you and your bank of choice. The bank is the lender and they will assess your application based on their own criteria. The bigger the bank, the tougher that criteria will be.
An SBA loan’s name can be a bit deceiving. The SBA is not loaning you the money. Rather, they are working to match you with other lenders in your area to try to come to an arrangement. These private lenders have slightly more flexible lending criteria than major banks, which is why the approval rates are higher.
The different types of loans may include:
- 7(a) loan program of up to $5 million (Processed through banks, credit unions, other lenders)
- 504 loan program of up to $5 million (Processed through private-sector lenders and nonprofits)
- Micro Loans of up to $50,000 (Processed through community-based nonprofits)
- SBA disaster loans of up to $2 million (Processed through the SBA)
Despite the higher approval rates, small business owners that are in need of a large amount of fast cash might want to look elsewhere. The SBA’s process can be just as lengthy, intrusive and involved as going through the bank.
You could be facing a few months’ worth of assessment and paperwork before you get an answer that may not even be a “Yes.”
What Happens if You Default on a Small Business Loan?
Like any other form of lending, there is an inherent risk attached to getting a small business loan. In the case of a default on the loan, you can be held personally responsible for the financial fallout.
Most bank loans or SBA loans need to be secured by:
- A signed personal guarantee from anyone who owns 20% or more of the company
- Business and personal assets as collateral
- Both
Signing a personal guarantee means you are now personally responsible for paying the remaining balance of the loan in case of default. This means your debt can be sent to the US Treasury Department and you could be facing garnished wages, or they could take your tax returns to pay the debt.
In terms of putting up collateral to secure the loan, SBA has stated that:
“When a loan guaranty is approved, we expect all available company assets to be offered as collateral. If company assets are insufficient to fully secure the loan, liens on personal assets may be required. Often, this means a lien on residential real estate.”
If your business doesn’t have expensive equipment, machinery or vehicles to offer, you may have to put up your own car or house.
This is a very risky proposition for many small business owners.
3. A Business Line of Credit or Credit Card
A third option to pump some cash into your business could be getting some revolving credit via a business credit card or a line of credit.
Revolving credit may be more appealing than a loan, particularly if you’re not sure exactly how much money you will need. A line of credit or credit card could give you a credit limit of up to $30,000, but you’re under no obligation to use it all and you will only be charged fees based on what you actually use.
A Business Line of Credit
Like any form of lending, the pros and cons of a business line of credit will vary slightly based on who your lender/provider is. However, generally speaking, this is how it breaks down.
Pro: Revolving Credit
You’re free to use a little bit of the money for cash flow now and use the rest for a financial safety net at a later time.
Pro: Potentially Lower Monthly Payments
If you were to take out a loan, you would begin making relatively large monthly payments on the entire balance (with fees) right away. However, with a line of credit, your fees are based on what you use. So if you only use $3,000 of your $30,000 credit limit, your fees will reflect that.
Con: Can Be Difficult to Get
Getting a business line of credit through a bank is essentially the same as getting a loan. You will be held to the same lending criteria and parameters. So, if you can’t qualify for a loan, you’re not going to qualify for a line of credit.
There are other private lenders that offer a business line of credit, however, they come with a higher cost of lending.
Con: Limited Spending Freedom
Your funds are not always yours to use as you see fit. If you need access to your business line of credit, you may have to fill out a formal request with your lender/ provider to explain how you intend to use the funds.
You may also be subject to an annual review to keep your line of credit.
A Business Credit Card
The business credit card has very similar pros and cons as the line of credit, with a few differences.
Pro: Revolving Credit
Like the line of credit, you can use this for multiple things.
Pro: Potentially Lower Monthly Payments
And like the line of credit, your fees are based on how much you use.
Pro: More Spending Freedom
Unlike the line of credit, your spending habits will not be monitored or controlled. You’re free to use the card how you see fit.
Pro: Perks and Incentives
Unlike the line of credit, your business credit card will likely offer things like cashback, reward miles or travel perks. However, only 1 in 10 business owners use their rewards to help their business’ bottom line.
Con: Low Credit Limits
If you need a large amount of money, you may want to look at other options. Most business credit cards come with a limit between $15,000 – $100,000.
Con: Employee Abuse
The flexibility of spending means that you’re opening the door to employees using/ abusing the credit card. You should always limit the authorized users and have firm policies and procedures in place.
Con: Credit Card Fraud
Like any plastic, a business credit card can be “hacked” and is certainly vulnerable to fraud. You need to be careful about how you/ your employees use it.
Con: Application Process
These cards are great for emergencies, if you already have one. However, they can take anywhere from 2-4 weeks to get. So, if your business doesn’t have one right now, you will likely not be approved and processed quickly enough to deal with an urgent emergency.
Final Thoughts
As you do research into each given lending/funding options, you will notice a pattern: There seems to be more doors open for bigger businesses with more revenue and more employees. It may seem like there are far fewer doors for smaller businesses, but the doors do exist and they are open to people like you!
There are lenders and funders out there who understand the plight and the challenges of the small business owner. They have realistic expectation and they’re more interested in your business’ future than your credit history. You can find someone who is willing to work with you, on terms that work for both parties.
Again, there is no one-size-fits-all solution in the world of small business. However, if you do your due diligence and look into alternatives away from the banks, you will likely find a solution that fits your business and your needs.