Of all the different types of financing used by business owners, one of the most prevalent is short-term working capital. The best way to cover these needs is with a bank line of credit. The difficulty with that, especially for early-stage businesses (often less than two years old), is that often their working capital needs aren’t great enough to make the efforts worthwhile for a bank, plus from the fact that banks in general often already have a bank built. -in bias against small businesses. And with working capital loans, banks have to spend much more time than any longer-term loan. If you have a 90 day loan, for example, it will be paid off (paperwork) or, if not paid, a new loan will be created, probably a different interest rate and term, new notes to sign, etc. (a lot more paperwork).
To fill this gap and take advantage of the tremendous computing power available today, more and more non-bank lenders have sprung up to serve the small business market. That computing power allows these lenders to make decisions almost immediately after a borrower submits an application. Lenders take advantage of the vast amount of data available about us on the internet and create algorithms that can instantly analyze it to make credit decisions. Things like credit scores, utility payments, insurance claims, cell phone data, social media posts, Yelp (and other) reviews, and more. This analytical speed often means that credit decisions based on lender-created algorithms can be made in minutes and, in some cases, makes funds available the same day. But to take advantage of this speed, you are going to pay for it. Much.
These are just a few examples using only the financing costs from a few different working capital lenders. There are many other factors that come into play for the lender to decide the final initial interest rate; things like time in business, credit score, loan amount and term (maximum time before payment is required) just to name a few. The examples:
- Lender A: 2.9% – 18.72% fixed fee
- Lender B: 1.5% – 10% per month
- Lender C; 9.9% – 99%
- Lender D: 0.25% – 1-7% per week
There are two very important things you should come away with here:
- Research, research, research. There is a wealth of information available on the Internet about online working capital lenders of all kinds. Learn as much as you can about all types, but especially working capital lenders. But if you’re starting to decide on one or two, you need to dig into the details of the terms. There may be asset requirements that would never occur to you unless you default on your loan and then you may find that the lender may liquidate some of your assets. Therefore, your investigation should be thorough if possible.
- But I think the most important thing for you to understand is how working capital loans are designed to work. They are designed to be paid out in a very short period of time to cover certain costs incurred while you wait for payments on what you have sold. Think of credit cards. Pay it in 30 days, without interest. But if you don’t pay it by the end of the term, interest charges on unpaid balances kick in, and depending on how the lender calculates them, the costs can be significant.
Online working capital lenders provide an incredibly valuable service that banks can’t (or more likely) won’t. Just make sure you understand what you’re getting into. Convenience can be expensive.