As we said in our post, “Small Business Lending is Booming”, the market is awash with capital. Just because you can get capital, doesn’t mean you should. It can be risky, and some loans are more dangerous than you might think So, how can you get capital without getting clobbered?
In fact, Kabbage just got $200M in funding to support its AI-based small business loans. When the market is saturated with capital, lenders start making riskier loans. Riskier loans mean higher interest rates, for example. Follow our three simple steps to know how to say afloat.
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First, can you grow faster than the interest rate being charged?
How do you know? Simple, what’s does your business plan project? Don’t have one? Write one.
Right now, small business lenders might be more willing to allow less thorough plans or none at all. You might think that’s a good thing, but it’s not. Remember, if you can’t grow faster than the interest rate, you’re losing money. Defaulting on easy capital is just as damaging as defaulting on hard. In other words, that’s the first way you can get capital and get clobbered.
A business plan requires a business model. Your business model can tell you whether or not you have a good chance to grow at the rate you need to grow in order to beat the interest rate. With one, you’re much more likely to be able to get the right capital without getting clobbered.
Second, how is your credit?
It’s unlikely that you will qualify for a low-interest rate with a small business lender if your personal credit score is less than 700. We’ve heard of lenders now willing to give capital to people with scores as low as 600.
While it may sound like it’s a great thing to give people a chance, unfortunately, it’s not. They’re not going to give you the capital for free. A lower score will mean higher levels of interest.
This takes us back to our first point. You can get clobbered if you get capital at a rate which is higher than you can grow. If you can, you would be better served to fix your personal credit before you seek capital.
Having a high credit score is the second thing that can help you get capital without getting clobbered.
Lastly, What’s your debt cash ratio (DCR)?
See our post “Small Business Lending is Booming” for the formulas to do the calculations. If you fail those fitness tests, then perhaps you should explore other options.
Being overleveraged is the final way you can get capital and get clobbered. It limits your options later if there is a downturn or a slowing of your growth. Since you’ll still have to pay back the debt, you’ll have less cash on hand for everything else.
You can really get clobbered if you gave any personal guarantees to get that capital. Why? Because now your personal possessions are at risk. If you’ve been in business less than 2 years and/or you lack collateral to offset the debt, you may be forced into this position.
Being properly leveraged is the final way to get capital without getting clobbered.
If all of this has made your head spin, you’re not alone. Unfortunately, this is really important to understand. The last place anyone wants to be is swimming in debt from a small business lender.