Of all the different kinds of financing used by business owners one of the most prevalent is short-term working capital. The best way to meet these needs is with a bank line of credit. The difficulty with that especially for early-stage companies (often less than two years old) is that often their working capital needs are not large enough to make the efforts worth it for a bank plus the fact that banks in general often already have a built-in bias against small businesses. And with working capital loans banks have to spend much more time than any longer-term loan. If it has a 90-day loan for example it is either going to get paid off (paperwork), or if not paid off, a new loan created, probably a different interest rate and term, new notes to sign etc. (lots more paperwork).
To fill this gap and to take advantage of the tremendous computing power available today more and more non-bank lenders have been appearing to serve the small business market. That computing power enables these lenders to make decisions almost immediately after the borrower files an application. The lenders take advantage of the huge amount of data available on us on the internet and create algorithms that can analyze them instantly to make credit decisions. Things such as credit scores, utility payments, insurance claims, mobile phone data, social media posts, Yelp (and other )reviews, and more. This analytical speed often means that credit decisions based on the algorithms created by the lender can be made in minutes, and in some cases makes funds available the same day. But to take advantage of this speed, you’re going to pay for it. A lot.
Here are just a few examples using just the costs of funding from some different working capital lenders. There are many other factors that come into play in order for the lender to decide the final initial interest rate; things such as time in business, credit score, loan amount and term (maximum time before payoff 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 that you should come away with here:
- Research, research, research. There is a tremendous of information available on the internet about online working capital lenders of all types. Learn everything you possibly can about all types but especially the working capital lenders. But if you are beginning to settle in on one or two, you need to really get into the details of the terms. There could be lien requirements on assets that would never occur to you unless you don’t pay back your loan and then you might find that the lender can liquidate certain of your assets. So your research should be in minute detail if possible.
- But I think the most important thing you need to understand is how working capital loans are designed to work. They are designed to be paid off in a very short period of time to cover certain costs incurred while waiting for payments on what you have sold. Think credit cards. Pay it off in 30 days, no interest. But if you don’t pay it off at the end of the term, interest charges on the 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 services that the banks can’t (or more likely) won’t. Just make sure you understand what you’re getting into. Convenience can be expensive.