How to Advise Clients on the New World of Small Business Financingby
More than 250,000 small business owners are expected to take an online or alternative loan this year – and some are likely your clients. While there is a broad range of options available today, the trade-offs and costs associated with those options vary from lender to lender, and evaluating the differences can be confusing. What’s more, the wrong financing choice can hurt your client’s business in the long run.
Companies like Amazon, Priceline, and Uber have changed the way we shop, travel, or hail a cab, and new technology-based companies are changing the way business owners borrow capital. OnDeck, for example, has delivered more than $4 billion to business owners since 2007.
It’s not just the technology; it’s looking at small business lending in a new way. They’re looking beyond a single-minded focus on personal credit, collateral, and other traditional metrics, and identifying ways to evaluate potential borrowers based upon information that helps assess the health of the business and its ability to service debt.
For starters, instead of the traditionally weeks-long process at a bank, borrowers are going online. Some businesses are getting an answer on their applications within hours and may receive their funding within a day or two – sometimes as fast as 24 hours. The process for many online lenders is simply faster, less painful, and more convenient for the business owner than traditional approaches.
Because you’re in a position to help clients navigate this maze of new options, understanding how to evaluate those choices becomes increasingly important in order to help your client borrow wisely.
Three Key Questions to Consider
The bank is still a good option in some circumstances, but it’s not the only option. Nor is it the one-size-fits-all solution it might have been 30 years ago. There are many situations where traditional financing options just don’t work.
With that in mind, here are three questions to help you and your clients determine the best fit for their situation.
1. What is the loan purpose? It should start here. Identifying the loan purpose helps answer other questions, such as: Is it a short-term or a long-term need? What kind of loan cost makes sense? Is there a positive and certain return-on-investment opportunity that exceeds the loan cost?
For example, if your client has an opportunity to purchase soon-to-turnover inventory at a discount but needs to borrow to do it, the total interest cost of the loan might be the key metric to help determine whether or not the financing makes sense.
Additionally, loan purpose should influence the term. In the above example, it might not make sense to borrow with a term of four or five years to purchase inventory that will turn within a few months. A shorter-term loan might make more sense and have a lower total cost than a long-term loan.
Think of it as you would when purchasing a new car. Most people would never purchase an automobile with a 30-year loan – the total cost of the loan would be very high. Short-term needs, such as purchasing inventory or ramping up for a new contract, might be best served by short-term financing.
There are times, however, when longer-term financing makes more sense. Purchasing heavy equipment, constructing a new building, or any other business purchase that could be depreciated over several years might be better suited to a long-term loan.
2. How much money do they need? Loan amount helps identify where to look. For example, many banks would rather lend $500,000 or $1 million instead of $10,000 or even $150,000 – it’s just too expensive for them to accommodate the lower loan amounts. However, with streamlined application and approval processes, online lenders are better positioned to offer those types of loans, as well as larger loans.
3. How is their credit profile? Your client’s personal credit profile could impact where they’ll find success. For example, the bank typically looks for a personal score of more than 680, and the US Small Business Administration’s minimum threshold is 650.
Nevertheless, a less-than-perfect personal score doesn’t rule out financing for an otherwise healthy business.
We’ve found that a business owner’s personal credit score really isn’t the best proxy of a business’ creditworthiness. Although a good personal score and a good business credit profile won’t guarantee financing, they do add options. A healthy business with cash flow to support regular periodic payments is a better measure.
Determining the right financing requires more than comparing interest rates. Loan term, total cost, the business’ credit profile, and the total health of the business are all factors that identify the type of financing that makes the most sense given a particular business-use case. These three questions will help you and your clients evaluate options and choose the financing that will likely be the best fit.
Frank Orofino leads the Accountant Advisor Program at OnDeck, a leader in online small business lending. In his role, he oversees a team who work directly with CPAs and the accounting community to bring value to their client's small businesses through OnDeck’s...