Businesses swim in the waters of credit, ranging from massive equipment loans to paying for $100 of merchandise 90 days after receiving the shipment. These are part of the ebb and flow of a business’ life cycle. At times, though, your company might be in need of a “quick fix” of cash to solve a problem or take advantage of an opportunity. These short-term business loans carry high interest, and attending higher risk, so knowing what you can about them is important.
The Pros and Cons of Short-Term Loans
The first thing to get straight in your head about short-term business loans is what’s good and bad about them. As with any other business decision, the degree to which you understand the positives and negatives is the degree to which you can make an informed choice.
- Cash Flow – Pro – A short-term loan can give your business a rapid cash infusion when it needs it the most. There are situations where this can mean the difference between life and death for a company.
- Often Interest Only (to Start) – Both – On one hand, an interest-only payment structure means you get more leverage from the money during the months you need it most. On the other hand, interest-only payments mean you have that much more to cover before it’s all paid off.
- Opportunities – Pro – There are times in the life cycle of any business when an opportunity to grow appears with little to no warning. If you don’t have enough capital reserves to seize it, a short-term loan can provide them for you.
- Emergencies – Pro – Stuff goes wrong. A piece of vital equipment could break down, or damage from an accident might not be fully covered by insurance. As with opportunities, a short-term loan could cover this expense if you lack the cash to handle it.
- Higher Interest Rates – Con – A short-term loan is almost always at a higher interest rate than long-term loans, often multiple times higher. In many cases this is because interest is calculated by the month…so a 5% rate is actually a 60% APR (as opposed to that 6% APR on your equipment loan that works out to 0.5% monthly).
- The High-Cycle Risk – Con – You take out a short-term loan because you need the money. If cash flow is really tight, you run the risk of not being able to make the payments on that loan…which can mean needing another loan to make the original payment. Less scrupulous lenders count on this, and include it in their business model.
Sources of Short-Term Loans
Where you get a short-term loan can be as important as what kind of loan, and even if you get a loan at all. Reputable, principled lenders will give you an expensive but fair cash infusion, while predatory lenders will trap you in a cycle of debt. Here are a few of the most reliably fair sources.
- SBA Microloans – The Small Business Administration offers loans of up to $50, 000 on short-term timelines. These carry the same beneficial terms as similar governmental programs like first-time home buyer mortgages and some student loans, since the SBA’s first job is to help businesses grow. They can be hard to qualify for, but if you get in the door they are often the best option.
- Banks and Credit Unions – The institutions most people think of first when they consider getting any kind of loan. Short-term loans with a new institution can be hard to make happen, since initial qualification can be an issue. But reaching out to a bank or credit union with which you already have a good relationship can get a loan with good terms pretty quickly.
- Factoring – This is essentially a very short-term loan secured by the future of your business. If you have an order currently in process that you know will net you $10, 000 a month after you need it, you can get a loan in the same way you might borrow a few bucks from your brother until payday.
- New Models – Kabbage is just one of dozens of new entities that have popped up in response to (a) the growth in new small businesses that need financing and (b) increased regulation of traditional lenders that make it harder to get a loan. This newest model doesn’t use your credit score, but rather more directly relevant indicators of your payment history and cash flow for your business. For anybody having trouble qualifying for more traditional lending, this is one of the better options available.
Short-term loans can be risky because they are usually in response to an immediate need, and people often make bad decisions under emergency circumstances. That doesn’t mean they aren’t sometimes necessary, or that you should always avoid them…but approach the question well-informed and with a number-driven analysis of the benefits and you’ll be able to leverage the extra money to be worth well more than the cost in interest.
What we’ve talked about here are the factors surrounding how to make decisions about short-term business loans. For a more basic primer on what they are and how they work with your business, read our article “When It Makes Dollars and Sense to Use a Short-Term Loan to Grow Your Business.”
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