Small businesses are often in need of business funding which has become increasingly scarce because of the reluctance so to say of commercial banks in providing loans for small businesses. The problem of financing for small businesses is an especially important since it is they that are responsible for the competitiveness of the American economy, is responsible for creating jobs for half of the entire workforce in the United States. Because of the impact of the recent economic depression in the country lending to small businesses has dropped by as much as 20 percent; while, ironically, lending money to big firms has increased by over 5 percent. Banks have also been notorious for creating stringent conditions for obtaining bank loans—conditions which small businesses more often than not are unable to fulfill. The issue of collateral has been one of the major reasons why firms are turning to private business loans. Other reasons also include the credit core requirements of the banks in which case small businesses quite often default on.
Equity Financing—Equity Investors
Before proceeding to look at private business loans in detail, we need to consider what is really involved in business funding. First, the business financing is either in the form of equity financing or it comes in the form of debt financing. Equity financing, on the one hand, involves a business receiving funds from individuals such as venture capitalist or equity investors in exchange for part ownership of the business. That is to say that a private investor offer funds which are unsecured and hope to gain from the profits of the business in the future. In the case of equity financing, high net worth individuals provides funds to small businesses which show great promise and form part of the board of the business for about 3 to 5 years, during which they recoup their investments from the profits of the business as well as make their own profits. In the case of venture capitalist, however, the situation is a bit different.
Equity financing—Venture capitalist
While the equity investor only stays a part of the business for a short period of time, the venture capitalist often becomes a part owner of the business on a permanent basis. The venture capitalist is known for seeking out startup firms which show great promise of becoming industry leaders especially by offering products which are patented. So the main difference between the venture capitalist and the equity investors which lie in the structure of the binding agreement. And because of the fact that a business has to sacrifice part of its ownership, loans from venture capitalists and equity investors are not regarded as private business loans.
The other form of obtaining business funding is in the form of debt financing. In debt financing, a small business obtains a certain sum of money which becomes a debt to the business. The debt is one which is to be paid back at a particular time if it has been from banks and other traditional financial institutions. Of course, some private business loans are in the form of debt financing while some others are structured as debt financing in that they involve the same process of obtaining a fixed sum of money and promising to repay later even if the exact period of repayment as in the case of merchant cash advance is not fixed per se. The most popular form of debt financing has over time been commercial bank loans. Loans from commercial banks have been particularly favored by small business owners for a number of reasons. Foremost among the reasons why firms have preferred to obtain loans from banks is because such loans attract minimal interest rate as compared with those from other non-traditional sources. In addition, banks should give borrowers a long period time to repay their loans. Some bank loans could even take decades to repay, especially those like mortgages.
Why Small Businesses Need Private Loans
But because of the difficulty which small businesses face in obtaining bank credit, they have had to turn other equally beneficial options. Private business loans are therefore useful for filling the gap created traditional and conventional bank lending institutions. Private loans offer flexibility and less stringent criteria the opposite of which commercial banks are known for. And in most cases, private business loans are not bogged down by the many regulations— both federal and state—which affect commercial banks and other traditional lenders. As a result of reduced regulations, private loan providers are able to cater for the needs of plenty of businesses which otherwise might not have had access to business funding. Once a business can prove its ability to repay the loan it would have no problems in obtaining business finance from non traditional lenders.
Benefits of Obtaining Business Funding From Private Lenders
There are lots of benefits that come with private business loans, chief among them being the speedy and easy access to capital. After all, banks have an approval rate in the neighborhood of 40 percent. This means that as many as 40 percents of the entire loan applications from small businesses to commercial banks end up in being rejected. But in contrast, private business loans boast an approval rate of close to 90 percent depending on the financial health and particular situation of the business applying for the loan, ensuring that almost any business that seeks alternative business funding gets it. There is also the obvious advantage of obtaining loans without having to provide many documents the screening of which could constitute an unnecessary delay in the approval process. And such private business loan sources as merchant cash advance make it possible for businesses with low credit scores to obtain funding. Other lending sources are known to place a huge emphasis o the credit score of a business in order to determine its creditworthiness. The credit score is given the lender insight on how the business is likely to behave in terms of meeting up with payment timelines by looking at its performance with previous loans. While most banks require a credit score of 680 and above, private lenders accept scores from 500 or even below that as in the case of merchant cash advance.
Some Objections to Private Loans
In spite of the numerous advantages of private business loans, some business owners seem to object to it or choose to remain skeptical because of its relatively high cost. Sincerely speaking private loans are more expensive than loans from traditional institutions in terms of the interest rates they attract. This is to be expected. Because when a firm is being evaluated for a business loan of any kind, lenders determine the interest the loan attracts based on how likely or not it is for the loan to be repaid, it is perfectly normal for private business loans which are very much riskier to attract higher interest rates. Part of the reason why private lending is such a risky venture is that the private business loans issued to small businesses are unsecured; that is there is no collateral security. In situations like this, the business bears virtually no risk in the transaction but the lenders which stand to lose everything if the business is unable to pay. After all, private lenders are not often allowed to extract personal guarantees from business owners; in cases where they did so and a legal battle ensued when the business defaulted, courts ruled in favor of small businesses, often stating that the personal guarantees that had hitherto been obtained are null and void. So small business owners who turn to private lenders should understand that the interest rates are somewhat justified.
One source of private loan examined—Merchant Cash Advance
This discussion of private business loans cannot be deemed complete without us taking a closer look at one of the most popular sources of alternative finance for small businesses—merchant cash advance. A merchant cash advance differs from most other sources of debt financing in that it does not attract interest. In short, it is not structured to look like a loan. Merchant cash advance transactions are often as a mere business to business transactions in which the merchant agrees to sell a portion of its future receivables in exchange for a lump sum of cash from the merchant cash advance provider. The merchant cash advance providers do not charge any interest on the advance but factor the advance by a factor that is usually below 1.5 in order to generate a profit. Unlike other sources of private business loans merchant cash advance involves the business making a daily payment to the merchant vendors until the total amount has been repaid. Merchant cash advance comes with all the usual benefits associated with private lenders—speed, no collateral, minimal documentation. However stands out as having the highest approval rate of all, as well as having the least stringent requirements. No wonder more and more small business owners who have been denied bank loans readily turn to MCA providers. Businesses that have opted for merchant cash advance have, in the overwhelming majority of cases, be grateful they did. Merchant cash advance in all remains a leading source of alternative funding and small businesses would do well do check it out.