It’s a Catch-22 situation that many small business owners, particularly those adversely affected by the recent recession, have faced. To successfully apply for a loan from a bank or another accredited lender, it’s important to have excellent credit. Yet suppose your business was hit hard by the economic downturn and as a result, your credit report is less than stellar? What then?
You certainly aren’t alone. According to a July 2012 study released by the Small Business Administration, the number of U.S. small business loans, characterized as $1 million or under, dropped by almost 5 percent in 2011, compared to three years before. Factoring into that decline was the low number of approved small business microloans, defined as $100,000 and below.
But that dismal picture could be fading. A recent report by Experian and Moody Analytics revealed that in the first quarter of 2013, small business credit improved markedly from the final quarter of 2012, jumping to a 4.5-percent increase.
However, such welcome tidings may not be of much use to small businesses plagued with bad credit scores. How then can they obtain the financing they need to stay afloat and survive?
1. Review your credit report and correct errors on it.
Before you even think of scouring nontraditional sources for financing, you must first review your credit report to check for errors. Rectifying them could help you hike up your credit score. And if this is the case, you certainly have plenty of company. According to a study released earlier this year by the Federal Trade Commission, the U.S. consumer watchdog agency, 42 million Americans have errors on their credit report.
In addition to correcting outdated information, you will need to remove duplicate or erroneous accounts, which according to Jeffrey Strickfaden, CEO of Improve Credit Consulting, a provider of financial management and credit improvement services, can magnify negative credit items. Strickfaden, who estimates nearly half of his clients are small business owners, also adds that “for any accounts that you may have closed in the past, make sure to verify that they are listed as voluntarily closed, and not closed by the creditor.”
2. Stop borrowing on your personal credit cards
Although often thought of as a viable short-term solution for financially pinched small business owners, the consequences of excess credit card use may hurt you in the long run, particularly if you’ve been borrowing way too much. Avoid this desperate measure at all costs.
Rohit Arora, CEO of Biz2Credit, an online resource for small business finance, agrees. “If you owe more than 50 percent of your outstanding credit limits, your credit score drops,” he says. “It is better to use multiple credit cards than maxing out one card.”
3. Document your business investments
If a small business owner can produce an extensive trail of documentation proving that she has invested in her own business, then it might be easier to obtain financing, even with a poor credit score, says Arora.
“It’s easier to tell banks that the reason you have debt is because you are spending to try and grow your business,” he explains. “This is especially true if you are trying to get lower financing, such as an SBA loan.”
4. Make credit card payments on time
This might sound like personal finance 101 but it’s a truism when it comes to maintaining good credit. If you want to clean up a spotty credit history, then it’s imperative you pay your credit card debt on time. Nothing will make your score plummet faster than late payments.
5. Use merchant cash advances
For small businesses that have been unable to repair their credit for whatever reason, merchant cash advances, which are funds provided to small business owners via their merchant provider for a percentage of credit and/or debit card sales, could be a viable financing option. The only drawback is the risk it incurs. According to Wanda Strickfaden, president of Improve Credit Consulting, becoming delinquent with monthly repayments “can lower your scores with the business bureaus and eventually cause further damage with a business rating.” But even with this risk, the option can still be a good alternative for small business owners exploring nontraditional avenues of financing.
Jeff Strickfaden cites an example to bolster his point. “One of our colleagues that is a certified public account was interested in this option because it afforded him the freedom of having cash flow on hand if needed,” he recounts. “It also gave him other opportunities with different resources for lending.“
6. Seek out community organizations or microlenders that provide nontraditional financing
For many start-ups or existing small businesses that have either nonexistent or poor credit history, going to the route of traditional lending is not an option. However, there are a plethora of alternative organizations that can help small business owners secure the financing they need.
Rohit suggests ACCION, a microlender, which according to its website, issued its first microloan 40 years ago, as an option. Another alternative is SBA’s microloan program, which provides loans of up to $50,000 to help small businesses.
And, according to Dawn Reshen-Doty, president of Benay Enterprises, Inc., a Connecticut-based provider of services to both small and large businesses, there might be development organizations in your state that provide non-traditional financing, loans and/or grants. “They also often provide small business training so that companies can learn how to better manage their money, watch their cash flow, and become more viable in the long run,” she adds.
As an example, Reshen-Doty refers to Community Economic Development Fund (CEDF) in Connecticut, which she says provides between “6 to 10-year low interest rate loans and even matching grants that do not have to be repaid.”
A caveat is issued with this recommendation. “Of course they require several years’ financials,” she notes. “Applicants have to show that with the infusion of loans and grants, their business will remain at the break-even point or become more economically successful. They even have programs to subsidize payroll costs for new hires so that businesses are incentivized to hire more employees.”
Other examples from Reshen-Doty:
- The Massachusetts Growth Capital Fund, which does provide low-interest financing to small business that are “able to demonstrate potential” but have been denied financing through traditional outlets; and
- Community Economic Development Fund in Virginia, which operates along the same parameters as the Massachusetts Growth Capital Fund.
Although the paperwork that these community organizations require might seem daunting to some small business owners, Reshen-Doty explains that “the process is worthwhile, as you can learn what your business truly needs to succeed as well as gain invaluable information and support from agencies that want local businesses to grow and thrive.”
For small businesses that have been unable to obtain financing due to poor credit scores, there are positive solutions in lieu of closing shop. Just do some research and you will find a wealth of alternative financing options at your disposal.
Disclaimer: The opinions expressed are solely those of the author and interviewees. You should consult a qualified professional to assist you in determining the most effective funding options for your business.