If your inbox is anything like ours, you are probably receiving updates from any business partner you have ever worked with. These updates are saying things like “we are still open during this crisis” or “we hope you stay healthy” or “please reach out if there is anything we can do for you at this time.” I don’t mean to bash these emails, after all they are well meaning in letting you know that these businesses are still operating for your partnership. But the emails I do want to bring to attention are the emergency COVID-19 “deals” or “relief programs.” As a small business owner myself, I see multiples of these funding programs in my inbox every day. As an expert in the financial lending space, it doesn’t take much reading for me to realize these “deals” are not going to help business owners. In fact it is no more than thinly veiled predatory lending during a global crisis.
What Does Predatory Lending Look Like?
The funding programs that you will see heavily marketed will most likely offer cash upfront with daily repayments until you have paid back the cash advance amount in addition to any fees they require. There is nothing inherently wrong with this method of business funding, although, I typically caution small business owners on this funding method due to the hit your cash flow will take through the frequent repayments. But it has specific uses that work for very certain businesses.
These programs can also come in the form of online loans. This means you work with an alternative lender rather than a bank and they typically issue the money quicker and with less paperwork than a bank may require. Both speed and looser qualifications are good for business owners needing immediate money or not having the time in business or credit score to qualify for a bank loan, but the price will reflect that. APRs for online loans are usually significantly higher than a small business loan from the SBA or a bank loan.
Are These COVID-19 Funding Programs “Relief” Programs?
The SBA Economic Injury Disaster Loan program and the upcoming SBA backed loans that will result from the government stimulus are aimed at small business relief. Those are the typical relief programs that the media will talk about.
Alternative lenders that are not backed by the SBA fall outside that circle of “relief” programs as they do not have the same interest rate maximums that the SBA backed loans do. Therefore, any marketing of alternative financing options as “relief” loans or advances should be evaluated skeptically. The issue with these “relief” cash advance programs is that the cost is almost literally an arm and a leg. Predatory lending programs may disguise the costs of their programs by using a factor rate. This factor rate may fall between 1 or 2 and looks like a small cost to pay. It is different from an APR which relies on the total that is owed on a loan. A factor rate of 1.3 does not look that costly by itself. This means that if you are advanced $1,000 today then the amount you will repay in the form of daily repayments will total to $1,300. But the additional fees on top of the factor rate show that this financing method is indeed costly.
Why Do You Need to Look for Hidden Fees?
Then you have to account for the extra fees that the financing company may add. This could be in the form of a “bank fee” of 3%. This could be in the form of a “Professional Services Fee (PSF)” of 7%. This could be listed in the penalties for missing a payment by literally doubling the required payment amount on top of the missed payment amount. There could be an early termination fee for paying back the amount before the due date. There are all sorts of hidden fees that without a trained eye could be easy to miss in your financing agreement. And it is not uncommon that these cash advances come at the equivalent cost of triple digit APRs. What looks like a small number is only a fraction of what you are paying. Taking that hypothetical $1,000 advance with a 3% bank fee, 7% professional services fee, and a factor rate of 1.3 means that you would really be receiving $900 with a total payback of $1,300.
What is Holdback Funding?
Cash advance companies may be offering your business a “deal” when it comes to making repayments. During this crisis it is completely normal to feel like you may not have enough money for the next two months to weather out this storm. You are probably needing more than $1,000 which would mean that the gap between what you receive and what you pay is even wider. A $100,000 cash advance for a term length of 12 months under these fees would lead to receiving $90,000 and a total payback of $130,000. Holdback funding is a relatively new concept where instead of having ~$500 daily repayments during the first two months of the funding term, you only have to make payments of $1 a day. This means that your initial advance will be less the first two months amount of money to accommodate this. Rather than the initial advance of $90,000, instead the initial advance is $68,333 (total repayment amount of $130,000 divided by term length of 12, then multiplied by 2 for the two months of holdback). So you receive $68,333 but still pay back $130,000 total on the advance.
Why Would You Want Holdback Funding?
Holdback funding sounds like a great solution to having short term insufficient funds. You get the money you need to cover payroll and overhead, and you don’t pay anything more than about $60 for two months. Unfortunately, once that grace period is over, you will be making daily repayments that will hurt your cash flow. Having healthy cash flow should be a number one priority for small business owners looking for financing. I wrote an entire article on why you need to focus on cash flow, so go ahead and give that a read if you don’t believe me. Aside from the repayments hurting your cash flow, you need to look at what your costs will be for taking out this advance. Could you find a financing option that is just as fast but more affordable for your business? Odds are that you can. And you can find one that improves your cash flow rather than harms it.
How Can You Avoid Predatory Lending During the COVID-19 Crisis?
The most important steps you can take to protect your business during the COVID-19 pandemic is to find a reliable source of business financing. It’s always smart to have a financing method in your pocket even during good times. Lines of credit are a favorite because they offer flexibility and you only pay on what you use. You may find that a line of credit doesn’t cover all your financing needs, and that’s when you can look at a traditional financing option like a bank loan or an alternative financing option.
Is Alternative Financing a Good Option for Your Business?
Alternative financing businesses gained popularity during the 2008 Great Recession when banks slowed or even stopped lending to small business owners. Alternative financing is not inherently bad. Online loans from reputable companies can offer financing to businesses that otherwise may not qualify for a bank loan or may not qualify for enough financing that they need to grow. The issue in the alternative lending space is that there are some companies that will not help your business. The salesperson may promise the moon but deliver a pebble. The contracts may be full of hidden fees, and they may have terrible customer reviews claiming that the required repayments bankrupted their business. Pay attention to these reviews. Are there lots of 5-star reviews with generic comments? This may be indicative of paying for review spamming. Is the business responding to the reviews and offering context? Sometimes a bad review isn’t reliable, but you can only make that decision if you take the time to research the company you are signing up with for funding.
Can you reach a decision-maker on the phone to ask them questions about your funding directly? A decision-maker means an account executive, the head of operations, or even the CEO themselves. If you have any issue arise in your funding, you want to be sure you can get it resolved without jumping through hoops. Large financing companies may be using a call center and you may have to be patient when trying to reach someone who can make executive decisions regarding your account. This may not be important to you, but if it is, be sure you can get in touch with the employees you need to reach.
How Can Your Financing Partner Help You?
This is a big question you need to ask. What exactly are your funding needs during this time? What will your funding needs look like in the future? Be incredibly honest about the situation you are in. This will prevent surprises on both your behalf and your lender’s behalf. If you need to cover payroll until people can safely go back to work, tell that to your lender. If you need financing to cover supply costs because you are still operating, tell them that. Be honest about your needs and ask specifically how their funding program can meet those needs. Research the best financing options for your industry. Ask your potential financing partner about their experience in your industry. And finally, partner with a financing company that will not only get you through the tough times right now but actually help you grow after.
What Entails Reliable Business Funding?
Flexible and reliable financing is not only a fair-weather friend or a last resort. Good financing options are customizable to your business needs in order to help you survive now and then help you grow after the crisis stabilizes. You don’t want to be strangled by repayments once you are back up and running at full capacity. Your cash flow needs to be strong to be able to survive or grow, so be sure you have a financing partner that can reliably improve your cash flow throughout this entire crisis and then afterwards as well.