7 Core Ways to Compare Lenders and Products
Many small businesses looking for a loan feel they are in a stormy sea being pulled and tugged in many directions, some of them potentially treacherous. There are lots of very different lenders vying for their business; some with approaches that are new and different and others that have been around since the early part of last century. Yet there are some basic ways borrowers can differentiate between the different lenders and determine which are appropriate.
Technology is revolutionizing how lender and borrowers meet and interact. “Big-data” analysis techniques are driving radical shifts in risk management, and are directly impacting which borrowers’ loans and approved and at what price; and changes in regulations spawned by the great recession drive shifts in banks’ appetites for and approaches to small business lending. Add to that hedge fund-backed lenders intending to raise rates to borrowers in order to boost returns for their investors.
The impact is very real for the 2.8 million small businesses in the US. More lenders than ever before are competing for their businesses with a broader range of products. It is a study in how capitalism works, with profit-motivated lenders reacting to the unfulfilled needs of entrepreneurs and business owners who want to borrow money and lenders, and new and existing are creating new and innovative products. The profusion of options does not always make it easier for a business to make smart borrowing decisions. In fact, I would say the variety and complexity that exists makes it much harder.
One useful way to organize the many options and to try and make some sense of them is to identify a few key characteristics with which to define and organize products. I frequently use a list of seven core characteristics when comparing lenders and products.
- Interest rate
- Term of the loan
- Maximum loan amount
- Probability of approval / speed to close
- Flexibility of use of loan proceeds
- Complexity of application (and time and effort it involves) / and the level of disclosure it requires of the borrowers personal and business situation
- The requirement for collateral and / or guarantees to support the loan
Each type of lender performs well on some criteria and less well on others. For example, on-line lenders focused on merchant cash advances and short-term loans have simple applications, approve a high proportion of applicants (relative to other types of lenders), provide rapid responses, require few personal guarantees, and close and fund quickly.
But their interest rates are high (often over 10 times the rates on more conventional loan products), the term over which they lend is short (rarely less than a year or two) and the maximum amount one can borrow are relatively low.
In comparison, SBA 7(a) loans have a more complicated and onerous application process, take significantly longer to approve and fund, and require personal guarantees. But rates lenders can charge are capped by the SBA at reasonable levels (currently around 6 percent on variable rate loans and just under 8 percent on fixed-rate loans), loan amounts can be as much as $5 million, the loans can fund working capital, equipment, or real estate improvements or purchase, and the term over which the loan is repaid can be as long as 25 years.
One thing we see frequently is borrowers who do not match the useful life of the asset being financed to the term of the loan, for example borrowing short-term debt to pay for a piece of equipment that will last ten years, putting severe stress on cash flow in the short term.
An eighth criterion is finding a lender that a business feels comfortable with and can build a relationship of trust with. Even on a short term loan the relationship extends beyond the closing until the loan is paid off.
Ultimately borrowers must weigh which criteria of a business loan are most important to them and make their own decision on tradeoffs. A small business will need to invest time in exploring and comparing financing options, as it might an equipment purchase or an employee hire. It seems a worthwhile investment when a business will have to live with, and literally pay for, the consequences of a poor borrowing decision made hastily.
