So you are looking for a business loan to expand, change, or save your business? I’d like to offer some free advice. I have spent years on the inside and the outside looking in to various business funding industries, and continue to study the growing trends and associated practices. Anyone reading this is old enough to make their own decisions about the ethics of these funding types, and form their own opinions. The purpose of this article is to provide anecdotal advice to better understand and navigate this hectic space.
Target audience
First, who am I not speaking to?
Loans through banks or credit unions can be secured or unsecured but by and large the rates are fair and the process standardized. When I say secured, these loans are attached to assets, collateral (think equipment financing), or your personal credit.
I am also not talking about SBA loans although many of these companies are getting involved with SBA 7a loans and property loans, and the same principles apply when I mention fees.
Keep in mind that we are exclusively talking about business loans. Personal loans may share some characteristics, but they are a different ball game.
I am speaking to small to medium businesses. If you qualify for venture capital or you have investors lining up for a piece of your business, then congratulations and enjoy the article but this isn’t exactly relevant.
If you are qualified for zero-interest credit limits on business credit cards or lines of credit, or even unsecured loans through large well known financial institutions and credit card providers, then maybe some of these principles will apply, but most likely, the process will be more straightforward.
Who am I speaking to?
Here is a general description: You make 5k-25k in monthly revenue. Your personal credit is 500-650. You are unqualified for a bank loan due to your time in business being under 2 years. You need funding this week or maybe even today and don’t have time to waste. You looked up “fast business funding”, “business funding”, “business loans” or less likely “unsecured business loans” online and saw a long list of online providers presenting a quick and easy process. As a result of this search, you are being bombarded with advertisements for business funding across all forms of social media. Or maybe you have received funding like whats described in this article and wish to better understand how it works to plan your escape.
Players in the industry
Lead generation platforms (you are the lead): These companies are always high on the search results when searching for a business loan online. Often whether you are looking for an equipment financing loan, a line of credit, an unsecured loan, a grant, or any other related financial product you will be routed to one of these companies.
These platforms make money by selling your “application” information to brokers. Usually, your information is routed to several brokers which will result in you receiving dozens of calls the moment you hit submit. If we take a look at compliance laws we find that these companies are limited in what educational information they can share with you due to their relationships with loan brokers, and lending companies. If your thinking of submitting an application, keep this in mind and don’t use a line or email that you cant afford to be contacted on constantly.
Brokers: Brokers are the companies who buy your information from the lead generation platforms and will be the ones calling to sell you an unsecured product. When they reach out they will have some of your information already from the lead generation company but will likely need more information from you to complete their own application and get you submitted.
These companies work with lots of unsecured lenders in the industry and sometimes even offer loans themselves. In this case they might introduce themselves as a “direct lender” and then they will say “but we also work with other partners in case we aren’t the best fit” but don’t be mislead. They are a broker that will give you a loan directly if you show interest in an offer that you’re overqualified for, but they will also happily give you their worst offer, if that’s all they can get you approved for.
You can do some digging and apply with these companies directly online to avoid the myriad of phone calls that come with lead generation platforms. Brokers make money by upselling the offers given by lenders, and by charging broker fees(which we will get into below). Usually, they are allowed to charge between 5%-20% in additional interest on top of the lender’s offer, as their commission.
Lenders: These are the companies that end up sending you the money at the end of the process. You may be able to find some larger lenders online if you’d like to apply directly, but, in this case, you won’t know if you’re getting the best deal possible because you’re only going through one company. Keep in mind that the rates vary widely based on the company’s underwriting. You could receive two very different offers from two different lenders with the exact same financials. The industry is anything but uniform.
Many unsecured lenders only offer merchant cash advances or MCAs, but some offer lines of credit, terms loans or a combination of the three depending on underwriting scores. Some lenders might also engage in broker activities if you do not qualify for any of their products.
The Process
So you looked up unsecured business loans online and you have decided to apply. You’re probably reading some vague loan qualifications online which all seem to be a good fit for you. Notice how most of these aren’t mentioning the “standard” interest rate. If you do see a range of rates, say between 5%-15%, this is a sales trick and later they will tell you that the rates “can be that low” or “you get what you qualify for”. More on that later.
Here is the first thing to keep in mind. Most likely, you are NOT about to apply with a lender or a “direct lender”. You are about to enter your information into a lead-generation platform which makes a killing selling your information to a dozen or so brokers, who will be calling you nonstop for several days, on and off for weeks, and might be emailing you on their marketing campaigns for years. The only way to get these to stop is by telling the agent to put you on a do-not-call list, or by replying “STOP” to an email or text. If they continue to contact you after this then you have a strong legal case on your hands. If you’d like to see some common examples of these lead generation platforms just do a google search for “business funding”. The first 5 results will likely be lead brokers. These days, you can also find many of these platforms on social media advertising based on your search history.
Alternatively, you might apply directly on a broker’s website. In this case, only the representatives from that company will be calling you unless they decide to sell your information later on (which if you don’t apply within a few days they likely will). These brokers work with several lenders in the industry (typically between 10-40) and the lenders these different companies work with often overlap, meaning you get the same offers from several brokers.
So you decide to apply. What’s next?
Now it’s time to complete your application. You will need to submit personal information and business information over the phone such as your: social security number, date of birth, business EIN number, personal and business address, industry info, etc. You’ll also need to provide six months of business bank statements, your photo ID, and possibly a business tax return. All of this information is then assessed by the broker’s underwriter and accordingly submitted to lenders most likely to offer approvals. They will then run your personal credit, verify your business information, analyze your financial documents, and possibly issue an approval back to the broker.
If you are approved, you’ll then be called back by the broker you are working with and receive the offer information. The initial offers are usually the lowest quality and least reliable as the better lending companies usually take longer (up to a week) to complete their more rigorous underwriting. Eventually, you will get all of the available offers on the table and the broker will start pushing you to sign a contract. This is where you negotiate the offer (see the How to get the cheapest offer section) to get the best rate.
If you decide to sign the contract and move forward, then you’ll need to collect stipulated documents and your business will go through another round of underwriting. You will only need to show that your business bank account is active, has a positive balance (sometimes it needs to be above a certain level), and all the transactions on your bank statements match what’s in the account (fraud prevention). This is most commonly done with a bank verification link, or a month to date statement from your business account. Some lenders might even require a manual bank login where they get your username and password and log into your business account to verify it themself.
Keep in mind even though you’ve verbally agreed to the offer, signed the contract, and provided all requested documents at this point, the lender still has every right to kill the deal and reject the offer at this late stage. The reason for this is these companies underwrite thousands of businesses every day and can’t waste time doing a full review of every potential customer. So they split the work into preliminary underwriting and final underwriting. This can get very frustrating for desperate borrowers who are continually signing contracts and getting rejected in the final review.
Provided everything goes well, the last step is usually the funding call. This is where a representative from the lending company calls you to verbally restate the offer and get your verbal agreement. Once you verbally agree over the phone, the lender will send the money via wire transfer or ACH.
Quick note on origination fees:
After you are “funded”, some brokers will then send you a one time fee, or broker fee, or processing fee for you to sign. This separate fee is usually sent after the funding process is completed with the lender. Brokers do this because they don’t want to compromise their existing commission they are making on your loan, but are happy to swing for extra money risk free once the deal is officially closed. These are usually sent post-funding, but can also be sent along with the contract depending on the confidence level of the sales rep. You’ll know the origination fee when you see it because it will have the broker’s name on it instead of the lending company’s name, unlike the official contract.
You may want to pay this out of the goodness of your heart, but if not, keep in mind that it is a completely made up fee. If you decide not to sign for this extra made up cost, the loan will not be affected. To verify this you can call the lender back on the phone to ask them about this extra fee the broker sent you. Most likely, the broker will not press the issue further.
Products of the industry
Merchant Cash Advances or MCA’s: This is the big one. These make up 75% or more of the industry and are most likely what you’re going to be working with if you: need the money yesterday, have lower revenue under 75k/month, have lower credit under 650, you’re desperate, or if you lack understanding of the broader unsecured funding market.
From your broker’s perspective, these offer the best opportunity to make money at higher margins.
Here are some hints that you are being sold a MCA: If you ask your broker what the interest rate is and they tell you “we go by a factor rate” or “the monthly rate is 4%” chances are your being pitched an MCA. If you get the contract and it says “this is not a loan” on the top or anywhere on the contract, you might be being pitched an MCA. If you see on the contract the “remittance percentage” don’t be confused as that is NOT the interest rate but rather the percentage of your revenue that will go towards paying back the loan based on your last few bank statements. Usually the payments on an MCA are taken daily (Monday - Friday on business days, on holidays you won’t be charged but they will charge double the day after the holiday) or weekly, based on your credit score.
MCA’s can range anywhere from 20%-59% total interest typically and the terms usually range from 4 months to a year. There are outliers on both extremes, but this is a typical range.
MCA’s usually do not report to any business credit platform, however, you can self report MCAs as a trade-line to build business credit. Do not be fooled when your told this will help you build business credit on it’s own, but rather be sure to press the issue and ask where on the contract is this stated.
MCAs usually have some kind of prepayment discount for paying the total balance back early, usually sometime during the first half of the term. For example, you might see a 30% discount on the total payback in the first 30 days, 25% in 60 days and 20% in 90 days. On the high end you might see 40% - 80% interest forgiveness offered for total repayment of the remaining balance by the better lenders in the industry, but be sure to request and read the amortization schedule as the interest is usually front loaded in these cases.
Most MCA’s today are structured as described above but there are also types of MCA’s that work by taking a percentage of your monthly credit card receivables. The loan structure is usually the same with upfront funding and fees along with daily or weekly payments to pay back the principal, but with these, payments are a set percentage of your credit card receivables rather than a fixed payment amount. Keep in mind that the interest rates can be just as high with this structure.
Term loans: These are unsecured loan products which are priced out the same way as MCAs (based on monthly revenue) but usually have more favorable terms. Term loans sometimes report to the major business credit bureaus but not always. These are usually priced out on a weekly payment schedule, but bi-weekly and monthly payments are sometimes available. Interest rates are usually more favorable coming in at 15%-35% depending on your business and the lender. The prepayment discounts typically won’t be quite as large given that the interest is lower to begin with.
Lines of credit: This is the product most people are looking for when they apply. Lines of credit have a set credit limit you can draw from, a monthly or weekly interest rate that is applied to each draw and a set payment term that each draw is paid back on. You can think of each draw being its own mini term loan that is paid back over the given term. The only difference here is that the interest is accrued monthly or weekly rather than a fixed amount as with a loan. On lines of credit you might see 1-5% interest monthly over a term of 10 months - 2 years. With some lenders, Each draw you make functions as a mini term loan itself, so be careful, a read the contract in detail to fully understand what your getting into.
Interest: the factor rate, buy rate, sell rate, and fees
The factor rate is the interest rate. When you ask your rep what the interest rate is they might start shifting their language and might mention something like “here is the monthly interest rate” and give you the actual rate divided by the number of months to confuse you or give to the total cost of the capital at the full term as well as at each of the prepayment periods to entice you with the prepayment discounts. Make sure you cut through the sales tactics and get all of the relevant numbers written down before ending the call to review them.
To do this, you need to ask for the factor rate. What is the factor rate? Here is an example: if you have an offer for 20k and the factor rate is 1.45, then your loan is 45% interest. Your total payback is 29k. All you do is multiply the loan amount (before fees) by the factor rate to get the total payback. Don’t be confused by the fancy language. This is the total interest before fees.
From the brokers perspective, there are two factor rates: the buy rate, and the sell rate. The buy rate is the factor rate that the lender is comfortable with. The sell rate is the buy rate plus the commission the broker is charging. Using the example above the buy rate might be 1.3 with 15 percentage points available for upsell. Therefore the sell rate would be 1.45 with the broker adding 15 points to the buy rate so that they make the difference in the form of their commission.
When going through the numbers you’ll also want to ask about fees. Most lenders charge origination fees in addition to the interest of the loan. These are typical with MCA’s, unsecured term loans and lines of credit alike. Usually these range from 2-5% of the funding amount. This is taken out off the top of the loan, so you never see this money. You can add this fee to the factor rate as it’s essentially extra interest paid before the first payment.
Like I mentioned in the process section above, you should also ask the broker if they charge any broker fees in advance, as the broker’s fees will likely represent another 2-5% that comes out of your account immediately after you receive the funding.
How to get to the cheapest offer
Now that you know what your in for, and who the players are, here are some tips to get you the best offer possible:
Diversify: To get a full perspective of what is available for your business you should apply with 2-3 brokers. I would set your limit to three as some lenders will discard your offer automatically if they receive your application from more than three brokers. Having at least two brokers will allow you to compare offers and negotiate the rate down more effectively. This will also help to ensure that all the best lenders in the industry receive your application as all brokers don’t work with the exact same mix or waterfall of lenders.
Patience: Ideally you want to set aside at least two weeks or longer for this entire process from the start of entering your information to the end when you receive the funds. I understand that as a business owner, you might not think you need a loan until the day that you know you do, but try your best to give yourself a week. These companies might tell you they can have funds in your account within 24 hours but the better companies they work with take longer to complete underwriting. The first offers that come back are almost always the worst and the least reliable. After 2-3 days you will have most likely heard back from all lenders, although some very high end lenders can take over a week. So leave plenty of time for underwriting.
Pushback: As mentioned above, the factor rate is the interest rate on your offer. Once you get the factor rate you should keep in mind that the broker is upselling the lender’s offer by a certain amount, usually 10-15 points(10%-15%). So the broker might be offering you a factor rate of 1.45 when the lender’s buy rate is actually a 1.3 factor rate.
The broker will do everything they can to make it seem like the rate they give you is set in stone, and straight from the underwriter. In reality, they are likely upselling you by 15%, and you have a lot of power to change the offer.
When you ask for a cheaper rate they are trained to give you the “pain”. Basically, they will remind you of the limitations on your file to knock you down and make you feel like this is your best, and only option. They are also trained to remind you of why you need the funding, and give you confidence that this investment is profitable. If you persist in getting a cheaper rate, they might come back to you with a 1.42 and tell you they negotiated a better rate or made a one-time exception, but of course, this is a sales tactic. They just want to make you feel like a winner so you sign the contract. In reality, they are still making a healthy 12% commission on the deal.
At this point, you could flip the script on them. Ask them what the buy rate is, or how many points they are upselling you. Or you can just tell them bluntly that you will only accept a 1.34, or a similar low-ball factor rate. The more industry terms you use the more they will know that you’re educated on the process. They want to get the deal done as quickly as possible as they are always under pressure from management to get deals done on a daily basis and meet their quota. Once you make it clear that you will not be taken advantage of, and that you are exploring other options for funding, they will most likely offer you the loan with 4-6 points(usually the minimum allowed by management).
In other words offer them a cheap but quick and easy way forward so they can move on, and get one on the books. This is how you sell the salesman.
Concluding thoughts
In a capitalist society every market exists for a reason. The unsecured lending marketplace is no different. They provide expensive money to high-risk businesses in the eyes of highly regulated banks, filling a necessary niche in our economy. We don’t need to replace or erase this industry. We just need to democratize the information available to make the industry function better for all. More transparency will lead to more efficiency.
I hope this helps to nudge the market in the right direction.