Learn about high-risk business loans and potential financing alternatives.
- A high-risk business loan is a financing option for certain types of businesses (e.g., those with poor credit, no credit, startups, new businesses, businesses with uncontrolled revenue streams, businesses based in volatile or risky industries, etc.)
- High-risk loans typically have high interest rates, large or frequent payment requirements, short-term agreements, and interest rate hikes if you default.
- Some alternatives to high-risk business loans include peer-to-peer lending, angel investors, external lenders, a loan co-signer, or borrowing from friends or family.
One of the most common problems that business owners face is securing the right funding for their businesses. Regardless of how world-changing you think your business idea is, you will need some type of financing to get it off the ground.
There is no one-size-fits-all funding solution, since the best business loan or financing option for each business depends on several factors; however, many business owners and entrepreneurs turn to business loans as a temporary means to an end.
Traditional lenders typically require businesses to have a good credit history. They follow strict guidelines to assess how risky each investment is, which ultimately determines whether or not they are willing to lend your business money. This is something that many startups and businesses in risky industries struggle with. As a result, some businesses and entrepreneurs have no choice but to finance their business with a high-risk business loan.
What is a high-risk business loan?
High-risk business loans (e.g., merchant cash advance, short term loan, invoice factoring, etc.) are last-resort financing options for businesses that are considered too risky by traditional lending standards.
When approving someone for a business loan, traditional lenders analyze a business's creditworthiness based on the five C's of credit: character, capacity, capital, collateral and conditions. Businesses that fall short in any of these categories are categorized as "high risk" and will likely find it difficult to obtain a traditional business loan. As such, they will have to seek alternative funding instead.
High-risk business loans are often too risky for traditional lenders to approve. Neal Salisian, a business attorney and partner of Salisian Lee LLP, represents predominantly lenders and investors, as well as small- to medium-size businesses. As someone familiar with lending and investing, he said there are specific conditions that often constitute a high-risk loan.
"High-risk business loans are ones with high interest rates, large payments or frequent payment requirements, [they are] short term, [have] interest rate hikes at default, [and are] collateralized with important assets or [they are] ones that are personally guaranteed," Salisian told business.com.
Although the conditions for financing a high-risk business may be somewhat similar, there are a few different high-risk business loan options to choose from. Each comes with its own set of advantages, disadvantages and stipulations. We spoke with financial experts to learn what the most common loan options are.
Rob Misheloff, CEO of SmarterFinance USA, said small businesses can seek out merchant cash advances, subprime equipment financing, subprime business loans or hard money loans against real estate.
Jared Weitz, CEO and founder of United Capital Source, said short-term loans and invoice factoring are other common high-risk financing options, and he said that business credit cards, asset-based loans, and personal business loans are also financing alternatives that can be considered.
There are many financing options available to high-risk businesses, but that doesn't necessarily mean they are right for your business. Research each type of alternative lending option and high-risk loan available to learn which one fits your specific needs. Keep in mind, high-risk loans should be looked at as short-term fixes during temporary working capital shortfalls.
"High-risk loans can be a good tool to get a business back from the brink if used properly, but they shouldn't be considered a long-term financing solution because of the risk and because of what they can signal to the industry (consumers, investors, potential partners included) about your business's health," said Salisian.
