Cash Crunch: What's the Best Loan for Your Small Business?

Cash Crunch: What's the Best Loan for Your Small Business?
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Small-business owners are often struck by a kind of paralysis when looking for a loan: Where should I go? How much can I ask for? Will I succeed?

It’s no wonder fledgling entrepreneurs fret over these details -- only half of small businesses that applied for financing in the first half of last year received any cash, according to a 10-state survey by the U.S. Federal Reserve Banks of New York, Atlanta, Cleveland and Philadelphia.

A lot of business owners think it’s hard to find financing, partly because there are so many lenders and types of loans from which to choose. As more nontraditional lenders such as Lending Club and Prosper help fill the gap in small-business funding alternatives, the potential for confusion just keeps increasing.

Related: A Basic Guide to Bank-Term Loans

Questions to ask yourself

First thing you should do is breathe. All of those options may be confusing, but it makes it very likely there’ll be a solution that works for you. To get started, take some time to ask yourself: What’s my best option? One problem is that business owners tend to go with what they know, and often that means going for a traditional loan from a brand-name bank. But that can be a demoralizing experience. As a 2014 Harvard University analysis notes: "The banking industry in the aggregate appears increasingly less focused on small business lending. The share of small business loans of total bank loans was about 50 percent in 1995, but only about 30 percent in 2012.”

Remember, what’s right for you as a small business is a function of two things: (1) What do you qualify for? (2) What are your priorities? For example, do you want your cash as fast as possible, do you need a set amount of funding or do you have to have the lowest rate?

The company I work for, NerdWallet, recently did a deep dive to compare small-business loans, examining key factors that help determine the best funding alternative. Here are the top factors that lenders will consider:

  • Age of your business
  • Revenue
  • Your personal FICO score
  • Size of proposed loan
  • How you plan to use the cash

Together these elements help a lender evaluate the likelihood that it will get its cash back.

Getting past the ‘terrible twos.’

All the factors above are important. But there’s another element to consider: Has your business reached its second birthday? If it has, you’ll qualify for the widest range of credit options.

Related: How to Finance Your Business Yourself

Yes, two years is a magic number. Once your business makes it to 24 months, a whole range of new lending options -- including Smart Biz SBA loans and small-business loans from Funding Circle and Lending Club -- open up to you.

That’s because around 20 percent of all new businesses fail in the first two years, according to the U.S. Bureau of Labor statistics. About a third fail by year three and roughly half by year five. Lenders are less likely to back a business that hasn’t proved it can survive its infancy when mortality rates are so high.

Still, there are many lenders who will cater to businesses that are less than 2 years old; it’s just that interest rates on their loans are generally higher.

A note of caution: Every loan you apply for will cause a “soft pull” on your credit history and will affect your FICO score. And each lender has a wide range of interest rates -- including some as high as 113 percent APR -- and several also have a one-time origination fee based on a percentage of the total loan.

It’s hard to divine any of this taking a look at each lender’s page — and you’ll face the difficulty of not knowing what you qualify for before applying. 

So we created a page that analyzes all these factors. It wasn’t easy work -- I had conversations with several lenders, pored over the fine print of lender corporate filings and, in many cases, applied for loans myself. (Keep in mind that you will face heavy marketing pressure once you go down this road. After I began my research, my voicemail was clogged with 50 follow-up messages from lenders.)

According to our analysis, here’s how alternative lending opportunities break down by years of business:

One year or less: BlueVine, Fundbox, Prosper and Lending Club (personal loan)
Between 12 and 24 months: Same as above, plus Ondeck, Kabbage and Dealstruck (term loans).
More than 24 months: Same as above, plus SmartBiz, Lending Club (small business), Funding Circle and Fundation

(For a complete look at rates, requirements and our suggestions for appropriate use, visit our small-business loans breakdown.)

What about your retirement funds?

Personal savings and credit are by far the most common way startups are funded, according to Entrepreneur, followed by loans from friends and family. Bank loans were only the fifth most popular source of funding.

Related: Applying for a Short Term Business Loan Online? These 4 Steps Can Protect Your Startup.

But before you max out your credit card or call your family, have you looked at your retirement funds as an option?

You might not know that you can use your retirement accounts as a tax-free source of business funding. “Business owners invest retirement funds in their businesses as an equity investment rather than a loan, such that the funds don’t need to be paid back to their retirement accounts. As a result, business owners avoid the debt and interest payments that come with other financing options,” writes financial planner Mark Nolan, a member of NerdWallet’s Ask An Advisor network.

“Typically, the business owner is able to access funds in 10 to 15 business days. For a time-sensitive business opportunity, quick access to funds can make all the difference,” he adds.

Of course, any new business venture is inherently risky -- which means you might never see this cash again. That’s a decision you could live to regret when retirement approaches.

It may seem tough to fund a new business, but entrepreneurs have more options than ever before. Investigate them all before deciding on what’s best for you. 

Related: When Seeking an SBA Loan, Remember the 5 C's