How to Access Capital in an Economic Downturn Considering taking out a loan when economic hardship is on the horizon? Here's what you should know.
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Concerns that the U.S. is headed for a recession have been mounting for a while, especially among business owners. One survey found that eight out of 10 small business owners anticipate a recession will happen sometime this year.
Recessions affect most businesses in two ways — first, revenue takes a hit as consumers start holding onto their cash instead of spending. Second, tightening credit conditions limit the number of financial resources available to help businesses weather economic challenges.
Some businesses consider taking out a loan or line of credit when economic hardship is on the horizon, but is this the right move for your business?
Should you get a loan during a recession?
You may not like the idea of taking on additional debt and wonder if applying for a loan during a recession is a good plan, but there are situations where taking out a loan or line of credit is the smartest option.
You should start by considering how much cash you have on hand. If you're heading into an economic downturn with little cash, a business loan can provide a financial buffer. Access to cash will give you options for solving challenges, making staying profitable and committed to growth that much easier.
This is especially true since no one knows how long a recession will last. You may have enough cash to get you through the next six months, but that won't help if the downturn lasts two years or more.
Waiting until you desperately need money can significantly reduce your options. As a downturn approaches, lenders tighten their guidelines, and you may be unable to meet their inflated eligibility requirements amid economic hardship. If you think you may need additional capital, it's best to act sooner rather than later.
Lending standards are starting to tighten
Many companies struggle during recessions as demand falls and uncertainty about the future increases. They'll start to look for ways to increase capital, like taking out a business loan or line of credit, but this becomes a challenge since most banks will tighten their lending standards during an economic downturn.
As the economy worsens, banks face a higher risk when lending money. Most banks will only lend money to established businesses with strong credit histories and limited industry exposure to mitigate their risk of financial loss, which inflates eligibility criteria and makes it harder for entrepreneurs to qualify altogether.
Fortunately, banks and credit unions aren't the only lending institutions. Non-bank lenders don't follow the same guidelines as traditional lenders, so they can extend credit to a wide range of businesses, even during a recession.
Consider using a non-bank lender
A non-bank lender is a financial institution that isn't a bank or credit union. They lend money like traditional lenders but don't have a full banking license, and they don't offer things like checking and savings accounts.
There are advantages and disadvantages to going the non-bank route. While this type of lender tends to charge higher interest rates than banks or credit unions, they offer numerous quality-of-life improvements and specialized benefits, including online communications, streamlined underwriting processes, fast funding times, alternative financing solutions and more.
What you lose in the cost of capital is gained through speed and efficiency. For example, you can complete the application in as little as 15 minutes at some institutions, and many lenders provide same-day or next-day funding.
These loans also come with fewer stipulations about how you can spend the money, and the cost of capital can be offset with revenue-driving opportunities. For example, spending $10,000 on interest charges won't matter as much if you increase your revenue by $50,000.
Plus, as you continue to build a relationship with that lender and improve your business credit score, you'll be eligible for better rates in the future.
Start looking for business financing now
After the Silicon Valley Bank collapse in March, some economists lowered their economic growth forecasts for the year. The lending environment was already starting to weaken following numerous prime rate hikes, but the SVB crisis caused many banks to tighten their lending standards even further.
In particular, small banks have to be more cautious about lending money in an effort to preserve cash. Small to medium-sized banks account for roughly 50% of commercial and industrial lending, so this will impact a number of businesses.
Federal Reserve documents predicted that the fallout from the banking crisis would likely lead to a recession later this year, and it's unlikely that we'll see any significant improvements for at least two years.
If you anticipate needing funds in the coming year, you should start looking for business financing now. Although you might be apprehensive, a loan or line of credit can tide your business over until the economy improves and give you the capital you need to continue growing.