Online Lending: What to Know if You Need a LoanThese loans are fast and flexible, but read the fine print and do the interest math to know what you’re getting — and risking.
Tempted to consider an online loan? Online lenders that cater to or target small businesses are one of the fastest-evolving segments of the ecommerce world. They represent welcome competition with banks and other financial institutions have dominated lending for decades.
But before you choose a lender and sign on the dotted line, remember the first rule of business: “If it sounds too good to be true, it usually is.”
The plusses: Online lending is often fast, and the loans easier to secure than loans from traditional lenders. You can often receive a response within days or even the same day.
The application process is generally streamlined, making the documentation process easier (i.e., not as much paperwork or “hoops to jump through”).
Certain online lenders will provide more flexibility with repayments to better match the ability for your company to generate cash flow with repaying the debt. In some cases, this may be relatively quick (for example, six months).
What’s not to like? That depends on the lender and loan you choose.
These loans can be expensive when evaluated from the perspective of interest rates. For example, if you borrowed $50,000 and established repayment terms of $5,000 per month for 12 months, you would pay back a total of $60,000, or $10,000 in interest and $50,000 of principal. This may appear to be an interest rate of 20 percent ($10,000 divided by $50,000), but because you are paying back monthly and don’t have full use of the money for the entire year, the implicit interest rate is roughly 35.4 percent. Expensive money.
Loan origination, service and maintenance fees hidden in some agreements can elevate the cost of the loan even higher.
The “PG” – Personal Guarantee
While you may be securing a loan for your business, most of the online loans will include a provision that the owners of the business provide a personal guarantee. In other words, if the business can’t repay the loan, the owners will be obligated to repay the loan.
The fine print
Lenders will often embed highly favorable language to protect their interests. Make sure you read the fine print to understand all your obligations, commitments, terms, and conditions. Default provisions (i.e., missed payments or inability to repay) are something to watch for both from the perspective of additional fee/default interest rate increases as well as settlement terms (that protect the lender). When possible and feasible, having professional counsel review the lending agreement is recommended.
The online lending world comes down to a very simple relationship: The higher the risk, speed, ease and flexibility of a loan, the higher the costs and potential legal obligations (including personal).
Do your homework on the lending company you will be approaching. While most online lenders are reputable, spend time completing your diligence or review of the financing source and obtain referrals and other confirmations of legitimacy (e.g., professional referrals from trade associations, BBB rating, etc.) when available. The concept of “due diligence” (i.e., the process of investigating, evaluating, and underwriting a third party) slices both ways as it is just as important for you to complete diligence on the lending company as it is for them to complete diligence on you and your business.
Online lending is ideally suited for relatively small loans ranging from $25,000 to $250,000. Anything above this amount and you are probably better off working with a more traditional lending source such as a bank. Anything smaller and you may want to look more towards revolving credit markets (for example, credit card offers).
I cannot emphasize enough the importance of properly planning and preparing realistic projections to ensure you have a clear vision of how much money is required, when your business will be able to pay it back, and just how much the money will cost. Setting sound expectations upfront and proper repayment schedules will save everyone countless headaches down the road.
Editor’s note: Tage Tracy is a financial consultant and co-author of several books including “Cash Flow for Dummies,” “How to Read a Financial Report” and “Small Business Financial Management Kit for Dummies.”