Lenders often rely heavily on the personal credit and repayment history of business owners when assessing the risk of startups. They will typically review your credit report from the credit bureaus when you apply to receive funding. The high-risk lenders that offer these loans usually try to offset the risk with high interest rates, shorter loan terms, and frequent repayment schedules.

Some high-risk lenders will also require collateral to help mitigate their risk. If the business defaults, the lender claims the collateral to recoup its losses. Collateralized loans are also known as secured loans since they provide security for the lender.

Securing unsecured high-risk loans is possible, meaning they don’t require collateral. However, unsecured loans will usually have higher interest rates and fees. In addition, lenders that offer unsecured loans might still require a lien on the business or a personal guarantee.

A blanket lien, also called a UCC lien, allows lenders to come after any business asset in the case of a borrower’s default. A personal guarantee means that you’re personally responsible for repaying the loan, which circumvents limited liability protections. If you default, the lender can come after your personal assets to recoup its losses.

Despite the costs, small business owners will turn to high-risk loans when they can’t qualify for conventional financing. The funding can still help businesses maintain operations or expand. These loans are usually short-term solutions to solve an immediate funding need or take advantage of a time-sensitive opportunity.

How do High-Risk Business Loans work?

There are several forms of high-risk business financing, and each functions differently. Lenders typically charge higher interest rates for high-risk business loans to mitigate their risk. Repayment terms for high-risk business loans are often shorter than traditional loans. Many high-risk loans involve interest rate increases upon default.

Here are the most common small business loans and financing structures used for high-risk borrowers.

Term Loans

Business term loans are a form of business lending where a business receives a lump sum and repays it plus interest in fixed monthly payments. A traditional term loan would carry a low-to-moderate interest rate, low fees, and long repayment terms of several years.

Short-term business loans are a modified version of these traditional structures designed to offset lender risk for small business owners who can’t qualify for a conventional term loan. Short-term loans are the most traditional type of high-risk loan, typically with a maturity of 18 months or less. In addition, they also carry higher interest rates and fees, such as an origination fee.

Merchant Cash Advance

Merchant cash advances (MCAs), also called business cash advances, are an alternative type of financing where a lender issues a cash advance in exchange for a fixed percentage of your future sales, plus a fee. Merchant cash advances typically require weekly or daily payments, but the repayment amount fluctuates based on credit card sales.

An MCA is technically not a loan but rather an advance of funds to purchase future receivables. MCA companies will review a merchant’s previous sales receipts to determine an advance amount, which the business receives as a lump sum.

The business repays the advance with a percentage of its future daily sales, known as the holdback rate. The holdback rate typically falls between 8% and 15%. The amount fluctuates with your sales. Merchant cash advances may come with costs higher than traditional bank financing, reflecting the flexibility of repayment that is tied to sales.

Most merchant cash advances use a factor rate instead of an APR. Factor rates are simple to calculate, but the interest applies as soon as the MCA goes through, so you can reduce your interest by paying early. MCA factor rates are usually between 1.09 and 1.15, with terms between 3 and 24 months.

Suppose you received an MCA advance for $100,000 at a 1.10 factor rate. You’d multiply the advance by the factor rate, $100,000 x 1.10 = $110,000, meaning you’d pay $10,000 to borrow $100k.

The terms, factor rate, and holdback rate you receive all depend on your credit profile. In other words, the riskier the lender views your business, the higher the holdback and factor rates, and the shorter the terms.

Invoice Financing & Invoice Factoring

Invoice financing uses unpaid customer invoices to secure a cash advance, reducing the risk to a lender. Invoice financing companies typically do not require business owners’ credit checks, focusing instead on the creditworthiness of the customers who owe the invoices.

Invoice factoring involves selling your invoices to a third party, while invoice financing uses your invoices as collateral for a loan or line of credit. In this process, a third-party invoice factoring company purchases the invoice with an advance that is usually between 85%-95% (advance rate) of the invoice value.

The factoring company makes money by purchasing the unpaid invoices at a discount rate, usually between 1%-5%. The factoring company then owns the invoice and collects payment from your customers. Once the customer pays the invoice, the factoring company recoups the advance amount and fees and issues the remainder to your business.

Bad Credit Business Loans

As their name implies, bad credit business loans are designed for small business owners with a low credit score, typically below 600. There are various bad credit loans, including the financing methods mentioned above. Many of these options base approval on a business’s cash flow more than the business’s credit history.

Other bad credit business loans include:

• Asset-based loans: Asset-based loans use business assets such as accounts receivable, equipment, or inventory as collateral to secure funding.
• Business lines of credit: Business lines of credit provide flexible access to funds up to a set limit, allowing you to draw and repay as needed, similar to a credit card.
• Equipment financing: Equipment financing allows you to purchase or lease equipment for your business by using the equipment itself as collateral.
• Working capital loans: Working capital loans help cover everyday expenses like payroll, rent, and inventory when cash flow is tight.
• Revenue based financing: Revenue based financing ties repayment to a fixed percentage of your business’s future revenue, making payments fluctuate with sales performance.
• Hard money loans: Hard money loans are often made by private investors based on the value of the collateral provided. Hard money loans are short-term, high-interest loans typically secured by real estate or other hard assets.
• Peer-to-peer lending: Peer-to-peer lending connects businesses directly with individual investors through online platforms, often with more flexible requirements than traditional banks.

Like other high-risk loans, bad credit financing includes higher interest rates and fees with shorter repayment terms and frequent payment schedules (usually daily or weekly).

One way to think of bad credit business loans, and high-risk loans in general, is as a form of bridge financing. You can use these high-cost financing methods to solve immediate working capital needs in the short term while reducing your business’s perceived risks so that you can qualify for more advantageous long-term financing in the future.

What makes a small business High Risk?

Understanding when your business is “high risk” requires knowing how lenders view you. Here are some of the most important factors lenders consider when determining their risk. Improving any of these factors will help you with conventional lenders.

Credit Score

The first and most obvious factor in lending is your credit score. Lenders will look at both your personal credit score and your business credit score. Most traditional lenders, like banks and credit unions, require a personal credit score of over 675.

Alternative lenders are usually able to work with lenders with a credit score of 600+, although that’s when business owners start to become high risk. Anything below 600 would indicate a high-risk borrower. A credit score under 580 typically indicates a poor credit history.

Time in Business

Traditional lenders usually require at least two years in business, while online lenders might only require six months to one year of business history. Startups and younger businesses are considered riskier because they are unproven.

Annual Revenue & Cash Flow

Many lenders prefer businesses with high annual revenue, typically over $100k. Equally important as revenue is your cash flow, since that’s the primary source of repayment. Businesses with low or inconsistent cash flow are considered risky. Lenders evaluate cash flow by reviewing recent bank statements to assess the financial health and risk associated with the business.

The Five Cs of Credit

Lenders also determine credit approval and rates using the “five Cs” of credit. Several of these are related to the above factors as well.

• Character. Lenders determine an applicant’s character by looking at their credit history and track record of paying off debts. Again, the lower a credit score, the higher the risk.
• Capacity. Lenders determine a business’s capacity to repay a loan by analyzing its debt-to-income ratio (DTI). A good DTI is 35% or lower, and a DTI of 43% or higher is considered high-risk.
• Capital. Lenders prefer to work with businesses that can put up some of the capital needed for a loan. If you can make a down payment of 15%-20%, lenders are more likely to approve a loan or give a lower interest rate. You can still get a small business loan without a down payment, but that’s riskier for the lender.
• Collateral. As mentioned, offering collateral to secure a loan reduces the lender’s risk. Unsecured (zero collateral) loans are considered riskier.
• Conditions. The conditions lenders consider involve time in business, the stability of your industry, and how you plan to use the funds.

How to apply for a High-Risk Business Loan:

Follow these steps to apply for alternative business lending.

Step 1: Consider Your Needs

Before you begin the application process, take some time to make sure this is the right product for your individual needs. Will you be able to use the capital for your desired purpose? Is the repayment structure conducive to your cash flow? Do you know exactly how much funding to request?

Answering these questions ahead of time will make the rest of this process much smoother.

Step 2: Gather Your Documents

Expect to provide these basic documents during the application:

• Driver’s license
• Voided business check
• Bank statements from the past three months
• Financial statements

Step 3: Fill Out the Application

You can begin the application process by calling us or filling out our one-page online application. Either way, you’ll be asked to supply the information from the previous section along with your desired loan amount.

Step 4: Speak to a Representative

Once you apply, a representative will contact you to explain the repayment terms, interest rates, and terms you qualify for. This will ensure that there are no surprises or hidden fees during repayment.

Step 5: Receive Approval

If approved, funds should appear in your bank account in 1-10 business days, depending on your loan type.

What are the advantages of High-Risk Business Loans?

While the term “high-risk loan” might sound scary, these financing arrangements do offer benefits to businesses when used appropriately. Alternative lenders and lending marketplaces are primarily designed to solve the problem for business owners who need funding but can’t obtain it due to perceived credit risk.

Many online lenders offer high-risk loans, and potential borrowers benefit from convenient online applications with minimal documentation. The qualifications are lower, and you can usually receive a determination on approval within 24 hours.

In addition to quick applications and approval times, most online lending platforms provide fast funding. Even if you’re considered “high risk,” you can apply for a loan, receive approval, and get your money within a few business days. Paying your loan off on time and in full can increase your credit rating, making your business less risky.

What are the disadvantages of High-Risk Business Loans?

As discussed, lenders offset their risk by charging more for these loans. You can still get credit approval, but it will cost you more in interest and fees.

High-risk loans also carry shorter repayment terms and more frequent payments. The combination of high rates and short terms can lead to high, frequent payments that strain your cash flow.

Falling behind on payments or not paying off a loan on time can lead to increased costs in late payments and further damage your credit, increasing your risk. Defaulting on these loans can cause you to lose collateral, personal assets, and prevent you from borrowing in the future.

High-Risk Business Loan Pros & Cons

Pros:

• Obtain business funding even when lenders consider you high risk.
• Quick and convenient online loan applications.
• Fast turnaround time for approval and funding.
• Potential to improve your credit rating with on-time payments.

Cons:

• Higher interest rates and fees.
• Short-term financing with frequent repayment.
• Often requires a down payment & collateral.
• Requires a personal guarantee, which puts your personal assets at risk.

Frequently Asked Questions

Here are the most common questions about high-risk loans for business.

Are High-Risk Loans a bad idea?

Hearing “high-risk” automatically makes these loans sound like a bad idea. And make no mistake; these loans are risky for your business. However, suppose you can reliably make the payments and pay the loan off in full and on time. In that case, these loan structures can help you solve business challenges while improving your credit so you qualify for more advantageous loans in the future.

Do banks offer High-Risk Business Loans?

It would be exceedingly difficult to find a traditional bank that would approve a high-risk loan. Most traditional financing options require a minimum credit score of 675, and they want every aspect of the application to be just as highly qualified.

Businesses that have tax liens or past loan defaults demonstrate a poor repayment ability. Some industries are inherently riskier than others, according to data collection and analysis of delinquency and defaults.

Likewise, you would need good credit for an SBA loan. While SBA-guaranteed loans are more accessible than traditional bank loans, you’ll typically need a credit score of 650+.

High-risk commercial lenders are almost exclusively alternative online lending platforms. Non-traditional lenders may have more flexible requirements for high-risk businesses compared to banks. Most alternative lenders specialize in saying yes when the bank says no.

What are my alternatives to High-Risk Business Loans?

You still have a few business funding options if you don’t want to take out a high-risk loan but can’t qualify for conventional financing. You could try to borrow from family, use personal loans, attract investors, or crowdfund for investments.

You might also be eligible for a business credit card. Several credit card companies offer secured business credit card options. This could be a way to obtain short-term financing if you’re credit history puts you in the high-risk category. Business grants allow you to access money that doesn’t have to be repaid, but they are highly competitive.

Ultimately, your best option is to improve your “five Cs” so your business is not considered high risk. However, if you need funding now, you might have to take out a short-term loan while improving your credit profile.

High-Risk Business Loans – Final Thoughts

Businesses that traditional lenders perceive as “high risk” still have options to get the funding they need. However, you will have to pay more for it, and missing payments could exacerbate the issues that made your business high risk to begin with.

That doesn’t mean you shouldn’t pursue these loans as a last resort, though. Instead, it means if you must take out a high-risk business loan, you should do everything possible to minimize the risk and costs.

You should consider the best loan option for your business needs and cash flow. Using a high-risk loan as bridge financing can work if you make timely payments. Avoid taking out more than you need, and ensure you work with a reputable lender.

The best high-risk commercial lenders are transparent about the costs, provide excellent customer service, and are rated highly. Look for Better Business Bureau-accredited lenders with outstanding online reviews.

Contact us if you have more questions about high-risk financing or want to apply for a small business loan. Our loan executives can answer your questions and help you find the best financing options for your business needs.