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Four Questions Every Small Business Should Ask When Obtaining a Loan, Part 1

Posted by Breakout Capital on 9/20/17 2:56 PM

This post is the first in a series presented by Breakout Capital, a technology enabled nationwide lender for small businesses with a focus on transparency, innovative lending, advocacy and borrower education. This series is intended to provide education for small businesses on topics that are crucially important, but rarely discussed.

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As a first time borrower evaluating options for non-bank capital, navigating the alternative financing market can be confusing and, in many cases, downright frustrating. There are so many different working capital products – small business loans, equipment leases, invoice factoring, to name a few – how do you know what is right for your business?  And with so many different types of companies – such as lenders, brokers, and marketplaces – how do you decide which type of firm will help you access the right product for your business? Then you get to the financing providers.  There are hundreds, if not thousands, of alternative lending companies. How do you know which company to choose?

In the alternative finance market, there are many responsible funding companies that will offer the right product for your business; however, there are also hundreds of companies that offer highly predatory products filled with hidden costs that can quickly send your business into a cycle of high cost debt your business may never be able to escape.  

So, how do you know you are working with a financing provider that is looking out for your best interests? To help you navigate this process, we’ve laid out four key questions you should ask your prospective financing provider.

Finding the right financing provider is 99% of the battle in alternative finance. And remember, the first option isn’t always the best option, so if you asked these questions and don’t feel like you’ve received suitable answers, look elsewhere.  

  1. Are you a direct lender or a broker?
This is always the first question you should ask. If you find an honest, knowledgeable broker, he or she could help you find the best alternative for your business. However, brokers currently operate under little to no oversight, and many of the unscrupulous brokers will look to place you with the product that generates the most commission for them, not the best product for your business. This result can have catastrophic consequences for your business, so it’s essential you ask this question and do a thorough background and reference check on the broker or funder. If the company states they are a direct lender or direct funder, ensure their company name is on the contract if you pursue a loan or factoring solution. If it’s not, ask why, and if the answer isn’t sufficient, move on. Don’t fall into the trap of enabling a commission-chasing broker to ruin your business.

If you decide to work with a broker, ensure that broker has your best interests in mind.  Brokers aren’t regulated, and they are paid (much) more to sell you a high cost product then they are to arrange a low-rate one. Also, ensure you ask them to present you several funding options, not just short-term capital solutions.  Most importantly, ask the broker how much they are being paid in commission to arrange the capital; remember, every dollar the broker is paid by the lender directly increases the cost of your loan – in some cases the broker commissions can be upwards of 15%.

One final recommendation: check customer review sites, like TrustPilot or Better Business Bureau, to read about the experiences of previous customers with the potential financing provider.

  1. What is the cost of my loan, including fees?

We discussed earlier that there are many different types of products in the market – short term loans, medium term loans, SBA loans, invoice factoring, equipment leasing, to name a few. Comparing cost can be difficult as not all offers are presented with a uniform cost metric. While Annual Percentage Rate (“APR”) is the most widely known cost metric, it isn’t universally applicable across all products, especially products that aren’t “credit”. However, Breakout Capital, along with some of the best actors in the space, recognizes the need for uniformity and is pushing towards a universal mechanism that allows small businesses to fully understand the cost of different types of products.

An important distinction is the difference between interest rate (or factor rate or other forms of stated “rates”) and APR. If your financing provider uses the term “rate” or “interest rate", ask if that rate is actually APR, and if it isn’t, ask for the APR equivalent.  “Interest rate” can be used to only represent the rate of interest that is charged over a specified time period (e.g. a month, six months, or a year). The good actors will not confuse interest rate (or, even worse, factor rate) with APR, but many of the unscrupulous actors will.  These companies may tell you that you are paying an “interest rate” of 20% for six months, and that may sound great, but it can actually represent an APR of upwards of 70% depending on how the loan is structured.

When you are working with a specific financing provider, ensure you know the total cost of the loan, including any upfront fees (origination fees, broker fees, or other) as well as any prepayment penalties or prepayment discounts before you sign any paperwork. If you are searching for a small business loan and would like to evaluate the deal across a few metrics such as total payback and APR, ask the lender to provide them to you. If they won’t provide this to you, you should probably contact another lender.  

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Breakout Capital is committed to responsible funding. We believe it is better for you to keep your business and grow it responsibly than set it up to fail with insurmountable debt. Please contact us today if you’d like to partner with us.

Topics: How-To, Small Business, Lending, Finance, Tips, Loans