Small business loans are scarce, but SMBs have loan alternatives: David Sussman in the Washington Post

When traditional small business loans are so difficult to find, which loan alternative is right for your company?

It’s no secret that since the credit crisis began three and a half years ago, small businesses have found it tough to get loans from traditional banks.

Although many of the larger banks, like Bank of America, JP Morgan Chase, Wells Fargo, claim to be expanding their small business lending programs, the reality is that 9 of 10 loan applications are rejected (source: Biz2Credit), and the number of small business bank loans has fallen 17% since October 2011 (source: Pepperdine University).

Why aren’t banks lending?

It’s a complicated issue, but in general, banks haven’t fully recovered from the 2008 financial crisis. Many wouldn’t be around today if not for the Troubled Asset Relief Program (TARP). These banks still face significant exposure to bad US mortgages and risky Eurozone investments which have prevented them from taking on new lending risks. The big banks know they can’t rely on a second TARP if they end up in difficult financial circumstances again. Therefore, they’ve become extremely risk adverse. Since small businesses carry a higher risk of default than their corporate counterparts,banks are reluctant to expose their books to this type of lending – particularly when it’s not that profitable for them to begin with.

The other factor at play: rising accounts receivables. According to Experian, larger companies now take 28% longer to pay their bills. Between this and the decline in bank loans, smaller companies face a serious liquidity crisis.

Until bank lending steps up, small business growth will remain stagnant due to slower cash flow – and that impacts the whole economy. Many economists believe it is this reduced cash flow, caused by the precipitous drop in lending, that is adding to the country’s high unemployment, sluggish recovery and declining household net worth. Small businesses are the engine that drive our economy. According to the U.S. Small Business Administration, small businesses  employ half of all private sector employees, generate 65 percent of all new jobs in the country and pay 44 percent of the US private payroll. Without sufficient financing or liquidity, these smaller companies can’t expand their operations, invest in new equipment or fund new research and development; they can’t hire new employees and in many cases have to lay off existing staff.

Loan alternatives for small businesses

When large banks are no longer an option, small businesses need to take advantage of alternative financing. Here are seven alternatives to the traditional bank loan for small businesses.

1. Credit Unions and SBA

Small businesses turned down for a bank loan should turn first to local credit unions or the Small Business Administration. According to BizRate, credit union loan approvals have slightly increased compared to their banking counterparts. SBA-backed lending (ex: 7a, 504, micro-loans) is another healthy option if good business credit exists with at least two years of tax returns.

• BEST FOR: Any business at least two years old, with good credit rating.
• PROS: Reputable lenders, reasonable terms and interest rates.
• CONS: Credit requirements only slightly less than traditional bank loans.

2. Asset-Based Lending

Every company has some type of asset that can be borrowed against. It could be inventory, work orders, equipment, machinery, raw materials, leasebacks, or even securities. By working with a knowledgeable broker, many businesses can leverage these existing assets to secure a much needed source of cashflow for working capital.

• BEST FOR: Businesses in manufacturing, industry, real estate or any company with substantial equipment, products or work orders.
• PROS: Loans can be approved regardless of credit rating or track record. And short-term loans can be relatively low-cost.
• CONS: Higher interest rates and the lender can legally seize these assets upon default.

3. Factoring

Accounts receivables are another asset that a company can borrow against – and many specialist firms are very interested in doing so. Think of it as a loan against future payments. Lenders pay the money in advance and can also oversee collections.

• BEST FOR: Any company to whom monies are owed.
• PRO: Same benefits as asset-based lending, and more financial companies are willing to lend this way.
• CON: Interest rates can range from competitive to high.

4.  Business Line of Credit

Business owners with good personal credit can take out a line of credit, or BLOC, which is typically for smaller loan amounts in the $25,000 to $100,000 range.

• BEST FOR: Individuals/partners with solid credit (700+).
• PRO: Good way to provide quick cash flow or start-up seed capital.
• CONS: Rigorous approval process to get the line and is based on personal credit.

5. Private Equity

Owners can also sell a stake in the business to private investors, similar to what takes place on the reality show ‘Shark Tank.’ By taking on new investment partners, it can be an effective way to raise cash and improve liquidity.

• BEST FOR: Startups or companies that expect high annual growth rates, such as product manufacturing, tech, financial service firms, real estate.
• PRO: Bypass banks and other lending institutions and still raise large sum of cash.
• CONS: Business gives up autonomy to new partner.; can be challenging to find qualified private investors; and requires thorough due diligence on the business.

6. Mezzanine Financing

A short-term high-interest loan that can offer considerable leverage for certain types of businesses. Think of it as a second mortgage on a business. Companies often use this to make real estate purchases or to acquire another business. The holder of the note charges a higher interest rate compared to conventional loans, which it takes out through payments on the debt, added interest to the debt and an ownership stake in the company.

• BEST FOR: Companies in midst of an acquisition or restructuring debt, or real estate development firms.
• PRO: Offers considerable leverage.
• CONS: High interest rate and may take a stake in company.

7.  Hard Money Loans

A high interest loan that should only be used if a business has no other option. This also should be considered a short term (one year or less) option due to the high cost. To get the loan, the business will have to use its real estate as collateral – and typically will only receive a maximum of 65 percent loan to value, usually at an interest rate of 15-20 percent, but it can go as high as 29 percent.

• BEST FOR: Real estate, manufacturing or any ongoing business that can’t get a loan elsewhere.
• PRO: Loan of last resort for companies that can’t get any other type of financing.
• CON: High interest rate and potential low loan to value