What Are High-Risk Business Loans?
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High-risk business loans are loans targeted to businesses with poor credit history or limited cash flow, as well as to startups or those who operate in volatile industries. In other words, borrowers who pose a high credit risk to lenders.
Lenders may attempt to mitigate the risk on these small-business loans by requiring higher interest rates, shorter repayment terms or collateral.
What are high-risk business loans?
High-risk business loans are a specific type of small-business loan given to borrowers who are considered to be risky to lenders. Risky borrowers may be those who have poor personal or business credit, whose businesses haven't been operating for long, who operate in a volatile industry or have a history of defaulting or missing payments on loans.
What makes a business high-risk for a loan?
Both lending money and taking on debt involve some risk; however, the risk associated with high-risk business loans generally refers to the one that a lender incurs. Also called credit risk, this risk is essentially the chance that a lender won’t make back the money it has loaned out.
Credit risk refers to a borrower’s likelihood of repaying their debt to a lender. Credit risk is usually measured by an assessment a lender makes during the underwriting process based on a borrower’s credit score and payment history, debt-to-income ratio and the amount of available collateral.
There are several factors that influence credit risk.
Personal credit
Although it’s not always the case, a bad personal credit score — usually a credit score from 300 to 629 — may reflect high credit utilization rates and spotty payment history, which are concerns for a lender considering issuing a new loan. You can improve personal credit by paying down credit card balances, limiting new applications and catching up on past due payments.
Lower scores may also reflect a younger age of accounts or a limited variety in types of credit accounts (i.e., loans, credit cards, etc.). If this is the case for you and your payment history and utilization are good, make sure your lender knows the whole history when it is reviewing your application.
Startups
Startup businesses may be considered high risk simply because they don’t have financial records to demonstrate their ability to make payments on a loan. In these cases, lenders rely heavily on a business owner’s personal credit and repayment history, and in some cases, collateral.
>> MORE: Best business loans for startups
Businesses in volatile industries
Volatility in business can affect the long-term predictability of a business’s revenue, and therefore its ability to repay a loan, which is why businesses that operate in volatile industries — such as energy, technology and financial services — may be considered high risk.
Offering collateral or having a co-signer on the loan can go a long way to help moderate that risk. A lender may also attempt to structure a loan in a way that matches up with your business’s cash flow, so it helps to be open to that.
Payment history
Businesses that have tax liens or past loan defaults demonstrate a poor repayment ability. To a lender, they are considered high risk because this payment history is an indicator of how likely they are to have difficulty making payments on any new loans.
If this is a part of your payment history, you may be able to help your case by being open and honest about it, and providing collateral to offset the lender’s risk.
Loan options for high-risk businesses
Merchant cash advances
Merchant cash advances (MCAs) are an alternative type of financing where a lender issues a cash advance in exchange for a fixed percentage of your future revenue, plus a fee. Exact payment amounts will fluctuate depending on your sales, and lenders will usually take payments directly from your account.
MCAs are one of the most expensive forms of financing for a borrower. MCAs can come with factor rates that convert to APRs of over 100%. In addition, since they technically are not loans, they’re not subject to the same regulations that lenders typically have to adhere to.
>> MORE: Best merchant cash advance companies
Invoice financing
Invoice financing uses unpaid customer invoices to secure a cash advance, reducing the risk to a lender. A lender advances a certain percentage of the unpaid invoices — to be repaid by the borrower once the invoices are paid, plus a fee.
This form of financing can be fast to fund; however, fees are usually charged by the week, and repayment is dependent on how quickly a business’s customer pays their invoices.
Short-term loans
Lenders may also lessen their risk by requiring repayment as quickly as possible. Short-term loans mirror the structure of traditional term loans but provide a condensed, often more expensive, alternative to a longer-term loan’s lengthy repayment terms and relatively low APRs.
Equipment financing
Equipment financing is a type of business loan used to purchase large equipment or machinery that’s necessary to run the business. Equipment financing uses the equipment being purchased to secure the loan, thus offsetting some of the lender’s risk.
Online loans
Online loans are offered by online lending companies, and the process can be completed entirely online. They can be easier to qualify for if you are considered a high-risk borrower; however, rates and terms will be less ideal than you would find with a bank.
Secured loans
One of the ways your lender might look to offset its risk is through collateral, or by offering a secured business loan. Loans can be secured by assets like cash, large equipment, vehicles or real estate property. If you default on your loan, your lender can seize the collateral you’ve pledged in order to recover some of its money.
Personal loans
If you’re having trouble qualifying for a business loan due to length of time in business, you can use personal loans for business purposes. Like business loans, the best terms and rates for personal loans usually come from banks and require good credit history.
Equity financing
If you’re considered high risk because your business is a pre-revenue startup, you may consider equity financing, which involves raising capital by trading ownership stakes in your company. Angel investing and venture capital are forms of equity financing.
Peer-to-peer (P2P) lending
Peer-to-peer lending is a type of business lending that connects business owners with individuals or private investors. P2P loans are a way to borrow money without relying on banks, but they are often facilitated by a third-party company that provides a platform for business owners to connect with investors. They typically have less stringent qualifications than traditional loans, so they are a good fit for high-risk borrowers.
