Once your business is successfully under way, it’s time to think about planning for growth. Growing means you’re able to serve more customers, employ more workers and see your revenues and profits skyrocket. Yet growth takes capital. Many owners are left asking when it’s right to invest in growth and when they should stay the course. Short-term loans can help your business get an infusion of capital.
Like with any type of lending, short-term financing has advantages and disadvantages. Knowing when to choose short-term loans is critical to your overall success as a business owner. Let’s review when it makes dollars and sense to use a short-term loan to grow your business.
5 Situations When a Short-Term Loan is Beneficial
1. Startup Costs
When it’s critical to launch as soon as possible to secure provisional patent protection or fulfill pent-up market demand, many promising entrepreneurs finance their startup costs using short-term loans. Often, a small infusion of money is all that’s needed to get the business up and running or implement necessary operational upgrades (e.g. larger processing power or storage space from Amazon Cloud Computing).
2. Seasonal Gaps in Accounts Receivables and Payables
Short-term loans can help businesses that are cyclical in nature, such as retailers preparing for Black Friday, Small Business Saturday and other major shopping days. For example, a florist business may need to purchase triple its usual monthly inventory to meet Valentine’s Day demand. A short-term loan can help you take advantage of a supplier discount for paying in advance while waiting for your accounts receivables to clear.
3. Short-Term Operational Costs
If you need seasonal help or require a particular piece of equipment to cover an unusually large client order, short-term financing can help get the job done. When considering the total cost of hiring seasonal workers, remember to include potential savings, such as tax credits, when hiring disabled veterans for the holidays.
4. Emergency Repairs
Unexpected issues occur from time to time. Having the cash on hand to deal with them is essential for effective emergency response and getting back on track as soon as possible. Whether it’s a computer server crashing or packaging equipment malfunctioning, you can get funds to cover your costs for when an emergency arises.
5. Other Types of Cash Flow Gaps
Every business is unique and has different types of situations that can cause cash flow gaps. When you don’t have the money now but can depend upon the money coming in within a certain period of time, short-term financing can help you get over the hump so that you can continue to operate business as usual.
Cost-Benefit Analysis of Short-Term Loans
Business owners with cash needs face important decisions about how to manage them. Rather than pull funds from other expenditures, such as payroll, to make a large, unexpected purchase, a short-term loan can cover your costs without affecting day-to-day accounts payable. In other words, if you know that you will recover from the financial event quickly, a short-term loan may be the solution.
Typically, banks provide short-term loans as lines of credit with the option of paying interest only with principal payoff at a specified time in the future. This can be from 90 days to one year or longer. For short-term loans from banks, the interest rate is usually adjustable based on the U.S. prime rate or the London Interbank Offered Rate (LIBOR).
However, the short-term nature of these loans comes at an extra cost. Because short-term loans need to be repaid at a faster rate than long-term loans, you pay a higher interest rate on short-term loans than on long-term ones. Financial experts recommend to avoid using short-term borrowing to cover long-term debt, such as the acquisition of fixed assets including cars, equipment, real estate and acquisitions of other businesses and their assets.
Equally as dangerous is simply buying long-term assets outright with money from short-term loans. Matching up the life of an asset with the term of a loan is a basic business finance principle that should always be considered.
Short-term loans are also not for risky business purchases. Instead of relying on a casual conversation about a potential large purchase, you could solidify the transaction by requesting a formal letter of intent. This document helps you negotiate a better deal with your lender, prevents your client from negotiating with other parties and protects all parties’ rights and responsibilities.
Having fail-safe solutions for paying back a short-term loan is a must. This can mean a variety of things including:
- Setting enough cash aside to meet the monthly loan payments even if the projected increases to revenue don’t occur
- Researching in advance potential buyers that would be interested in finished goods on short notice
- Finding last-resort buyers, such as suppliers who buy back unused inventory, to liquidate the inventory fast enough and at a proper price to cover your financing costs
Getting an SBA Short-Term Loan
While personal lines of credits, home equity loans and asset-based loans are potential short-term financing options, many businesses take a look at short-term loans from the U.S. Small Business Administration (SBA).
The SBA works with intermediary lenders to secure loans that are designed to specifically help small businesses grow. Each institution has their own lending and credit requirements. You still need to have good business credit even if it is a loan backed by the government.
The most common short-term loan option from the SBA is the microloan program. This program provides loans up to $50,000 with the typical loan amount being around $13,000. Microloans can be used for a variety of business needs, including working capital, equipment or machinery, inventory or supplies and furniture or fixtures
Repayment of SBA loans vary and are based on a variety of factors including the loan amount, planned use of the funds, lender requirements and the needs of the borrower. Interest rates vary but typically range between eight and 13 percent. The maximum repayment term for an SBA microloan is six years.
There are training and planning requirements required before an SBA loan application is considered. This is designed to provide you with the information you need to successfully launch or expand your business. Contact your local SBA district office to find out more information or to get a list of participating microloan intermediary lenders.
Short-Term Financing Alternatives
Lines of credit, home equity loans and SBA loans all require you to deal with a bank. However, not every small business owner has stellar credit. The reality of online business, for example, can make it hard to quantify transactions in forms that traditional lenders understand. Fortunately, there are alternative sources for getting funds when you need a short-term loan.
Micro-businesses, seasonal businesses and other types of businesses that don’t meet traditional bank requirements can still get financing through platform lenders such as Kabbage. Instead of relying on credit scores as the primary tool for determining approval, platform lenders like Kabbage use a variety of business data from dozens of business operations, including Square, PayPal and Etsy, to provide a decision in minutes on working capital loans from $2,000 to $100,000.
For businesses that are just starting to build or re-building their credit history, Kabbage may be a good option for short-term loans. In under seven minutes, you may be able to receive funds to take your business to the next level.
Short-Term Loans: The Bottom Line
Whether you’re dealing with a temporary financial crisis or a sudden increase in business, short-term loans can help in a cash crunch. Consider short-term loans as part of a larger pool of business financing options and always perform a cost-benefit analysis. For businesses looking for alternative sources of funding to traditional bank financing, platform lenders can help you secure the funds needed for your business to grow.
Are you planning to take a short-term loan – or have you already done so? Tell us your story on social media.