I listen to a lot of talk radio, and it seems that at least once or twice an hour I hear a commercial for "small business loans" where you can get cash "the next business day." Testimonials from friendly-sounding business owners (or actors, since I have no way of verifying their legitimacy) seem to reiterate how easy the application process is for business owners and how reasonable the terms are once you are approved. Sounds almost foolproof, right?
Before you race to pick up the phone or fire up your web browser, be cautious. I have had clients who have taken out these sorts of loans in the past. While I certainly will not paint all small business lenders with the same brush, my particular clients have talked about daily debits towards the loan balance that are crippling them. When I get the ability to review the loan origination documents, I notice a few things that should really be red flags to everybody:
- The business owner is granting the lender a security interest in all receivables. What this means is that every dollar that you earn in business before the loan is paid off in full is collateral for the loan. In theory, if you were to default on the loan, that could mean not just the end of your business, but the seizure and liquidation of all business assets, in a manner that you will not necessarily have a way of controlling.
- With respect to the amount you are paying towards the loan, bear in mind that the interest rate can be exorbitant. For example, I have seen a $10,000 loan contain a payoff of close to $45,000, with interest and other fees taken into account.
- How does $10,000 turn into $45,000? With the loan in question that I reviewed, the business owner was authorizing a daily debit of $450 from his business checking account to be applied to the loan. If your business has hit a rough spot, this is not an amount to sneeze at.
- If the lender is requiring you to personally guarantee the loan application, watch out. Default on a loan agreement may not mean the end of your business, but if you personally guarantee any debt, you will be liable to be sued personally, and your personal assets, including your home and/or car are exposed to judgement, foreclosure, and possible sale.
- If you take out one small business loan, you may well find yourself inundated with other applications for similar loans. While not to suggest that these organizations are colluding with each other, I imagine it works on the same principle as personal credit card offers -- you apply for one card, you get offers for ten the next day in the mail. Again, for a business owner struggling, it may be tempting to try to maximize the amount of cash infused into the business, with the hopes that things will turn around in time.
An old Russian proverb used frequently by Ronald Reagan is "trust, but verify." If your gut tells you that something is too good to be true, it probably is. When it comes to lending agreements such as these, be sure to review them carefully to determine if you are putting yourself in a situation that you may not be able to get out of.
If you are a business owner facing crisis, whether due to complete lack of income and creditors hounding you, or if you are in over your head with these kinds of small business loans, bankruptcy may be a viable alternative. Whether you want to liquidate your business or restructure your debt and maintain your business as a going concern, filing bankruptcy will halt the direct debits and collection activities. You will get some room to breathe as you evaluate what steps you need to take for the sake of your business.