How Business Financing Has Changed
October 24th 2019 at 6:24am Published by firstdownadmin
The first thing small business owners think about when deciding to take on funding to grow their business is the ten-year, 3% traditional bank financing that was the standard ten to twenty years ago. The application and approval process was much slower, and if a borrower didn’t fit the mold that mainstream funders were looking for, approval was difficult. Today, the business funding landscape has changed, and alternative financing methods have captured much of the market. Small business owners who can’t get approved by the banks have access to the funding they need to grow and expand their businesses.
The technology that these alternative funders use has made small business funding more accessible. Applications are online, underwriting techniques are fine-tuned and often times quicker, and borrowers get personalized offers and service.
More money is going out and more business owners are getting approved.
Changes in funding accessibility
Increased funding accessibility has resulted in more funding, but what does this mean for small business owners? And what are the risks to small business funders?
While alternative funding has opened up more doors for small business owners, as both the industry as a whole and individual funders move faster, so increases the risk of people taking advantage of the system. Twenty years ago, fewer funders meant that business owners had fewer options, but on the flip side, it meant that funders didn’t need to worry as much about dishonest borrowing practices.
Increased competition pushes more funders to approve more funding faster than ever. After all, if one funder won’t, another may, and the competition is just a Google search away. Unfortunately, this has also resulted in more opportunities for both borrowers and salespeople to take advantage of the system, and one of the largest risks to small business funders and small business owners alike is funding stacking.
What is funding stacking?
Loan stacking is used to refer to borrowers who take out multiple funding from multiple sources within a short window of time without thinking of their business’s long term health, due to the speed and efficiency that the funding occurs in, most business owners do not think twice as it becomes easy to obtain funding. Typically, this situation occurs when a borrower can’t get approved for the total amount of money they need, or when a borrower is promised better rates at a future date by accepting the first offer from an overeager salesperson. The biggest red flag for all small business owners is when a promise is made without it being put in writing. If the funder or funder is not willing to put future promises on paper then steer clear of any future funding dealings.
Who is the culprit?
While some small business owners that cannot qualify for the full amount of cash they need may instead obtain multiple smaller funding to satisfy their requirements, others have more malicious intentions. Some borrowers take on funding for their business intending to use those funds for non-business related expenses. Whether it’s to go on vacation, pay down debt, or make a large purchase, this type of funding stacker may not fully understand the consequences of taking on more debt than their business can comfortably handle. During the funding verification calls, prior to funding, any mention of outside use for the funding can have a lasting effect on future funding relations.
An owner whose business is about to go under is another common offender. These borrowers make the decision to accept multiple funded deals, knowing that their business is at the end of its life, take the cash, close their bank accounts, and often declare bankruptcy, leaving the funder with no way to collect.
Finally, a small business owner may choose to lie to the funder about the purpose of the funding, thus convincing the funder to approve them for additional funding. Business funding to help with a larger long term project, like opening a new location that will bring increase revenue. But, when a borrower lies to a funder to get additional funding and thereby stacks funding on top of funding, this can become an issue.
While the borrower is often the offender, this isn’t always the case. Some brokers and salespeople prey on potential borrowers by employing aggressive and unethical sales tactics. “Baiting the borrower with a promise of a better rate down the line, but more importantly offering terms of approval that are unrealistic is a recipe for disaster. It is perfectly fine for any funder or funder to customize approvals to gain long term business relations, but to purposely or viciously offer unrealistic terms in the future, creates a need for a “Small Business Funding Code of Ethics”. Long term funding relationships are created with trust, transparency, and willingness to meet halfway. With the right Code of Ethics in place, the entire Small Business Funding industry can shine above all other financing,” explains Paul Pitcher, managing Partner at First Down Funding and SharpShooter Funding. Often these borrowers have just taken on funding, probably for less than they had originally wanted, and the prospect of additional funds is quite appealing. The problem is that this often leaves the borrower overstretched, putting all parties at risk.
Understand the risks & signs
Business owners who stack loans are not only affecting the funders they obtain funding from but are putting both their personal and business finances at risk. “Every business owner must analyze their 30, 60, and 90-day cash flow in order to better serve the purpose and total cost of capital for all rounds of funding” explains Pitcher.
Chances are if a funder doesn’t approve a business owner for the full amount they wanted, it’s because their finances can’t handle more and the funder did not want to put the business in a difficult position. After all, it is in the best interest of the lender for the small business to succeed.
In many cases, a business owner could be personally liable for their debt. However, aggressive brokers looking to quickly cash in on funding commissions put funders at risk as well. Therefore, funders need to be wary of both deceptive business owners and lenders.
When it comes to prevention, most funders benefit from a three-pronged approach; a strong underwriting system, helpful consumer education, and open communication with the competition. “The most important part of funding deals day-to-day is the strength and volume of business and personal references. When the inner circle of the business owner vouches for them positively, 99% of the time, the deal can fund cleanly and perform,” explains Pitcher.
A strong underwriting system and a solid set of procedures can help funders make sure they don’t unknowingly enter into a cycle of funding stacking. Experience plays an important role, but if you have a strong understanding of what you’re looking for and perform the appropriate amount of due diligence, you should be able to prevent the majority of funding stacking. Nevertheless, most small business funders already have such systems in place and yet funding stacking is continuously growing problem.
An informed applicant becomes a great borrower. Dealing with a frustrated business owner who can’t get approved for the full amount they want, is never fun. But, educating them about why they can only qualify for a certain amount is a key component in preventing loan stacking and ensuring a borrower isn’t taken advantage of. “The first impression a funder gets from an owner, a hand-signed and dated application, and the organizational skills needed to send over prepared financials and bank statements, can say a whole lot about the business owner’s interests, intentions, and overall health. The more rushed we feel, the less likely we will want to work with that said business,” explains Pitcher.
Finally, chatting with your competition might not seem like a great idea, but maintaining open lines of communication with those in your industry can help spot funding stacking schemes before they get out of hand. Trade shows and other industry events are a good place to network and meet other industry stakeholders.
Running a small business takes time, persistence, passion, and money. This is why small business owners need funders to be on their side of the court.
Educating and providing borrowers with useful information at the right time can help reduce the risk of loan stacking and helps to maintain healthy accounts.