A high-risk business loan, as the name implies, is one that involves high risk on the part of the lender. High-risk business loans are typically issued to businesses that have bad credit histories, or are unable to provide the requisite collateral, or have no clear idea of how they will go about paying back the loan.
Any of these situations increase the possibility of the debtor to default on the loan if the lender decides to grant the financing. This explains why most banks and loan issuing institutions usually turn down loan requests from such businesses.
Although some lenders still approve high-risk loans, they take drastic measures to protect their own interests. These measures include charging very high interest rates and a very high down payment. This way, the lender will recover most of the principal amount before the defaults begin.
In addition, since most high-risk loans are not secured with collateral, lenders usually specify that repayments will be drawn directly from the borrower’s bank or credit card account. This ensures maximum recovery in case of defaults and makes lenders feel a little more secure about repayments.
However, high-risk business loans come with certain benefits. First, they can help a business get out of a tight situation. So, if a business only needed some funds to keep running until the profits start coming in, or a construction company needs the funds to complete a project for which it will be paid only after completion, a high risk business loan will come to the rescue.
In addition, high-risk business loans can give a business the chance to re-establish credibility by making the repayment on time. Most borrowers know that being behind schedule with high-risk loan payments means real trouble, so they try to avoid that situation by making their repayments timely.
Alternatives to High-Risk Business Loans
While high-risk business loans may seem like a good option for business owners to secure the cash they need when they are struggling with bad credit or poor sales, the high interest rates, long approval process, and strict requirements may make most business owners think twice.
They are afraid the high interest rates can do even more damage to their business and cripple it the more. This explains why business owners only consider high-risk business loans as a last resort. Here are alternative financing options usually exploited by business owners whose businesses are in difficult situations:
1. Friends and family funding
Many business owners seek funding from their friends, family and colleagues when their businesses are in a tight situation. This option is one of the best because the process of securing the loan is usually very quick. Interest rates are very low—if there is any interest at all—and repayment terms are usually very friendly.
Although some experts do recommend that business owners leave their friends and family out of business matters, but when options are limited, most business owners can seek funding from close ones.
2. Specialty lending
Specialty lenders are lenders that specialize in high-risk business loans. They generally have high interest rates, too, but they reduce their interest rates once the business starts to show positive cash flow and increased possibility of repayment.
3. Equity lending
Equity lending programs offer high-risk loans to business owners, but tie repayment of the loans directly to company receivables. This model allows companies to draw cash against outstanding invoices. For example, restaurants and service businesses can participate in equity lending programs by running credit card transactions directly through the lender’s merchant terminal.
Equity lenders retain a share of the proceeds and deposit the remainder into the client company’s bank account. This relationship continues until the initial loan has been repaid
4. Micro lending
This simply involves obtaining a microloan, which consists of a loan amount smaller than a typical loan. Banks and credit unions facilitate most microloan programs, but these institutions receive significant subsidies from governments and foundations to manage the programs.
5. Peer-to-peer lending
This is a new form of micro lending that is done in online communities. Rather than seek funding from banks or other loan issuing institutions, business owners with bad credit histories or no collaterals now turn to their peers for short-term loans.
Online lending clubs assess borrowers’ risk using the same credit scoring rules as traditional banks, but investors can choose to participate in high-risk loans in exchange for higher returns on investment. These clubs mitigate lender risk by pooling funds from many contributors.