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The Danger of Daily Payment Business Loans

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Over the last 5 years I have managed an SBA Microloan Program at a non profit in Indiana.  Our microloan program helps startups and small businesses that are unable to secure traditional bank financing.  Recently I have watched the explosion of daily payment loan products offered by alternative, online lenders like:

What are Daily Payment Loans?

First, a daily payment loan is just what it sounds like.  Many of these online lenders might offer a business $20,000 that they can apply for and access within 48 hours.  These loans typically have short terms 3 to 18 months, and the business makes a small payment every single day, or maybe every day the business is open.  The interest rates on these loans are typically high, but you are paying for a very quick turnaround and a unique repayment structure with daily payments.

Why Daily Payment Loans can be Great?

These loans can be great for small businesses.  For example, let’s say you are a restaurant and your walk-in refrigerator dies, you have to shut down the business.  You must act fast, you can’t afford to shut down for a month while you apply for a traditional loan from a bank.  You are losing business, momentum and profit every day you are shut down.  In this situation a daily payment loan is perfect.  You can get cash fast, and you can pay it off each day over the next 12 months with a small payment.  This works well for a restaurant because a restaurant generates sales each day, so coming up with a small payment each day actually matches the cash flow of the business.

Why Daily Payment Loans can be Dangerous?

Now recently I have noticed some of my clients who do not have daily cash flow businesses, taking out daily payment loans.  For example, let’s say you are a contractor and you get paid in big chunks as you complete projects.  It is very dangerous to take out a daily payment loan because you don’t generate cash each day.  What if your customer pays you a little bit slower than normal?  You might not be able to make your payment each day.  I have noticed that some of the smaller, unknown alternative lenders are making daily payment loans to businesses that don’t have daily cash flow.  This seems very dangerous for the lender and very dangerous for the business owner.

Understand your Cash Flow Projections

As a business owner you must be careful not to simply take out a loan that doesn’t fit your business cash flow just because it is fast and easy.  That is a great way to go out of business.  These online lenders will likely take all business assets as collateral and if you stop making those daily payments because a customer is paying you 30 days late, the lender may come in and start taking their collateral.

My suggestion – Spend some time with ProjectionHub and create a cash flow projection and play around with different scenarios, will you be able to make your loan payment even if customers pay you late?

Why Banks Must Standardize the Financial Projection Process

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Standardization.  Banks have standard forms for everything.  Standard loan applications, standard personal financial statements, standard credit release forms, etc, etc.  But for some strange reason, banks do not have a standard for financial projections.  When it comes to financial projections, banks will accept just about anything.  I have seen a projected income statement that shows expenses on top and revenue on the bottom, I have seen annual projections, monthly projections and even weekly projections, I have seen Excel templates with 50 or more tabs, and 1 tab Excel templates, I have seen projected balance sheets that don’t balance! 

Why is this acceptable?   

Why in such a standardized industry like banking, do bankers continue to put up with such a messy process when it comes to financial projections?  

I think there are a few reasons:

  1. Financial Projections are Just a Check-mark on the List – For the average business banker it can be like pulling teeth to get a loan applicant to put all of their documentation together, so once you finally have a set of financial projections in hand, the last thing you want to do is criticize them,  you now have a full packet to send to underwriting, so just let them deal with it.

  2. There is a Gap Between Sales and Underwriting – The previous point really represents the fact that there is a gap between sales and underwriting.  Sales, aka the business banker, wants to get complete packets to send to underwriting.  The underwriting team wants quality projections that they can analyze quickly and efficiently with their spreading software.  Underwriters don’t want to have to go digging around for the numbers they need to produce for their spreading software.

  3. Because Projections are Typically So Bad Lenders Don’t Give Them Any Weight – Finally, I think because projections are typically so far off, lenders don’t really care what they say, they don’t have time to educate the business owner on how to create realistic, data driven financial projections.  So the easiest thing is to simply give the projections a 50% haircut right off top line revenue and see if they can still handle the debt service.

Despite these issues, there are several reasons why banks large and small should standardize the financial projection process.

  1. Save time – I can not fathom how much time is wasted in underwriting departments around the world each year because there is no standard format for financial projections.  Somewhere in a dark room there are underwriters clicking through 50 tab Excel templates looking for the numbers they need to enter into their spreading software or credit memo.  If there was a standard format, underwriters could find those number immediately.

  1. Make better comparisons between businesses – If you don’t have a standard format for financial projections how can you compare one business to another?  How do you know whether the business owner “get’s it” or not.  If you can’t complete a set of financial projections for your business, and you don’t have anyone else helping you that can, then you probably don’t deserve a loan.  When you have a standard format, it will be much easier to compare a good set of forecasts to an unrealistic forecast.

  1. Push their clients forward – Finally, lenders should be pushing their clients forward.  Push them to grow, push them to imagine how to be more profitable and to plan their growth.  If the business grows, so does their need for capital, their deposit base, and their need for other bank services.

So at ProjectionHub we are at the very beginning stages of determining how we can help banks benefit through the standardization of financial projections.  We have a solid tool in place now, and we continue to iterate and improve.  In Q1 2015 we will launch Version 2.0 of ProjectionHub which will support white label versions of the tool for banks to implement into their loan application process and customers will never have to leave the banks website.

We think there is an incredible opportunity for lenders to up their game when it comes to financial projections, and we want to be that gold standard for the future.

How to Know When You Need a Line of Credit?

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Every month I talk to several business owners who think they they need an investment or a business loan to help fund their business.  I often ask if what they really need is a line of credit rather than a fixed loan or investment, and they have no idea whether a line of credit would be helpful for their business.  So what signs should you look for in your business that might suggest that a line of credit would be your best option?

1.  You Produce a Product or Provide a Service Before You Receive Payment –

Many business models require that you produce a product or provide a service before you receive payment for the work. This means you may need to buy materials to make the product, you will need to pay employees to provide the service or manufacture the product all before you will get paid from your customer. An example of this might be manufacturing or auto repair. We offer a comprehensive manufacturing financial projections template and auto body shop profit and loss template. For this reason, a line of credit should work well to even out your cash flow cycle and help you sleep at night.

2.  You Provide Payment Terms for Your Customers –

If you allow your customers to pay you 10, 30, or even 60 days after providing your service or delivering your product, you are a good candidate for a line of credit. Again, in this situation you will likely need to borrow funds for those 10, 30, or 60 days, but you don’t need a 72 month loan, and you shouldn’t give up 10% in your company for an investment that you only need for 30 days. A line of credit allows you to pull down funds as you need them and then pay them back once you are paid so you only pay interest on what you actually use.

3.  Gap Between Accounts Payable Terms and Accounts Receivable Terms –

Sometimes business owners are required to pay their suppliers much sooner than their customers pay them. For example, you might need to pay your suppliers for the components to build you product within 10 days after receiving the raw materials, but your customer may not pay you for 45 days after receiving the finished product. This means you could have a 60+ day gap where you are paying others before you get paid which can put a real strain on your cash flow. A line of credit is an excellent option here.

So if these 3 signs sound familiar it might be time to start shopping for a line of credit.  One place to look is Lendio.  We partner with Lendio here at ProjectionHub to help entrepreneurs find the best financing options available for their specific situation.  Lendio is kind of like the match.com of business loans.  They help match you with the best lenders and those lenders will compete for your business so that  you get the best possible deal.

If you have any questions about whether a line of credit makes sense for you, or would like us to review your financial projections, don’t hesitate to reach out at help@projectionhub.com

How Long Does it Take to Get a Business Loan?

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This is a common question that many business owners never ask until it is too late.  Business owners expect that they can walk into the bank complete the application, and walk out with cash tomorrow.  From my experience banks don’t move that quickly, especially if you need them to.  As a lender myself I hate when applicants fill out an app today and say they need the funds in the next week or 2.  It comes off as bad planning on your part.  It makes you look unreliable and probably not fit to run a business, so many bankers will just ignore it, you probably are not the type of client they want to work with anyway.

So realistically how long does it take to get a loan for your business?

Realistically, you should plan on a month or two if you are a small business.

How can you expedite the process of securing a business loan?

You simply need to come prepared if you want to speed of the process.  Here is a list of what you will likely need:

  • 2 years personal tax returns
  • 2 years financial statements for the business
  • 2 years business tax returns
  • Personal financial statement
  • Customer list
  • Bank statements
  • Financial projections
  • Executive summary of your business
  • Specific loan request

If you are prepared with these documents, you should be able to impress your lender, and hopefully speed up the process.

Why Small Businesses Won’t Need Bank Loans in 2020

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I am the Director of an SBA microloan program in the midwest, and I can honestly say that I am not sure if small businesses will even need a local bank to secure a business loan in 2020.  As a microlender we are working with small business owners who have been denied by a traditional bank, or simply don’t qualify for a bank loan because their loan request is too small for the bank to make any profit on the loan.  

Our goal with the microloan program is to graduate our borrowers to traditional finance, but in nearly three years of running this program I have not had one of our 50 some clients graduate to a traditional bank.  These businesses are actually growing just fine without a bank loan.  Of course it would be nice to have a line of credit, and they could grow faster with a larger business loan, but they are surviving and many are thriving.

For many of my clients I am starting to suggest alternative financing options like:

With the explosive growth many of these companies have already seen, or are poised to see in the near future, I am convinced that the traditional bank is in a lot of trouble when it comes to small businesses.  Here are 2 key reasons that I think the traditional bank won’t be a financing option for small businesses in just 7 short years.

1.  Overhead – First of all, the banks have built and leased building after building in order to get a physical presence in their market.  The problem is the average small business does not believe their local banker will lend to them, so they go straight to Google to look for financing options.  Now the local bank can try to advertise on Google in the competitive small business lending category, but now they are competing with alternative, internet based lenders who do not have the overhead associated with all of the office space required by traditional banks.  New lenders don’t have to worry about a vault, security systems in the building, utilities, mowing the grass in the summer, removing snow in the winter, etc, etc.  In a world where you can move money around with a click of a button, it is only a matter of time before these highly efficient alternative lenders will be able to completely dominate the traditional banks because their cost structure is so much lower.  This is the exact same story that is playing out in the retail world.  Amazon.com is crushing the competition because they can offer lower prices, online lenders will be able to do this soon, if not already.

2.  Technology Cuts Out the Middle Man – A bank is just a middle man.  The bank takes your deposits and then uses those deposits to lend to credit worthy projects that will keep your money safe and earn a positive return.  The banks are profiting from your deposits and what do you get to see from it?  .01% interest in your savings account?  This can’t last forever.  Depositors are going to demand more from banks, but because of their cost structure the banks won’t be able to offer competitive rates when compared to other options like Prosper.com and LendingClub.com which are peer to peer lenders.  These peer to peer lenders cut out the middle man, or at least much of the overhead associated with the middle man.  You can lend directly to individual borrowers or you can invest small amounts of money into many different borrowers and earn a return on your investment.  The platform will take a fee, but at least you will earn some return on your deposits.  Now I understand that peer to peer lenders are not FDIC insured, and you investment may not be liquid, but I think over the next seven years these platforms will improve and offer certain levels of insurance and liquidity to directly compete for your deposits.

At the end of the day, I think the traditional banking system could be in a lot of trouble if they do not innovate.  The problem is that regulations make it incredibly hard for banks to innovate, which could ultimately lead to their slow death.  What do you think?  Will small businesses even need the traditional bank in 2020?

The Sure-Fire Way to Get a Loan for Your Small Business

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At the end of the day it all comes down to one question.  Any potential small business lender is going to ask one ultimate question that will decide the fate of your loan application.  That question is: “will we get our money back?”  There are 3 ways that a small business lender can recoup funds from a borrower, and if you can prove that you can repay the loan from at least 1 of these 3 sources, you will likely get approved for a loan.

1.  Cash Flow – The best way to secure a loan is to convince the bank that your business will produce enough positive cash flow to repay the loan.  In order to do this you are going to need to create a set of pro forma financial statements with reasonable sales and expense assumptions.  You will also need to show that you can repay the loan based on past financial statements.  If you lost $300,000 last year, you are probably going to have a hard time convincing the loan committee to approve a loan.

2.  Collateral – If the business fails, and can’t pay back the loan from cash flow, then the lender is going to come after your assets.  If you have assets that can be legitimately valued at more than your loan amount, then you are much more likely to be approved for a loan.  Different types of collateral have different levels of value in the eyes of a banker.  For example, your inventory may only be worth half of what you value it at to the bank because the bank may not know how or where to sell the inventory.  A vehicle is stronger collateral because it can be easily sold, but may not hold its value over time.  Finally, a building tends to be strongest form of collateral because it has a longer useful life, and should hold its value longer than other forms of collateral.

3.  Co-Signer – Sometimes your past financials, future financial projections, and the value of your collateral won’t be enough to make a banker feel comfortable with your loan request, so you need to bring a strong co-signer to the table.  Lenders want to see a co-signer with a strong credit score because that means they have something to lose if they don’t pay back the loan.  A co-signer with assets and a strong credit score can really solidify your loan application.

Bankers really aren’t that hard to figure out.  At the end of the day they just want their money to come back with a little bit of interest.  Bankers really don’t want to have to come after your collateral or your co-signer, so your cash flow projections are going to be vital to your success.  

Top 3 Reasons Banks Will Deny Your Small Business Loan Request

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Let’s face it, these days there are hundreds of excuses that a bank could come up with to deny your loan request.  I manage a small business microloan program in Indianapolis that tends to make loans to small businesses that have already been denied by the bank.  I have heard many reasons, but there are 3 things that come up again and again.

1.  Less than 2 Full Years in Business – The banks must use data to show that after a business makes it past year 2 their chance of survival increases substantially, because almost every traditional bank I know will not lend to a business less than 2 years old.  Something to keep in mind here is that banks determine how long you have been in business by your tax returns.  So you must file your business tax return in the first year even if you don’t have much to show yet.

2.  Bad Personal Credit – Unfortunately for many business owners, your personal credit history impacts the ability to get credit as a small business.  In the early years of a small business the financial situation of the business and the business owner go hand in hand.  It takes a lot of time, and a lot of paying your bills on time to establish credit for the business that is looked at separately from your personal credit.  If you have bad credit, the best thing you can do is to use credit and pay your bills on time.  Sometimes business owners with past credit problems just tear up their credit cards.  Unfortunately you can’t increase your credit score if you never use credit.  Responsible and wise use of credit will improve your score over time, and help your small business secure bank financing.

3.  Scary Industry – It is very common for banks to have internal policies that keep them from making any loans in certain industries.  Restaurants are a good example.  Banks avoid funding new restaurants like the plague because so many fail.  I think the reason that so many restaurants and coffee shops fail is because everyone thinks they can own a restaurant.  They think, “Hey I know how to cook, I bet we could have a successful restaurant.”  What these hopeful entrepreneurs fail to realize is that the food has very little to do with your chances for success.  Just take McDonalds for example, they sell more hamburgers than any other company in the world, yet I can count 100 places to get a better burger just off the top of my head.  There are certain industries like restaurants and sometimes construction that just keep the banks running in the other direction.

These are just a few of the reasons that you will get a quick no from the bank, as I mentioned there are many more, as there seems to be an endless supply of reasons for the big banks to deny your small business loan request.

Is your Startup 98.82% Likely to Succeed? If Not, No Loan for You

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recently reported that delinquencies for business loans are now down to 1.18%.  In my opinion, this is truly incredible!  Only 1% of businesses with loans from banks fail to make their loan payments on time.  This means that you must convince your lender that you are 99% likely to make your loan payments.

Based on this data, it is no surprise that startups and early stage businesses have a nearly impossible time securing loans from banks.  When you look at the data for small businesses, you will find that there is a significant percentage of businesses that will cease to exist in 5 years.  Let’s say 25% of the small businesses with less than $1 million in annual sales will be out of business in 5 years.  That means that banks are going to be incredibly unlikely to lend to these small businesses because they need to feel 99% confident that you will still be around in 5 years.

That rules out startups and early stage small businesses in technology industries like software, mobile computing, alternative energy etc because technology moves so incredibly fast that 5 years is a lifetime.

Unfortunately for small business owners banks can be selective.  There are still plenty of credit-worthy, established businesses that will take loans.  The banks don’t need to lend to small businesses in order to make a profit right now.  In fact, the top 10 banks in the United States only approve approximately 10% of loan applications.

If you are a startup, what do you do?

I believe there are still some great options.  There are 3 places I encourage you to look for a loan:

  1. Lendio – Matches you with lenders that best fit your needs and stage of business
  2. On Deck Capital – Unique way of lending to “Main Street” businesses.  Lends even if your credit score is low
  3. Prosper – A peer-to-peer lender where you may be able to build up to a loan capacity of $25,000.

Of course these options will have higher interest rates than your traditional bank, but if you are able to utilize other funding sources during the early stages of your business, you may be able to reach a point in time where you can actually convince your local banker that you are 98.82% likely to pay them back, and pay them on time.

Have you been successful finding other sources of funding since the banks don’t lend?  If so, leave us a comment, and share with other entrepreneurs who are looking to grow and expand.

Software Development Loans – Impossible to Find?

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Red No Circle Clip ArtBanks don’t give loans for software development, it is simply too speculative.  If the software has not been developed yet how do you know whether anyone will be willing to pay for your product?  How do you know what a potential customer is willing to pay?  How does the lender even know if you actually know how to program?  There are so many hard questions to answer that most banks will simply avoid providing loans for software development altogether.

If you are determined to get a loan to develop software there are a few ways you might be able to convince a bank to lend to you.

1.  Get a Signed Contract – If you have a signed contract from a customer this will answer a couple key questions.  Now the lender knows that someone is willing to a buy a product, and they know how much they are willing to pay for it.  There is still a major question though.  How can you prove to the lender that you and your team can successfully overcome the technical challenges and fulfill the contract?

2.  Demonstrate a Track Record of Success – Have you completed other software projects?  Have you worked with this specific client before?  If you can demonstrate that you have been doing this kind of work for 10 years and you have worked with this client on several similar projects, then you might be able to convince the lender that your past success will guarantee your future success on this project.

3.  Generate Sufficient Cash Flow from Current Business – If your business is currently profitable and providing sufficient cash flow to cover your loan payments you can probably secure a loan to expand your current business.  The bank will want you to use the loan to expand your current, stable business, but if you can use the loan to increase cash flow from your current business, you can then take that excess cash and invest it into your software development project.

If you can get a signed contract from a client you have worked with in the past, or you can generate sufficient cash flow from your current business, you might actually be able to secure a loan for software development.  If not, then you should probably start looking for investors who have an appetite for risk.

About the Author:  Adam Hoeksema is the Co-Founder of ProjectionHub.  ProjectionHub is a web application that helps entrepreneurs create financial projections without the need for a PhD in spreadsheet modeling.

Why Banks Require Pro Forma Statements | Learn What A Pro Forma Bank Statement Is Why Banks Require Them – ProjectionHub

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What Is A Bank Pro Forma Statement & Why Do Banks Require Them?

What is a pro forma statement and why are pro forma statements required at banks? A pro forma bank statement is a financial statement that serves as a prediction tool used to help companies make future business plans and conduct comparisons between strategies.

When you apply for a small business administration (SBA) loan or other commercial loan you are often required to provide financial projections. In fact, the SBA requires a 1 year pro forma income statement and narrative explanation of how you will reach your projections with an application for the following loans:

  • SBA 7(a) Loans
  • SBA 504 Loans
  • SBA Express Loans

Why do banks require pro forma financial statements? There are two core reasons why banks require pro forma statements in addition to the fact that the SBA requires it.

1. Have A Pro Forma Bank Statement History Based on Cash Flow

The bank does not want you to have to borrow additional funds from another source in order to make your loan payment each month.  Your pro forma bank statement history should demonstrate that you have sufficient cash flow from operations to make your loan payment.  Your pro forma financial projections should also show 2 scenarios.  The first scenario is your business without the loan, while the second scenario shows how your numbers change when you do take out a loan.  The idea is to show positive cash flow and profits due to the use of the loan.

2. Demonstrate Competence In Your Pro Forma Bank Statement Data

Your pro forma bank statement data should demonstrate to the lender that you know what you are talking about.  If your projections are completely unrealistic and out of line with the industry, the bank is going to slap a denial on your application immediately.  Do some research.  If you are opening a coffee shop, and the average coffee shop has profit margins of 3%, then your projected  profit margins shouldn’t be 30%.

Check out ProjectionHub’s services or choose an excel financial projection template to prepare the necessary materials for your pro forma bank statement and get ahead of the game.