Lending Library

Understanding the concerns and challenges lenders face can help you avoid what lenders see as “red flags” and make yourself an ideal candidate for the next time you need a business loan. The age of online lending has brought a couple of new challenges. One of the biggest is loan stacking. 

What Is Loan Stacking? 

Loan stacking is the practice of taking out multiple loans from different bankers at the same time and letting the amounts “stack up.” Traditionally, if you took out a loan for $20,000, and then you received another loan for $40,000, you would use the second loan to pay off the balance of the first loan. 

Loan stacking occurs when you don’t follow that practice. As Brock Blake, Lendio’s CEO, explains, “Stacking means that you don’t pay off the other loan, just add $40,000 on top of that. So now, the customer has the $20,000 loan and a $40,000 loan. And so they’ve got $60,000 worth of loans outstanding, a larger payment, and in some cases that’s appealing to that business owner because they think more money is better. But then they get caught up in high payments.” 

The Dangers of Loan Stacking for Lenders

When a lender approves your loan, they set the amount based on what they think your business can reasonably repay. Even if the amount is less than you originally hoped for, it’s often for the best. Stacking multiple loans can come back to bite you if those payments pile up. You may find yourself behind on not just one, but multiple loans. 

From a lender’s perspective, loan stacking increases the risk that the borrower will become delinquent on their loan. According to a 2015 study conducted by credit reporting agency TransUnion, loan stacking accounted for $39 million of charge-offs, the point at which the lender deems it unreasonable to expect repayment. That number accounted for 7.8% of total charge-offs. 

In addition to borrowers inundated by payments, lenders have to look out for borrowers with malicious intent. Some borrowers will intentionally stack loans without any intention of paying them back. 

The Risks of Loan Stacking for Borrowers

We’ve covered this one already, but it’s worth repeating: stacking loans can give you a case of mo’ money, mo’ problems. You’re more likely to let payments build up, fall behind in repayment, or go delinquent on a loan—which is counterproductive to that business credit you’re trying to build.

Loan stacking may also jeopardize your ability to get financing in the future. As we’ve discussed, lenders really don’t like it when you stack loans (and with good reason). Some lenders include a clause in the lending contract that stipulates the borrower can’t stack loans. If you’ve signed a contract with a clause like this and your lender discovers you’ve stacked a loan, they may not lend to you in the future. 

While loan stacking may seem like it’s giving you more capital, it works against everything you’re trying to build in your business financing. It will affect your business credit negatively, and it may make it harder to qualify for another business loan. Barring yourself from access to future financing ultimately costs more than the benefit of a bit more cash in the short term. 

How You Can Protect Yourself

There are 2 main ways that loan stacking can occur—borrower-initiated loan stacking and lender-initiated loan stacking. You want to steer clear of both of them. 

Borrower-initiated loan stacking is the process where the borrower seeks out additional loans. This one is easy for you to avoid because all ya gotta do is... refrain from taking out new loans if you already have one (unless you pay off the first loan with the second, which is a whole different can of worms). 

But what if a new lender comes to you and offers you a new loan? Borrower beware. Some unscrupulous lenders comb public records looking for businesses that have recently taken out financing. They then try to sell those borrowers loans with poor terms, with little interest for how it’s going to affect your business credit score. 

The best way to protect yourself is to do your due diligence on any in-bound loan offer. You want to vet lenders the same way they vet you. If you have questions, talk to an expert. The same way you go to your doctor for questions about your health, you can go to your Lendio Funding Manager for questions about your financial health. They’ll help you understand the fine print, make sure you’re getting the best terms, and help you avoid anything that could hurt you down the road. 

Very few e-commerce businesses survive beyond their first few years. Analysts peg the failure rate of online stores anywhere between 80 to 97 percent. There are several reasons contributing to this. For starters, e-commerce is highly competitive but has a very low barrier to entry. This attracts a lot of non-serious players to the business who close down at the very first hurdle. More significantly, financial mismanagement plays a critical role in the closure of many well-funded e-commerce stores.

This is ironic because one of the reasons e-commerce businesses are so lucrative compared to brick-and-mortar stores is they have fewer liabilities. Online stores can make do with small office spaces and very little inventory, and this is a big draw for many entrepreneurs. So why do so many e-commerce stores struggle financially?

A Primer on Working Capital

Working capital is similar, except it is the difference between all your assets and liabilities in a financial year. If all your assets (properties, inventory, income, etc.) totaled $500,000 in a year and you spent $400,000 of it to pay off loans, salaries, and rent, then you have a surplus of working capital.

Here is the tricky part. By definition, working capital does not include your liquid cash. If you face a deficit of $20,000 that needs to go into paying the mortgage, it is not realistic to sell off your property to meet the deficit. However, liquid cash or inventory that can be quickly liquidated may be used to pay this off. A business only has high working capital if there is sufficient liquidity in its operations to meet any of its immediate expenses.

What E-commerce Businesses Do Wrong

On paper, inventory is listed as an asset; you can liquidate inventory just like your property or equipment. In practical terms though, this may not always be the case. For one, inventory can be a depreciating asset (technically, called “current assets” since the value changes with time). If you sell phones online, the value of your inventory may go down each time new models launch in the market.

It is worth noting that inventory is not a capital asset. A manufacturing plant or equipment is necessary to build a product, and hence vital to your business operations. This is not true with inventory which is essentially your liquid cash converted into a depreciating asset. If you do not convert your inventory back into liquid cash by selling it, you'll potentially lose money over time.

In other words, the more inventory you hold, the more vulnerable your working capital.

Vendor terms can also wreck your working capital situation. Let's go back to the example of an online store selling phones. This seller may procure $100,000 worth of phones from a vendor with a 60-day credit period. To maintain the current working capital, the needs to sell these $100,000 worth of phones within the next two months to pay the vendor back. If it fails to sell the phones, the business could be staring at a deficit which needs to be recovered by selling off other assets. Alternately, the business could procure a short-term loan to pay the vendor, but this does increase liabilities for future months. It is a healthier financial habit to use small business loans for capital purchases rather than paying off liabilities.

Bad vendor terms can mean only one thing for e-commerce owners—digging deeper into a hole trying to meet financial obligations.

How to Improve Working Capital

Reduce inventories. Inventories are a depreciating asset and a ticking time bomb. Holding too much inventory could put your business under greater pressure to sell, forcing you to try strategies you may have not executed otherwise. For instance, you may want to increase your advertising spend in order to liquidate your inventory assets faster. If your ads do not work out, not only do you continue to own the inventory, you also stack up more liabilities to your advertising partner.

Change the business model. Depending on your industry, you could look at changing your business model. A made-to-order product can allow your store to charge higher prices for a bespoke design. At the same time, you also get to sell your product before paying your vendor for the manufacturing. If that does not work, you may also look at dropshipping. With a dropshipping business model, you pass on the responsibilities for order fulfillment to your vendor. This way, you do not hold any inventory at your end and also get paid before you pass on the vendor’s share.

There are a few challenges with this model, however. Dropshipping can increase the shipping time of your product (especially if your vendor is from another country like China), and can bring down the user experience. While that is a cause for concern, it is still better than shutting down your store or filing for bankruptcy. There are other ways to deal with long shipping times.

Update vendor terms. Bad vendor terms are one of the biggest causes for poor working capital among e-commerce businesses. Each product goes through its own unique sales cycle. The time it takes for a customer buying a dress online is much shorter than it takes for one to buy a smartphone or a TV. At the same time, it costs more to hold an inventory consisting of electronics compared to apparels. Consider these factors before agreeing to your payment terms.

Establishing a healthy cash flow and working capital is paramount for any business, not just e-commerce stores. Consider hiring an advisor to assist you with managing your finances. As any successful entrepreneur will tell you, while these advisors are a liability on your balance sheet, they are one of the most important assets you can have.

Whether you’re just starting a business or you’ve been in business for years, you’ve probably asked yourself this question: “Should I get a small business loan or find an investor?” The short answer is, it depends. There are a lot of factors that go into play when making that decision and each decision has the potential to forever change the course of your business. Don’t make the decision lightly. Here are some of the biggest pros and cons of each route for you to consider.

Business Loan

Getting a business loan can be a viable option for those who prefer a straightforward path to funding, without relinquishing company control. However, like any financial decision, it comes with its own set of considerations and implications.

Pros:

• You maintain sole ownership of your business: The nice part about getting a business loan is that no one else gets a part of your business. You borrow money from a lender, pay them back, part ways with the lender, and at the end of the day, you still own 100% of your business.
• You maintain sole decision-making rights for your business: When you own and operate 100% of your business, you can do whatever you want with it. Want to change your menu or start selling a new line of something? Great! Go right ahead. A business loan allows you to make whatever decisions you want, no matter how crazy or unorthodox.
• You retain all the profits you make: Say you’ve had a killer year and your revenues are through the roof. Everyone wants results like that, right? Of course! And when you own your business outright, you get to keep every last penny of the profits you make.
• You build credit: When you get a small business loan, you are simultaneously building your credit. Were you only able to qualify for a small amount and hit with a high interest for your first loan? Once your current loan term is up (assuming you’ve made timely payments), you will have built your credit and increase your chances of getting a larger loan with lower rates the next time around.
• Shorter-term than an investor: If you have an immediate need that will likely be fixed or solved in a short period of time, a small business loan is absolutely the way to go. Even if your loan term is 3-5 years, once that timeline is up, you own your business free and clear. Investors are in it for the long haul and will likely be around as long as you are in business. It’s not worth it to give up a portion of your company if you only need short-term assistance.
• More predictable: If you want finances you know you can count on, you are actually safer with a business loan. Why? Because if you take out a loan for a certain amount, you can count on that money to help run your business. A lender can’t back out of a loan. Sure, they require payments and if you don’t pay, they will cash in on collateral or whatever else you put up to secure the loan. But as long as you are in good graces with the lender, they’re not going to change their mind. An investor on the other hand, can decide one day that they are no longer interested and take their financing with them.

Cons:

• You are charged interest: Yes, that pesky thing called interest that we all despise. Yet, it’s a necessary evil if you want to secure funding for your business endeavors.
• Monthly payments are required: Rain or shine, your payment WILL still be due on the due date and there is no negotiating around that. Whatever terms you agreed to with the lender are the terms they will hold you responsible for, so if you have a tough month and don’t have enough to make your payment, the lender isn’t invested in your business so they won’t care. All they’ll want is your payment and they will do whatever they can to make sure they get it.
• You may have to put up collateral: If you are a newer business or a startup, you may not have enough credit built up to secure a loan based on merit and credit alone. In this scenario, lenders will often require you to put up collateral that is worth the value of your loan, to protect their interests in the event that you don’t pay. If your business doesn’t have much in terms of collateral, you’ll likely have to put up personal assets such as your house or a car.
• You risk losing your business and personal assets: When you take out a small business loan, you are responsible for that amount and that will never change. Depending on how you set up your business, there is a very likely chance that if you don’t pay they can not only liquidate your business to cover your business debt, but they can also come after your personal assets as well. This is why many small business owners choose to become an LLC - to protect their personal assets.

Investors

Shifting our focus to the other side of the coin, let's delve into the dynamics of securing funding through investors and the associated pros and cons it brings to your business.

Pros:

• You typically don’t have to repay the money – even if your business fails: If you’re just starting your business and you need cash in order to start but don’t have enough business credit to secure a small business loan, an investor can be a great idea. They will provide you with the funds needed and won’t require you to repay it either! Investors realize that there is always a risk associated with investing in a new company. So, unless it is explicitly stated in your contract with the investor, if your company fails, you are not responsible for any repayment.
• No interest or monthly payments: When an investor gives you money for your business, there is absolutely zero interest you have to worry about, and no monthly payments either. It is definitely a lot nicer to not have to worry about if you will have enough to make your payment for the month.
• Advice from investors may help your business: If you’re new to running a business, the advice and mentoring of an investor can prove to be invaluable. Investors have typically “been there, done that” and they know the pitfalls to avoid as well as tips and tricks. If you want immense amounts of help along the way, this may be a great option for you.

Cons:

• You have to give up a share of your business: Investors don’t typically give businesses money out of the goodness of their hearts. They do it because they see a chance at a bigger return than their initial investment. They invest in a company because they see that the business may be going places and they’re placing their bet on that success. This means that they want a piece of the action: your company. If you use an investor, they will usually require a portion of your company in the form of equity. Be careful how much of your business you give up to investors. If you give up too much, it’s no longer your
• Investors now have a say in how you run your business: If you know what you’re doing and have a clear vision of how to get there, you likely won’t be able to execute your plan exactly. Because investors have money invested in your business now, they want to make sure they see that return. This sometimes means that they will dictate how you run your business based on their own experience. This can become cumbersome and frustrating, especially if you started your business to be your own boss.
• Too many investors and you may end up getting kicked out of your own business: If you give up too much equity in your company, you will no longer be the primary shareholder. That means that all the other shareholders combined hold the majority of your business. If you get to that point, they could very easily vote you out of your own company!
• Share of profits: While you may not have to worry about interest payments on a loan, you do have to worry about sharing your profits here. If your business isn’t making much yet, then this may not seem like that big of a deal. But once your business really starts to take off, suddenly the interest rates of small business loans begin to sound very appealing. Depending on your revenue, the amount you end up having to pay to shareholders runs the risk of being far higher than any interest payment.

Choosing between investors vs loans

The important thing to remember is that there is no wrong answer. Whatever direction you choose is entirely up to you and your immediate needs. If your needs are short-term, you are almost always better off with a small business loan. But if you want ongoing funds with lots of advice and you’re willing to relinquish part of your business for it, investors may be your best bet. The most important thing is that you are happy with your business and have the funding that you need to grow it!

You know that your company needs a business loan, but how much should you borrow? Should you base the amount on the needs of a project? On your revenue? Your profits? Financial projections? It’s important to take a variety of factors into account when looking for financing for your business. Here are a few.

1. How much money your business needs

It’s very important to determine the correct amount of money that your business needs, because if you ask for too much, lenders will question your ability to repay them, and if you do not ask for enough, you will have trouble funding your business. To find out how much money your business needs, you should create detailed costs projections for the use of borrowed funds. You should also prepare financial projections, including profit & loss and cash flow statements to estimate the revenue that you will generate by taking out a loan, and your costs. Doing this will not only help you determine the amount of money that you need, it will also show lenders that you are responsible and informed.

2. How much your business can afford

Making sure that you can make payments on the business loan is paramount. Lenders evaluate a company’s available cash to pay back a loan in a given year, which they call debt service coverage ratio (DSCR). To calculate your DSCR, you need to know your cash flow (how much money comes in and how much goes out), and the amount of money you’ll have left to make debt payments.

Many lenders also look at the borrowers’ personal finances, using a term called DTI (debt to income ratio), which calculates your total monthly income and monthly debt, including car payments, mortgage payments, credit cards, and other debts. Most lenders prefer that borrowers’ personal debt makes up no more than 36% of monthly income.

3. The costs of your business loan

What closing costs are there? What is your interest rate? What is the total amount that you will pay back? These questions all factor into how much you can and should borrow. Knowing the total costs of a loan can help inform you about the type and amount of financing that you should pursue.

4. The impact of your loan on your projections

How will the influx of money influence your future revenue projections? How much profit can you expect to make by taking out a loan after factoring in the loan’s costs? If you borrow more, will you make more as well? Calculating this can help you determine the optimal amount to borrow.

5. Future financing needs

Does your business plan call for future expansion that will require financing? If so, will taking out a smaller loan now and repaying it help you build your credit to secure a larger loan in the future? Is it necessary to take out a loan now to reach the point where you can meet your plans for future expansion? Or, if you borrow too much now will your debt from that loan get in the way of securing financing at a later date? By planning ahead, you can make informed decisions about financing your business now, and into the future.

Lendio’s small business loan calculators can help you gauge the level of financing that you need and compare loan types from many lenders.

Sources:

http://www.forbes.com/sites/aileron/2014/10/02/7-steps-to-getting-a-business-loan/#75e5270921e5

http://www.businessnewsdaily.com/6237-small-business-loan-calculaitons.html

Occasionally, employees come to their employers strapped for cash and asking for a loan.

Lending money to employees may seem harmless, but if not handled correctly, the practice can cause significant problems and disruptions to an organization's operations. Here are a few general comments regarding lending to employees:

Chronic financial problems.

Employees who borrow from their employers generally have chronic personal financial problems. Unfortunately the problem is usually much more severe than the employee will let on, and the employee has come to the employer as a last resort.

Multi-time event.

It generally won't be a one-time event. You want to be kind as an employer, but once this door is opened it is very difficult to shut.

Do some research to ensure the employee has not already attempted or committed fraud against the company. The "Fraud Triangle" identifies the 3 elements generally present if fraud occurs --opportunity, financial pressure, and rationalization. If an employee has come to you for a loan, they are most likely feeling financial pressure. Because of the many and shared responsibilities in a small business, many employees have the opportunity to commit fraud. And, a person under financial pressure and who may be overworked in a small business, can always find good rationalizations for taking "just what's owed to them" from their employer.

Watch employee carefully.

If you decline an employee's request for a loan, make sure to watch the employee carefully. The stresses related to the fraud triangle may have increased by you saying "No," and the employee may get desperate.

Empathy

When an employee comes to you asking for help, this opens the door to a frank, and what can be, healthy discussion regarding their personal finances. Make sure you are well aware of the circumstances that have put the employee in this situation. Your understanding will help you not only make the correct decision, but also help the employee with more permanent solutions. This is also an opportunity for you to evaluate the employee's compensation. Many employees do not know how to ask their employer for a raise, it it may be that they've earned it.

5 keys to lending money to employees:

1. Make sure there is a specific need. Ask your employee to provide a bill or invoice related to the money they are borrowing. This helps the employee understand you are helping them with a specific need and not just dolling out money.

2. Limit the number of times employees can borrow. Limiting the number of times an employee can borrow accomplishes two goals: First, it encourages the employee to fix the financial problems in their personal life because you've eliminated a crutch for them to turn to. Second, you limit the potential personnel problems that can accompanying employee lending.

3. Charge interest. Employees may come to an employer because they won't have to pay interest like they would at a "payday loan" company. A common action by those in personal financial difficulty is to seek out lending sources with the "cheapest" money. By charging interest you show your employee your company's money is just as valuable as that of anyone else, and you avoid employees taking advantage of you. Make sure you abide by any related state laws.

4. Require employee to sign a note with repayment terms. For the safety of the company, and to ensure the employee understands the severity of borrowing from the company, formalize the arrangement by drafting a note payable to the company and require the employee to sign it. Make sure to include the repayment terms, interest rate and actions if employee defaults.

5. Draw a hard line from the beginning. Whatever your stance on lending to employees, you will be better off if you define the boundaries in which you will lend and stick within them. Employees in desperate financial situations will become like children; they will push the boundaries to get as much as possible. As a good parent would do, employers need to stand firm and act in a way that is best for the employee.

6. Follow through on your side of the agreement. If the employee defaults on the agreement, follow through on the default terms specified in the note signed by the employee. These actions may include automatic deductions from the employee's paycheck or legal action if the employee has quit.

7. Don't overestimate loyalty. A person in financial distress may do irrational things. The employees who can do the most damage and cause the most pain are those you feel are most loyal.

8. Don't do anything that will jeopardize your company or other employees. This needs no more pontification.

In our role as employers it is sometimes difficult to make hard decisions that are more beneficial for the employee than he or she may realize. Again, it's like being a parent. When you involve an employee's personal financial matters, it gets even more complicated. It's always best to err on the side of what benefits the overall business and what is best for the employee.

Business owners: Have you ever loaned money to one of your employees? Employees: Have you ever asked for a loan from your employer? If so, please share your experience:

With the onslaught of natural disasters that have occurred over the past few years, many businesses have suffered the loss or damage of assets, and more. These physical and economic damages have caused many businesses to have to shut their doors, or reduced their production and output.

To help combat some of the problems for homeowners, renters, and businesses -- both private and non-profit -- the SBA provides low-interest disaster loans to help repair or replace real estate, property, machinery, equipment, inventory, and other business assets that may have been destroyed or damaged by a declared disaster.

SBA has disaster offices throughout the country, where they provide low-interest, long-term loans. There are a variety of SBA loans, including:

• Home and personal property loans- These loans are available to those in declared disaster areas, and those who are known as the victims of a disaster. Even though they are from the SBA, you do not have to be a business to get them.
• Business physical disaster loans- Any business or private, non-profit organization located in a declared disaster area that incurred damage during the disaster can apply for a loan to help replace or repair the said damage.
• Economic injury disaster loans- This is a loan for small business or private, nonprofit organizations that have suffered economic injury, even if they did not suffer physical damage, due to a declared disaster.
• Military reservists economic injury loans- These loans are only for eligible small businesses to help them meet ordinary and necessary operating expenses that it could have met, but are now unable because an important employee was called into active duty because of a disaster.

The loans that are of greatest importance to businesses are physical disaster loans and economic injury disaster loans. Here is a little more information about said loans:

Physical Disaster Loans

• Businesses of all sizes and private, nonprofit organizations may apply.
• Loan amounts can be up to $2 million.
• Loans must be used to repair or replace damaged real estate, equipment, inventory and fixtures.
• Loans may not be used for expansion unless required to be up to code.
• The loan may be increased up to 20% of the total amount of disaster damage (verified by SBA) to prevent future damage by disasters of the same type.
• Loans are to cover under-insured loses or uninsured losses.

Economic Injury Disaster Loans

• Small businesses, small agricultural cooperatives and certain private, nonprofit organizations of all sizes that suffer from substantial economic injury may be eligible to apply.
• Loans may be up to $2 million.
• Loans may be used to meet necessary financial obligations that they would have been able to pay had the disaster not occurred.

For both loans, interest rates won't exceed 4% if the business does not have credit available elsewhere. The repayment term may be up to 30 years, and will depend on the business's ability to repay. If the business has credit available somewhere else they interest rate won't exceed 8%. The loans may be applied for directly to the SBA, at which time the SBA will send out an inspector to estimate damage, if the loan is awarded, funds may only be used under the stipulated SBA guidelines.