Why Is a High Interest Rate a Good Thing?
Let’s face it, the cost of capital for big, profitable, mega-corporations is significantly less than what it is for the small businesses on Main Street. In fairness to the bankers, Main Street businesses carry greater risk for lenders, fail at a higher rate than their larger colleagues, and don’t have the track record a large company has. Despite the fact that Main Street creates the lion’s share of new jobs, about half of them are out of business in five years—not making risk averse bankers too excited to stick their necks out.
Although there are some community bankers who take a different approach and don’t think this way, it’s not uncommon for bankers to expect the smallest of small business owners (the kind that run Main Street businesses) to use home equity or personal credit cards to finance their businesses. I’ve certainly leveraged the equity in my home on more than one occasion and I know of a number of small business owners who have walked the razor’s edge of financing business projects with personal credit cards.
When compared with the interest rates on most credit cards, the interest rates associated with a Merchant Cash Advance (MCA)or other alternative loan product start to look more attractive. Particularly if you need the capital right away to take advantage of a special offer from a supplier or have less than perfect credit.
Over the last 15 or more years many banks that once offered small business loans have left the market. When added to the diminishing number of community banks, the lenders really motivated to offer financing to small businesses are alternative lenders that offer specialized products like MCA loans, factoring, franchise loans, equipment loans, and other similar loan products. The cost of capital for these lenders, combined with the risk profiles of the borrowers they serve, equates to higher interest rates than a traditional term loan at the bank. Most alternative lenders would suggest, and I wholeheartedly agree, if you have the ability and the time to get a traditional low-interest rate from the bank, that’s where you should go.
Unfortunately it’s becoming more difficult, not less difficult, for Main Street to do.
Alternative lenders are also geared up for the smaller loan amounts many Main Street business owners are looking for. One of the biggest challenges Main Street business owners face is not that they are asking for too much, it’s that they aren’t asking for enough. A $20,000 or $50,000 loan is a big loan to many Main Street businesses and are just too expensive for many banks to process.
I don’t believe that higher interest rates are the best thing for every small business, but I do believe the capital they make available to many on Main Street is critical to growth and creating jobs. In fact, I wouldn’t be surprised to see alternative lenders become the primary source of capital for most of the smallest of the small businesses.
Please share your thoughts, opinions, and experiences regarding alternative financing options to the bank.
Small business evangelist and veteran of over 30 years in the trenches of Main Street business, Ty makes small business best practices, tips and advice accessible by weaving personal experiences, historical references and other anecdotes into relevant discussions about leading people, managing a business and what it takes to be successful. Ty writes about small business financing and other best practices for Lendio, in addition to sharing his passion for small business every week on Forbes.com.