Red Flags in Small Business Financing Agreements

4 min read • Mar 04, 2021 • Ian Varley

When downturns come and banks are less likely to lend to small businesses, other financing sources can step up and fill your need. Unfortunately, some of these small business financing options can be predatory. But if you read your contract carefully and consider your actual financing needs, you’ll likely avoid getting burned. When a lender sends you a financing agreement, take notice of any alarm bells going off inside your head. Pay special attention to these areas and be on the lookout for red flags.

Proposed Financing Amount

First, be sure the financing amount will be enough to satisfy your business needs. This is a double-edged sword. You don’t want to be offered financing outside your means and be on the hook for repayment, but you may need to find another option if a lender doesn’t offer you enough financing. Consider the type of financing you are applying for and how it fits into your overall financing plan. Would you have to reapply for more financing and incur additional application costs if you need more money? Make sure the proposed financing amount makes sense to your need. 

Are You Locked into a Contract?

Most financing agreements will lock you into a contract for a set length of time or until you repay the loan amount. When reading the contract, watch out for termination penalties. These costs can be quite high, so make sure you understand the penalty for ending your financing agreement. It can be a red flag when a lender wants to lock you in for a certain length of time. In a perfect world, you will stay with your lender because they are serving your financing needs. Just be aware of how long your financing agreement will last and the repercussions of ending that agreement.

What Is the Cost of Financing?

This is probably the most important detail to small business owners. Sometimes the cost of small business financing is not obvious. Legal jargon and finance industry terms can be confusing to understand. Short term loans are probably more expensive than loans with longer terms, so be sure to weigh the costs when making your decision. Not only do you need to pay attention to the overall cost of the loan, but what do the repayment terms look like? Frequent repayments could hurt your cash flow, but some loan types (like merchant cash advances and ACH loans) depend on weekly or even daily payments.

Are There Hidden Fees?

Hidden fees are called that for a reason. You may not realize the extra costs associated with your financing agreement, even after reading the contract carefully. It’s not a bad idea to get an extra pair of eyes on the agreement to look for issues. Is there a fee for paying back the loan early? Are there fees for service or additional funding? These costs can add up, and if the lender is not up front about additional fees, you should hold some skepticism. Check out the customer reviews for your lender. A bad review does not have to be a dealbreaker, but tons of bad reviews are Empire State Building-sized red flags. You don’t want to be locked into a contract with a company that is going to nickel and dime you to death.

Is the Agreement Different From What You Discussed?

A surprise birthday party is great! A surprise in a financing agreement…not so great. If the financing agreement is full of costs and schedules that you did not already discuss with your lender, this is a red flag. You should be aware of major costs, penalties, and requirements before you even receive an agreement. Any large discrepancies between your written contract and what you discussed verbally should be addressed before you sign anything. If a lender surprises you with penalties and requirements before you have signed an agreement, it doesn’t look good.

Does the Financing Agreement Make Sense?

Suppose you’ve read through the agreement, probably multiple times. There seem to be no obvious red flags or discrepancies in the document. The lender has decent customer reviews, and nothing is holding you back from signing the financing agreement. Your last question to ask is simply if the agreement makes sense for you. Is this financing option going to improve your cash flow and help you grow? Sometimes you can only see 10 feet in front of you and you’re focusing on meeting payroll and staying alive. When you sign up for small business financing, it’s essential not just to survive but also to grow. 

Small Business Financing Without Red Flags

It’s important to shop around when you are looking for financing. You want to get the best rate, financing amount, and service for your business. A solid financing partner will offer you flexibility and transparency. If there are red flags in your proposed financing agreement, call your lender and address them—there are other small business financing options available to you.

 

Disclaimer: The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice. All information, content, and materials available in this post are for general informational purposes only. Readers of this post should contact their attorney, business advisor, or tax advisor to obtain advice with respect to any particular matter.
Ian Varley

Ian Varley

Ian Varley is a cash flow expert with decades of experience in the small business finance industry. After noticing small businesses’ lack of access to working capital, he started Eagle Business Credit, a factoring company that specializes in funding small businesses of all shapes and sizes.