We should all do a good deed to our clients. However, in some cases lenders don’t issue a high rate because of pure greed. First, there is a big risk factor or there are certain circumstances on why a higher rate may be issued to a business. As an ISO you have the right to determine how much you want to make on a transaction based on what the market can bear. However, setting aside the commissions there are three main topics to discuss with business borrowers.
1. Use of Funds
2. Return on Investment
3. The Reality of Their Business Finances
If a borrower has to many non-sufficient funds, low close out balances, they are in a restricted industry, have poor credit; these are all justifiable reasons why a higher rate is being provided. In this case, the borrower is being given a new opportunity to establish business credit. We call this the reality of their business finances and risk factor. Most of these borrowers, will not have a chance to get a bank loan until 3 to 5 years into the future unless if they make radical changes.
What will the borrower use the funds for? As an ISO you need to assess short-term and long-term needs. In some cases a 3 month to 6 month term may be offered to your client. Your client may not be happy with a short-term. Let’s assume a business is buying inventory and their sales cycle is every 30 days. Why would this business need a 2 year or 3 year bank loan if they will see a return on investment within 30 days? If a business is expanding and they are going to do a built out than a short-term loan may not be the solution. Most inventory based businesses see cash weekly, monthly, and quarterly. If the use of funds is inventory; a short-term loan is ideal. Businesses that cannot qualify for factoring and have accounts receivables that are 30 to 120 days net are ideal for short-term financing. The use of funds is very important.
Assessing return on investment versus cost of capital is the third key ingredient for selling short-term loans and above average interest rates. A loan is not only about the cost of capital. A loan is really about making money. Sure, a lower interest rate is always better but if the business does not know how to make money with other’s people money a loan is not the solution. If the borrower makes a 10% return per month and they pay even 4% per month; they are still making 6% per month. If they can do this every month for the next 5 months, that’s a 30% return on investment. There is no bank Certificate of Deposit or Money Market that is paying 30% within 5 months. If the business owner knows their net margins, how they will use the money and how they can achieve return on investment, the rate is almost irrelevant.
These are some tips on how to address short-term financing and high interest rates. In the end, many of these businesses cannot obtain a bank loan and alternative financing is their only solution. At the same time, once they establish a good payment track record the rates can be lower and terms can be better.