How to Get a Short-Term Small Business Loan

Short-term loans can be the bridge between a liquidity crisis and long-term financing. Read on to learn when they are useful and how you can get one.

Business is unpredictable. You can go for months without a cash crunch and then, all of a sudden, two customers don’t pay on time right when you need to buy some bulk inventory and you start scrambling.

At a time like that, it doesn’t make sense to commit to a long-term loan that will have you stuck paying interest for years. Let’s take a look at how to get a short-term loan for your business.

Overview: What is a short-term business loan?

Short-term small business loans are meant for one-time liquidity crises. This can be a gap in time between one loan coming due and a new loan closing to pay it off. The loan use is usually either paying off an existing loan or working capital to be used as needed.

Short-term loan eligibility requirements

The following items are often required to qualify for short-term loans for your business.

Personal guarantee

Short-term loans are often unsecured, and the short-term lender will require a personal guarantee to lower the risk. This means that if the loan defaults, you will be personally liable for it -- even if your business is an LLC.

Financials

Lenders will go in one of two directions. Either they will do a full underwrite of your business, which would require financials, a business plan, and other miscellaneous documents, or they’ll run your business through an algorithm to get a quick decision.

If they do a full underwrite, it will be a little different than a normal term loan. Usually the bank wants to see if your income can support loan payments. With a short-term loan, you often make interest-only payments or no payments until the full amount comes due. So the bank will be looking at your working capital position and analyze whether you’ll have the cash to pay off the loan when it comes due.

Credit score

The best short-term business loans, at least in terms of ease of application, use an algorithm to grade your business. One of the banks I worked for had a hybrid model, where we ran prospective small loans through a software model and then still did a mini-underwrite.

If the lender you apply with uses an algorithm only, it will likely be based mostly on your personal credit score and business credit score. Your personal credit score is given most of the weight.

Years of study about which loans fail has led lenders to believe in the efficacy of personal credit scores for business loans. If your score is lagging, work on paying down revolving balances and taking care of any existing judgments or derogatory accounts.

Advantages of short-term business loans

Here are the advantages of getting a short-term loan.

Bridge loans

Most conventional real estate loans end with a balloon payment. The bank structures the loan to have a monthly payment based on a 20-year term, but, after 10 years, the balance comes due. A lot can happen in 10 years, and it can be difficult to find financing to pay off the balance, especially because the first 10 years of payments won’t pay for half of the principal balance.

If you’re stuck in underwriting or even stuck trying to sell the place, you may be able to obtain a short-term loan to pay off the note until you can pay it off fully.

Seasonality

Seasonal businesses often have problems meeting payroll or other fixed expenses in off months. It’s easy when the cash is flowing, but once the customers stop, you have to be disciplined to keep the lights on. Short-term loans can help pay operating expenses until you start making sales again.

Economies of scale

Big businesses can reduce their inventory cost by buying a (sometimes literal) ton of inventory all at once. It helps vendors clear out their existing stock and budget better. Small businesses often can’t pull off these same large purchases.

However, if you know you’ll be able to turn over inventory quickly with a one-time sale or by selling at a conference, it could certainly make sense to look for a short-term loan to make a big purchase if you can get a discount.

The two things to keep in mind are the likelihood of turning over the inventory -- you don’t want to be out the cash with inventory burning a hole in your warehouse for three years -- and if the cost of the loan is actually less than the discount on the purchase.

Disadvantages of short-term business loans

Here’s where you may go wrong getting a short-term loan.

High interest

Short-term loans are higher risk than long-term loans, and lenders make up for that by charging higher interest rates and fees. Pay attention to the annual rate. If you get an 8% rate on a four-month loan, that’s a 24% annualized rate.

Loan amount

Another way lenders reduce risk is by originating a lot of small short-term loans. Lenders often have a policy declaring the highest they’ll go for loans that meet certain risk characteristics.

If you need to buy real estate or a big piece of equipment, you’re better off trying to find a loan term that matches the life of the purchase.

Refinancing addiction

It’s theoretically possible to go on continually refinancing short-term loans with other short-term loans forever, especially if you’re using a lender that underwrites with an algorithm and isn’t worried about the use of proceeds.

Don’t fall into this trap. If you have a bunch of shorter-term loans floating around with high rates, consider applying for an SBA loan to refinance them all into one note.

How to find and apply for short-term business loans

If you do need a short-term loan, here’s how to make it happen.

1. Start at your bank

The best option is to get a loan from your existing bank. If you have a good relationship with a community bank, they’ll likely be willing to make a policy exception to extend a short-term loan that they normally wouldn’t.

Bank loans will have lower interest rates, lower fees, and more knowledgeable relationship managers.

2. Consider credit cards

If you already have business credit cards, consider maxing them out before engaging a new lender. It will reduce your overall fees, and you’ll probably get rewards points. You can also reach out to your credit card provider if they can usually do short-term notes and already have information about your company.

3. Online lenders

I don’t have much experience with online lenders, but I know the short-term business loan rates at an online lender will generally be higher than what you would get at a bank. This is because online lenders usually only have one product and can’t make up profits with other fee sources, such as deposit accounts or treasury management.

If you do end up going through an online lender, take some time to research the company first to make sure it’s reputable and that you won’t be surprised by hidden fees.

Ready, set, loan

There are endless types of loans, but they’re all underwritten in the same way: Can you make the payment(s) on time? Likewise, the process of finding a loan and budgeting for it will be mostly the same regardless of what type of loan you go after.

Remember to take the time to consider your options and avoid high-interest and high-fee loans when you can.