Startups often need to go through several rounds of external funding to sustain themselves, especially in their earliest stages when research and development costs may be high and revenues are likely low.

Unfortunately, most brand new startups don’t have business credit, or they have poor business credit scores due to their lack of credit history, if they can even generate a score at all. That can make securing the necessary funding frustratingly difficult.

However, it is still possible for startups with bad credit to get the capital they need. Here’s what you should know about the process, including the best types of financing to consider and the risks involved.

Can You Get a Startup Business Loan With Bad Credit?

Yes, you can get a startup business loan with bad credit. Your business can make up for it in other ways, such as having solid financials. However, your options will be limited, and you’ll inevitably pay more for the privilege than you would if you had a better score.

If you have bad personal or business credit, it’s going to be hard to qualify for business financing from a traditional lender, like a bank or credit union.

Those types of lenders usually have high standards. They generally want to work with borrowers they’re confident can repay their loan and are less inclined to take risky bets, even for a higher possible return.

Fortunately, other creditors might be interested in offering you a startup loan, even with bad credit. In 2021, countless online and alternative lenders are eager to work with businesses that traditional banks are unwilling to finance.

If you’re going to consider working with these types of creditors, though, keep in mind that they’re going to charge significantly more for their services.

For example, Bank of America offers unsecured business loans with interest rates as low as 4.75% in 2021. By comparison, Funding Circle’s interest rates start at roughly 12% per year, and they’re a well-respected alternative lender.

The Catch With “Guaranteed Loans”

If you’ve ever shopped around online for bad credit financing, you’ve probably come across advertisements from lenders that claim they can offer you guaranteed approval for one of their accounts.

They often go so far as to skip the credit check process entirely. When it comes to borrowing money, that’s usually a red flag. There are only a few circumstances where it makes sense to offer an account without a credit check.

Credit builder loans, for example, are a type of secured loan that keeps the principal balance locked in a savings account during the repayment term, so there’s no risk to the provider.

In that case, it makes sense that an account provider wouldn’t be worried about checking your credit. However, if the lender isn’t protected somehow, guaranteeing your approval or skipping the credit check should probably concern you.

At the very least, it means that they charge such high-interest rates that they can afford to take risks on anyone willing to apply, regardless of their credit history.

In the worst-case scenario, they could be a scam artist looking to entice you into giving up your money or sensitive information.

Either way, be careful when you hear an offer that sounds like it might be too good to be true. Do your due diligence before filling out a loan application so you don’t share anything with anyone you might regret.

Types of Loans for Startups With Bad Credit

With the popularization of online lenders and new alternative forms of financing, there are more types of loans available for businesses now than ever before.

However, not all of them make sense for startups with poor credit, and your other circumstances will probably make some of them more viable for your company than others. Here’s what you should know about the options available.

Invoice Factoring

Invoice factoring isn’t exactly a small business loan in the typical sense, but it’s one of the fastest and easiest ways for a business with bad credit to acquire working capital. It involves selling off outstanding invoices to a third party at a discount.

You get your earnings immediately, and the factoring company keeps the difference between the invoice value and the amount they gave you for it. The customer follows up with them, so you don’t have to worry about collecting.

If you’re looking for financing to smooth out your cash flow problems due to customers that take weeks or months to close invoices, factoring could be a viable solution for you.

For example, say your startup generally lets customers pay on a net-30 basis. That means you’d usually have to wait at least a month before you receive payment for the work you’ve performed.

You’ll likely incur expenses while providing your services, such as labor or material costs, but you won’t receive the funds you need to cover them until much later.

Using invoice factoring, you could sell off the outstanding invoice as soon you complete your end of the deal. That would help you cover any expenses you incurred and let you take home your profits immediately.

Unfortunately, invoice factoring isn’t always the cheapest strategy. You could lose up to 5% of each invoice to the factoring fee, and there may be other hidden fees that can further eat into your income.

However, it can be a beneficial tool in a pinch, especially if you need financing but struggle with bad credit.

Merchant Cash Advances (If You Have Revenue)

A merchant cash advance is another alternative form of financing. If you qualify for one, you’ll receive a lump sum upfront like you would from a typical business loan, then pay back the principal, plus a significant fee in one of two ways.

You can sign away a percentage of your credit and debit card sales, or you can set up fixed daily or weekly withdrawals from your bank account. Either way, you pay back the advance incrementally.

Merchant cash advances offer several attractive advantages. For example:

• Fast funding: You can apply and get your advance in a couple of days or less.
• Easy to qualify for: Roughly 84% of applicants received funding in 2020.¹
• Flexible terms: You can get an advance that ranges from a few thousand to a few hundred thousand dollars and pay it back over months or years.

Unfortunately, there’s a catch, and it’s a pretty significant one. Like credit card cash advances, merchant cash advances can be shockingly expensive.

Most merchant cash advance lenders calculate their fees using a factor rate that ranges from 1.2 to 1.5. They multiply that by your cash advance amount to get your total repayment.

For example, a factor of 1.3 multiplied by a $100,000 merchant cash advance equals $130,000. In that case, your finance fee would be $30,000.

As you can see, merchant cash advantages come with a hefty price tag. If your startup has bad credit, you can still use it to get the financing you need, but it won’t come cheap.

Equipment Financing

Equipment financing functions like a standard term loan. You receive a lump sum that goes toward your purchase, then pay it off in fixed monthly payments of principal and interest.

However, your purchase has to be equipment for your business, and the loan will generally be for its exact purchase price. You can’t take one out for any other purpose, and there won’t be any funds left over to put toward anything else.

Equipment financing may be easier to qualify for with bad credit than other business loans because the equipment becomes collateral for your loan. If you ever default on your payments, your lender can seize it to recoup any losses.

If you’re going to apply for an equipment loan, it’s generally best to match the repayment term to the equipment’s useful life as closely as possible. You don’t want to find yourself making payments on something that no longer benefits you.

You can get an equipment loan from traditional lenders, but it would be difficult with bad credit. It’d be easier to find an online lender willing to work with you, though they’ll charge you a higher interest rate.

Small Business Credit Cards

After business loans and lines of credit, small business credit cards are the most commonly sought type of business credit. Roughly 21% of businesses that applied for financing in 2020 were trying to get a credit card.¹

Their interest rates are too high to help you finance anything past their short grace period, but they still provide several significant benefits. For example, they can help you:

• Build business credit for future rounds of funding
• Smooth out cash flows when customers are slow to pay
• Distinguish between personal and business expenses for accounting and tax purposes

If nothing else, you can use a small business credit card to earn cashback for your startup’s day-to-day expenses. Even if you only discount your spending by a few percentage points, it adds up with consistent use.

You might not be able to qualify for the best business credit cards with bad credit, but there are options available for just about any situation.

If you have bad business credit or bad personal credit but not both, you can try to use the score that’s highest to get a competitive card. If you’re lacking in both areas, you’ll have fewer options, but there are still plenty available.

Many lenders have business credit cards specifically for businesses with bad credit, though you may have to use a secured credit card.

Online Business Lenders

Online business lenders may be the best way to get a bad credit business loan. They’re generally much more willing to work with risky businesses than a bank or credit union would be.

For example, to get a business loan from Bank of America, you need to be in business for at least two years under existing ownership, have $100,000 in annual revenue, and meet their undisclosed credit score requirements.

By contrast, OnDeck is an online lender that only requires one year in business, $100,000 in annual revenue, and a 600 credit score.

Unfortunately, as we’ve mentioned, the flexibility of online business lenders comes at a price. Using Bank of America and OnDeck as an example again, their unsecured business loan rates start at 4.75% and 11.89%, respectively.

If you don’t have the credit score necessary to qualify for a business loan from a bank, online lenders are a viable financing option, but they’ll be expensive. Make sure you shop around with at least a few options to minimize your interest as much as possible.

Microloans

A microloan is exactly what it sounds like: a loan for small businesses and startups with a much smaller principal balance than you’d usually see elsewhere.

For example, the Small Business Association (SBA) claims that microloans average about $13,000, though the loan amount can be as much as $50,000.

Because they involve much less money than a standard business loan, it may be easier to qualify for a microloan than one where the lender has more to lose. They can still serve as a valuable working capital loan option for startups with lower financing needs.

Note that the SBA isn’t a direct lender, which means you can’t get an SBA loan from them personally, micro, or otherwise. They sponsor the program and work through other lenders.

Most traditional institutions aren’t interested in offering such small loans, so you’ll usually find microloans at nonprofit organizations and online lenders.

Fortunately, they’re often still relatively affordable. The SBA reports that their interest rates range from roughly 8% to 13%. The qualification requirements can vary significantly between lenders, so feel free to shop around.

Good Business Credit Is the Best Long-Term Solution

Bad credit is a significant obstacle, but it doesn’t mean that your startup can’t get business funding. You can still qualify for many different types of credit accounts, especially if your business’s finances are strong.

However, scraping by with a low score isn’t ideal. Not only does it limit your borrowing options, but a bad credit loan can cost you thousands of dollars in unnecessary interest.

For example, say you want to take out a $75,000 business loan for your startup. Because you have bad credit, you can only qualify for a loan at 11% interest from an online lender. Over a three-year loan term, you’d pay $17,859 in interest.

However, if you could increase your credit score enough to lower your loan’s interest rate to 6%, you’d only pay $9,519. That would save you a whopping $8,340!

Raising your personal credit score may be the easier way to avoid paying high-interest rates, but taking the time to build good business credit is a much better long-term solution.

If you can qualify for business accounts using your business credit scores, you can separate yourself from your business. That has many benefits, but the most significant is that it lets you avoid taking on a personal guarantee for your business debts.

That means if your startup were ever to default, its creditors wouldn’t be able to come after your personal assets to recover their losses. You would still lose your business, but you’d be able to protect your house, vehicle, and personal savings.

One of the best ways to build your business credit score is with a credit builder loan like Credit Strong’s. You can customize your monthly payment to whatever’s comfortable for your business.

As you pay down the loan, we’ll report your timely payments to Equifax Business and PayNet to help you establish a payment history on your business credit report.

To qualify, you only have to be in business for three months, form an entity other than a sole proprietorship, and provide your Employee Identification Number. Give it a try today!

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