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Among the financing solutions available to startups and small business owners, microlending is one of the more accessible. Also known as microcredit, microlending has been gaining popularity in recent years – and for good reason.
Keep reading to learn more about microlending and why you should consider this option to fund your startup.
What is microlending?
Essentially, microlending is the practice of giving small loans – it can range anywhere from $500 to $50,000 – to entrepreneurs and business owners in need of funds. Typically used by startups and small firms that would otherwise find it difficult to get approved for a loan, microlending serves as an alternative to more traditional lending.
Microloans help entrepreneurs and business owners who either 1) have no access to sufficient funding where they live or 2) can’t get funding from traditional financial institutions due to their lower credit scores.
Who uses microlending?
Microloans help small businesses get up and running, grow, and flourish. As such, if you’re looking to get a small amount of funding quickly to launch your startup and don’t necessarily have the best credit score to obtain a loan from traditional financial institutions, a microloan might work for you. Generally, microlenders have less restrictive requirements, making microloans considerably easier to get compared to traditional options.
Commonly provided by nonprofit organizations, some focus on microlending to specific types of borrowers, such as minority-owned or women-owned small businesses. Microlending clients are typically self-employed, household-based entrepreneurs. However, microlending programs may also be suitable for other small businesses, such as small retail shops, local auto repairs, cafes, personal services (i.e. spas and salons), and more.
Here are some types of businesses and situations in which a microloan may be a suitable option:
Businesses with no or few employees.
Usually, microloans are provided to sole proprietorships and small businesses that only employ a few people. Such companies typically find it very hard to secure financing from more traditional lending institutions. Such businesses may operate out of a local storefront, are home-based, or operate online. Microloans can be a good fit for restaurants, small retail shops, and beauty salons.
Businesses with small financing needs.
Even if you already have a steady business history and a higher credit rating, you can still consider using a microlender if you’re only looking to borrow a small amount of money. A microloan allows you to borrow just what you need without taking on too much debt. Plus, it’s usually payable in equal monthly installments, so you can budget well in advance.
Why get a microloan?
As an entrepreneur, you might have a successful business plan but lack sufficient funds to launch your business. In this case, a microlender can help you get enough funding to get your business off the ground and start generating revenue. Eventually, you will pay off the loan with your business profits.
Listed below are other reasons why you might want to consider a microlender to fund your startup:
Microloans provide a starting point for small business owners who want to build or rebuild their credit history. Many applicants have little to no credit history or don’t have the collateral that bigger businesses can use to secure a loan (e.g. commercial real estate).
Working with a microlender, however, can help you build your credit. As you pay off your microloan, the microlender reports its payment experience to the appropriate credit bureaus. This, in turn, builds positive credit history and increases your level of creditworthiness in the eyes of other lenders.
Usually, once a microloan is paid in full, micro-borrowers are able to qualify for larger amounts of funding from traditional financial institutions.
As they say, time is gold – this is especially true for small business owners in need of working capital. Waiting for a traditional loan backed by the SBA and other traditional financial institutions can take several weeks, even months. On the other hand, a microloan may take as little as 14 days to come through!
However, do note that each microlender has its own requirements, interest rates and lending limits, and timeline, so make sure to carefully weigh your options to find the one that best fits your needs.
Another reason why you might want to consider a microlender to fund your startup is that they have flexible loan requirements.
Generally, microlenders are more flexible with their underwriting criteria and require less documentation. When making their decision, most microlenders will look at your business idea as a whole – they don’t just plug numbers into a software and have it spit out a yes or no answer. Moreover, while most traditional lenders are unwilling to approve a loan unless you have a stellar business and credit history, as well as sufficient collateral, microlenders take other factors into consideration such as a personal collateral and a personal guarantee.
If you’re a startup and/or don’t have much of a company history, you need to have a strong business plan in place to help convince a microlender to take a chance on your company.
However, this also means that if you’re a startup and/or don’t have much of a company history, you need to have a strong business plan in place to help convince a microlender to take a chance on your company.
Some microlenders are required by the Small Business Administration (SBA) to provide business and technical training to potential borrowers. This training, which borrowers must complete before their application is accepted, is a big benefit for entrepreneurs as well. Remember, with the right knowledge and training, you can avoid costly mistakes and you’ll be likely to succeed in repaying your microloans while building a solid business in the process.
Even if you aren’t required to complete training as part of the application process or as a condition of approval, most microlenders offer workshops, classes, and one-on-one mentoring on a broad range of topics. Make sure to grab this opportunity! Taking advantage of these resources isn’t just beneficial for new business owners, but even seasoned entrepreneurs can gain valuable knowledge.
Each microlender has their own eligibility criteria and requirements. However, startups and businesses usually must meet the following criteria:
Located in an area served by the microlender
Have sufficient income to support microloan repayment
Display good payment history with other personal and/or business creditors
Be able to offer personal collateral and/or a personal guarantee
Most microlenders require little to no requirements when it comes to the age of the business (even startups can apply!), the business credit score, or even the owner’s personal credit score. You don’t need perfect credit to qualify for a microloan, since microlenders usually consider your credit history in the context of your whole application. You can offset your weak credit history by strengths in your application (i.e., good payment history). However, note that issues like recent bankruptcies, recent delinquent payments and outstanding tax liens may disqualify you.
The bottom line
Microloans can be a major game changer for startups, small businesses, and underserved entrepreneurs. If you’ve just lost out on a traditional bank loan or other SBA loan program, consider going for a microlender to fund your startup. You might not be able to get a lot of capital, but you’ll be able to fund the launch of your business and get moving in the right direction.
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