Last Updated January 21, 2025
Many businesses rely on external financing to get the cash they need for expansion, improving working capital, or other essential business activities. However, many businesses are considered high-risk borrowers. A variety of factors could make a business high-risk and ineligible for standard loans. In these circumstances, businesses must often turn to high-risk business loans and other alternative lending options.
What Are High-Risk Business Loans?
High-risk bad credit loans are loans that are issued to borrowers who are considered risky by lenders. As part of evaluating potential business loan risks, lenders look at factors such as the business’s credit history, its debt-to-income ratio, and its revenue streams to determine its creditworthiness and ability to repay.
If a business is considered to be high-risk, a standard lender may be completely unwilling to lend to them. In this case, the business must generally seek out a high-risk lender. While these lenders are willing to offer loans to businesses with poor credit or inconsistent revenue, the loans themselves come with higher interest rates, shorter repayment terms, and stricter repayment guidelines.
Examples of High-Risk Borrowers
What is a high-risk borrower? In terms of outlining a high-risk borrower definition, this generally refers to any business that is deemed more likely to default on a loan due to poor credit history or insufficient or inconsistent revenue.
Business loan risk categories are generally divided into several types of high-risk borrowers, and loan terms and options may vary based on the risk category that a business falls into.
Business Owners With Bad Credit
A bad credit score is one of the most common reasons a borrower could be considered high-risk. Bad credit could stem from a variety of factors, including having little to no credit history (a common issue for new businesses). High-risk loans for bad credit will often require that the business put down a larger deposit or use a physical asset as collateral to obtain a loan.
Seasonal Businesses
Seasonal businesses are considered high-risk because their income is inconsistent. Seasonal businesses often rely on loans and financing to get through their off-peak season. However, lenders may be reluctant to provide a loan if the business will not be able to generate revenue for a significant period of time or if seasonal income seems unlikely to enable them to pay off the loan in the future.
Brand New Businesses (Startups)
High-risk business startup loans are often required when startups seek external funding. Startups generally don’t have a credit history to fall back on, nor do they have a consistent stream of revenue. Quite often, they don’t have any revenue because they are still making investments to get the business ready for its operations and future growth. This inherently makes the business a higher risk for lenders.
Business Owners With a Past Bankruptcy
As a business owner, your own credit history can play a role in qualifying for a business loan. Business owners with a past bankruptcy (either personal or business-related) send an immediate red flag to lenders.
Business Owners With a History of Late Payment on Loans
Though not as extreme as bankruptcy, business owners with a history of late payments on other loans (either for business or personal loans) will make lenders reluctant to provide a traditional loan. Lenders will generally only stick with high-risk loan options, offering smaller loans at higher interest rates.
Borrowers With No Hard Assets
Many lenders want businesses to stake a hard asset as collateral as part of the lending process. If a borrower has no hard assets, a lender could view them as riskier because they potentially have less to lose if they don’t repay the loan.
How Providers Protect Themselves When Issuing High-Risk Business Loans
High-risk lending companies will perform a business loan risk assessment to determine if a borrower is high-risk. If a borrower falls into a high-risk category, the lending provider will generally protect themselves by making the lending terms less favorable for the borrower.
This will usually involve lending less money than would be made available to a low-risk borrower, as well as charging higher interest rates. Many lenders also require larger or more frequent payments as part of the loan terms, especially when offering an extremely high-risk loan. The increased revenue from higher and more frequent interest payments helps offset the risk of nonpayment.
Pros and Cons of High-Risk Loans
Here are some key pros and cons of high-risk loans to consider when evaluating this type of funding.
Pros | Cons |
Allows businesses to borrow money when they might not be able to borrow from other lenders due to poor credit | Comes with higher interest rates and shorter repayment terms |
Helps new business build a credit history | Could hurt credit score if you fail to repay |
Provides funding for expansion and other opportunities | Typically offers lower lending amounts (so you might not get as much funding as you need) |
Often provides fast funding | Increases your risk of default or loss of collateral due to less flexible repayment structure |
Most Common High-Risk Business Loans
There are several types of high-risk money lenders who are willing to provide business loans for high-risk borrowers. The following are some of the most common types of high-risk business loan lenders that your business might come across.
Short-Term Business Loan
A short-term business loan operates the most similarly to a traditional business loan, but typically, it must be fully repaid within 18 months. Short-term business loans offered by banks or credit unions generally require the business to make at least $50,000 to $100,000 in annual sales revenue and be in operation for six months. Many also have minimum personal credit score requirements for business owners.
Merchant Cash Advance
A merchant cash advance (MCA) is an advance offered by a lender based on the business’s past sales data and future sales projections. The loan and interest are typically repaid by giving the lender a percentage of future revenue from credit card sales. Withdrawals are made on a daily or weekly basis, with fees determined by a factor rate tied to your perceived risk. MCAs tend to focus on business revenue rather than credit scores when determining eligibility and lending amounts.
Asset-Based Lending (Such as Inventory Financing)
Asset-based lending is when a business secures its loan against equipment, inventory, property, accounts receivables, or even securities. This collateral allows the business to secure the loan, but failure to repay results in the seizure of the asset used for collateral.
Payday Loans
Business payday loans are a common nickname for merchant cash advances (MCA) and Automated Clearing House (ACH) loans. Both options provide cash quickly but have higher annual percentage rates. With MCAs, the lender deducts a set percentage of the business’s credit card transactions to repay the loan. With an ACH loan, repayments are withdrawn automatically from the business’s bank account at a fixed rate based on projected sales.
High-Risk Borrower Looking for a Low-Risk Financing Solution? Try Invoice Factoring
High-risk business loan options can help you get cash fast, but the high interest rates and inflexible repayment terms can create serious financial risk for businesses. While working to improve your business credit score can help you qualify for better loan options in the future, invoice factoring may provide a lower-risk alternative to get the funding you need.
How Does Factoring Work?
Invoice factoring involves a business selling its outstanding invoices to a third-party factoring company. The business provides the invoice to the factoring company in exchange for a cash advance that is typically worth 80-90% of the total value of the invoice.
The factoring company then assumes responsibility for collecting payment from the invoiced customer. After the client payment is received, the factoring company will provide the remaining value of the invoice to the business minus its factoring fee (typically applied as a percentage of the total value of the invoice).
Advantages of Factoring
The advantages of factoring help remove many of the risks of taking out a business loan. Business owners can get fast access to the cash they need without going into debt or putting up assets as collateral.
Factoring also does not depend on the business’s creditworthiness. Instead, the factoring company evaluates the creditworthiness of the business’s clients. This results in faster approval than most traditional lending options. While the business loses a small portion of revenue due to the factoring fees, this tends to be more cost-efficient than the high interest payments associated with high-risk business loans.
In-Summary: High-Risk Business Loans
For business owners with bad credit (including a history of bankruptcy or late payments) and startups, seasonal businesses, and borrowers without hard assets, a high-risk business loan may be the only borrowing option available. These loans allow business owners to borrow money, but they also have a variety of potential issues, including high interest rates, stricter repayment requirements, and shorter terms.
While high-risk business loans may work in some scenarios, other businesses may be better served by using invoice factoring to sell unpaid invoices for a cash advance. This allows them to get the funding they need without the potential pitfalls associated with high-risk loans.
Michael McCareins is the Content Marketing Associate at altLINE, where he is dedicated to creating and managing optimal content for readers. Following a brief career in media relations, Michael has discovered a passion for content marketing through developing unique, informative content to help audiences better understand ideas and topics such as invoice factoring and A/R financing.
