One of the biggest financial pitfalls that small business owners need to avoid in the modern era is loan stacking. It’s become easier than ever to take out multiple concurrent loans from different partners, sending your business into a debt spiral that can end with you in bankruptcy.
In and of itself, taking out a small business loan isn’t an issue. In fact, the right loan at the right time has been a common tool for growth for many small businesses over the years.
A loophole in the online lending process, however, allows for small businesses to take on more funding than they can reasonably afford. This takes the form of loan stacking, and if you’re a new or even well-established small business looking for financing, you should avoid this risky practice.
What is loan stacking?
Loan stacking is when a business owner takes out a loan (or cash advance) on top of another loan already in place. The two (or more) loans will have similar characteristics and repayment terms, but they’ll come from different lenders, all of whom expect to be repaid on time.
Now, the business owner has multiple loan payments actively due — perhaps on a weekly or even daily schedule. That’s a lot of debt to pay off in addition to regular cash flow needs such as making payroll and purchasing inventory.
Loan stacking is when a business owner takes out a loan (or cash advance) on top of another loan already in place.
Why would a business owner take on so much debt from multiple lenders? If a lender refuses to extend the full amount of a business owner’s requested funding, they likely have a good reason for doing so. Maybe they don’t trust the business owner’s business credit history, or they don’t see the business’s projected revenue as sufficient.
Yet some small business owners will then “stack” more than one loan in an attempt to cobble together their needed funding — $10,000 here, another $10,000 there — even if it means they don’t have an obvious path toward repaying all of it. They’re taking on a lot of risk — which is fine if it works out — but devastating if it doesn’t.
How does loan stacking work?
In theory, business owners shouldn’t be able to stack loans as often as they do. Many small business lenders often state that it’s a violation of your loan agreement to take out multiple sources of similar credit, putting you in default automatically.
But not every lender has such stipulations. Some predatory lenders make a living by following up with business owners who just took out a business loan (which is part of the public record) and offering them even more capital. They do so knowing you will have a hard time making all your payments and will charge you a higher interest rate due to your increased risk, to boot.
Some predatory lenders make a living by following up with business owners who just took out a business loan and offering them even more capital.
Even lenders with an anti-stacking policy often have a loophole: New accounts and credit inquiries can take up to 30 days to appear on your credit report. Even if a lender refused to extend you a loan if you had an existing one (OnDeck, for example, requires outstanding debt to be paid off before extending a new loan to applicants), they don’t have all the information they need at their disposal.
Therefore, it’s fairly easy for a business owner to take out multiple loans from different lenders in a matter of days or weeks. The automated underwriting systems of these lenders can’t account for their multiple loans, and suddenly the business owner has a stack of loans under their name.
Why you should avoid loan stacking?
The case against loan stacking is fairly obvious, even if the reasons for doing so are complex.
As mentioned above, if a lender turns you down for a loan or doesn’t fund the full amount you were seeking, they probably have a good reason for doing so.
...it’s fairly easy for a business owner to take out multiple loans from different lenders in a matter of days or weeks.
If you instead look to take on multiple loans on your own, you risk not only defaulting on your payments and harming your business credit, but you may also violate the terms of your first loan and forfeit important collateral you put up to secure the loan.
If your business is really growing quickly and a lack of capital is holding you back, you have other options besides getting a very similar loan from multiple lenders.
What should you do instead?
As the owner of a growing small business, you have a few alternatives to loan stacking you can explore.
Ask for more funding from your first lender.
Don’t go behind your primary lender’s back looking for more funding. Instead, ask your lender to reconsider their original offer and approve you for a larger loan or line of credit.
Make timely payments on your original loan over the first few months, or until you’ve repaid 50 percent of the loan.
As with most things in life, you’ll need to prove yourself first. Make timely payments on your original loan over the first few months, or until you’ve repaid 50 percent of the loan. Your improved credit score and higher revenue should help you secure a better deal.
Refinance with a better rate from another lender.
Refinancing is not the same as stacking. Once you’ve taken out your first loan and made on-time payments for a few months, you can approach a lender with a lower interest rate and ask them to refinance your more expensive loan product.
The lender then extends you the money to pay off your original loan, plus the rest of the money you wanted, at their lower rate.
You’ll continue to make payments on just one loan, and best of all, it will be at a lower interest rate than what you started with.
Use complementary — not similar — financing products.
Stacking is when you take out multiple similar loans, or use the same collateral to “secure” multiple loans. It doesn’t mean you can’t use different loan products to finance your business.
For example, every good small business owner should have a business credit card — which functions as a form of short-term financing. Using that in conjunction with a term loan or line of credit is both smart and acceptable to lenders.
...every good small business owner should have a business credit card — which functions as a form of short-term financing.
You can also use other forms of financing, such as equipment financing, invoice financing or inventory financing in conjunction with your loan, line of credit or credit card (assuming the equipment you’re financing isn’t the collateral for the other loan). Getting creative while being responsible is good business — stacking is not.
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Loan stacking has hurt a lot of business owners in the post-recession years, and there isn’t much to recommend the practice. If you’re a small business owner who doesn’t get enough capital from your lender the first time around, don’t overextend yourself.
Instead, find smart ways to finance your growth initiatives without violating the fine print on your first loan. Soon you’ll be picking and choosing from various quality loan options rather than cobbling together stacked loans — and much better off than you would be otherwise.
Have any recommendations for funding a small business? Leave us a comment below!