It’s no surprise that we are living in a world of technology. Anywhere you go, you’ll spot smartphones, tablets, watches, etc. Within the millennial world, technology changes everything we do; how we shop, how we make travel arrangements, how we get immediate answers to questions. Likewise, modern day technology has allowed us to have access to more available loan options than ever before.
With that being said, how do you know which lender or loan will be the best fit for your business’ needs? How can you be sure that you will have the business loan transparency you need to make proper business financial decisions? There are many financial terms and loans that a small business owner needs to be aware of in preparation of seeking out a lender for a loan. Do you understand the cost of financing and the fees associated with it? Have you looked into the potential benefits if you pay off your loan early? Before you autograph your signature on that dotted line, it’s crucial that you have done your research.
Were you aware that there was a big breakthrough in 2016 with business loan transparency? If not, we are glad to be the first ones to tell you! When a small business owner needed to borrow in the past, they could stroll right into their local bank and directly speak with a loan officer. They would then fill out the business loan application and present the documents required. Then they’d wait however long was needed to find out if they received the approval.
The interest rates at one bank may have slightly differed from another. However, they had similar terms that were presented in an APR (Annualized Percentage Rate). At the time, this made it incredibly easier for small business owners to weigh their options. You could even say there was financial transparency. How nice does that sound as a small business owner?
In the millennial world we live in now, small business owners have a lot more loan options. For example, a small business owner could veto a traditional term loan from a bank or credit union and instead go for a MCA (Merchant Cash Advance), an online loan, leasing, short term or long term financing, etc.
With multiple loan products being displayed before small business owners, they all have different ways of showcasing their cost of financing. If you toss in the different types of lenders too, knowing you made the proper financial decision can be challenging.
Introducing, the SMART Box
With the different ways that financing is presented, the intent of lenders is not to confuse or oversell you. The differences happen because of the nature of new loan approaches. To give you an example, short term and long term loans are decidedly different. When you compare them with the same financial metrics, you will not receive enough information as a small business owner to make an informed choice.
Due to the increase of confusion in financing options, some of the largest online lenders and a national non-profit microfinance trade association came together to fix the problem in 2016. In May of this year, these companies created the SMART Box (Straightforward Metrics Around Rate and Total cost). The SMART Box can become a powerful tool when making financial decisions for your small business.
What is the Purpose of the SMART Box?
The proposed intent of the SMART Box is to empower small businesses to more fully understand and assess their small business finance options. The SMART Box includes clear and consistent pricing metrics, metric calculations, and metric explanations. We fully trust that lenders are responsible providers, however, their products frequently portray their pricing characteristics in differing ways from one another.
When the SMART Box was first implemented, one participant proudly said:
“It’s great to see leaders in our industry come together to create standards that promote transparency and ensure small business owners have consistent, clear information when selecting a funding provider. As the online lending and alternative funding industry continues to serve a critical role in providing capital to businesses, this initiative driven by ILPA is a good representation of our commitment to operating in an ethical and fair way.” (The Business Backer October 22, 2016)
What are the SMART Box Metrics? First and foremost, the SMART Box was not intended to replace the current disclosure, but rather be used as a supplemental disclosure. It’s purpose is to identify key pricing information and foster common verbiage to help borrowers compare differing loans and loan products.
- APR (Annualized Percentage Rate): This metric is used to represent the cost of capital. APR also includes the fees for receiving the capital. When it comes to comparing loans with similar terms, APR can become a beneficial comparison tool. Examples of this can be a home mortgage or an auto loan. However, APR is not used to determine the total dollar cost of financing. Navigant consulting will validate that your SMART Box calculations are consistent with Regulation Z (The Truth in Lending Act).
- TCC (Total Cost of Capital): This financial metric includes all interest and other fees associated with receiving capital. Disclosing the total dollar cost is crucial for a small business owner that is borrowing a use case that also includes a ROI.
- Average Monthly Payment: It’s important that you become familiar with the cash flow within your business. This metric will show the impact that your average monthly cash flow has on your finance options. Your periodic payment may be daily, weekly, or monthly. Regardless, this metric will help you analyze and monitor your monthly costs.
- Cents on the Dollar: For every dollar borrowed, this metric will identify the amount of interest (or loan fees when applicable). This metric is exclusive to all other fees to allow for comparison with other common pricing metrics in commercial finance, including the factor rate, simple interest, and total interest percentage.
- Prepayment Conditions: This metric is intended to make any prepayment policy transparent to the eyes of the borrower. Prepayment conditions identify if there will be additional fees for prepayment. It will also include what those fees might be. It can also identify if prepayment will result in a reduction in interest or loan fees.
The SMART Box disclosure assumes that the finance option will be repaid in its entirety according to the terms of the applicable agreement and that no payments will be missed.
What Does This Mean For You?
As a small business owner, you want to make sure that you have enough information about your finances to make an informed decision. As you dive in a little deeper and learn about the different loans and lenders, you may come out feeling more confused than educated. Financial transparency is crucial for small business owners. The SMART Box can be a powerful tool to help you compare different loan types and determine which one is best suited for your business and its financial needs.
Participating lenders will include the SMART Box disclosure within their own loan documentation. If you are interested in doing business with a lender that is not associated with the SMART Box, you should still ask as many questions to increase your understanding of what the costs and terms are that are associated with the loan that you want to be approved for.
As a small business owner that is looking to borrow, you’ll need to begin the approval process equipped with enough information to make smart financial decisions. Borrowing for a short or long term loan may demand different financial approaches.
Furthermore, borrowing to fuel growth in your business might present different loan costs. Many loan cases today are tailored to fit you and your business’ needs. This can become a great benefactor to you as a small business owner. However, it can also become a great con if you do not understand the total costs linked with borrowing or the payment frequencies and terms.
As well as being familiar with the SMART Box metrics, it’s equally important that you come prepared with the documentation that is required of you. Though the type of documentations needed will vary from where you go to seek your small business loan, here are the documents that are generally required:
A business license
Business bank statements for the last 3 months
Business financial statements
Personal financial information
Copy of your business lease
Income tax returns
As you increase your knowledge of different loans and lenders, you will be better prepared to make informed financial decisions for your business. You will also be able to sidestep a lot of confusion as you implement the SMART Box metrics. Thanks to the tech-savvy world we live in, these leading small business lenders were able to collaborate and create a very useful tool to help your small business. You can now experience an easier process of comparing small business loans. You can now have financial transparency at your fingertips.