July 25, 2022
Adam Hoeksema
As it looks like we might be heading into a recession in 2022, business owners are wondering:
- Should I take out a business loan if we are in a recession?
- Can I even get a business loan if this is truly a recession?
- What types of business lenders continue to lend during a recession?
- How to know whether I should borrow money to try to keep my business alive?
I want to hit on these questions and give you some tips and things to consider as you look to make the best decision for your business.
Should I Take Out a Business Loan During a Recession?
I think there could be a couple of good reasons to take out a business loan for your business during a recession.
- Cash gives you options - Optionality is important during a recession. If you don’t have a stockpile of cash going into a recession and you see a slow down in your business you might have to start cutting staff or budget items that you really don’t want to cut and that will set you back strategically in your business.
- You don’t know how long the recession will last - The average recession lasts 6 to 12 months according to CNBC but you never know whether this time is different. It would be dangerous to assume a 6 month downturn and then end up with a 24 month downturn. Extra cash gives you a longer runway to survive.
At the same time there are some downsides to securing a loan during a recession:
- Monthly cash flow will get worse with a loan payment - Taking out additional debt is not all positive. The loan payment will actually make it harder for your business to breakeven from a cash flow perspective. Make sure to run your numbers and understand your situation with our free cash flow forecast template.
- A loan might allow you to delay decisions that you should have made earlier - This one hits close to home. If you have extra cash on hand you might not fire that vendor that you really need to let go because you aren’t feeling how tight things are yet. If you aren’t profitable each month, you need to cut costs, not rely on taking out increasingly more debt to cover your losses. A loan should not be a crutch, but a way to take advantage of opportunities and survive during a downturn.
If you do take out a loan during a recession, I would recommend that you don’t spend it. Stick it in a separate account and just make your monthly payments from the proceeds of the loan. You should only use the loan in case there is a true emergency, or if there is an incredible opportunity that you want to take advantage of during a recession. Maybe you will have the opportunity to buy out a competitor, and having extra cash on hand might give you that option.
Can I get a Business Loan During a Recession
If you decide that you want to get a business loan during a recession, the next question is whether you are even able to get a loan.
By the time you are reading this, I am not sure. It might be too late. Lenders tend to tighten up during a recession, but my suggestion is at the first hint of recession is the best opportunity to find lenders that are still willing to lend. Once we are in a clear economic slowdown, lenders will tighten up.
For example, see the graph below from the St. Louis Federal Reserve of business lending after the 2008 recession:
You can see the gray area was the official recession. Business lending continued to increase during the first several months of the recession, but then business lending slowed down for quite some time, even after the recession was over.
Why is it hard to get a business loan during a recession?
Ray Dalio talks about the “Beautiful Deleveraging” that happens during a recession. To give you an idea of how this works, let’s assume your home price drops in value which means you have less paper equity which means you have less collateral which makes it hard to borrow because banks want collateral. So when asset prices drop, you don’t have as much equity aka collateral. It just takes time to build up an equity position again.
Which Business Lenders Continue to Lend During a Recession?
Although traditional banks and small business lenders will likely pull back from lending during a recession, there are certain lenders that might actually lend more when banks pull back. The Small Business Administration (SBA) has a program called the SBA Microloan Program. There are hundreds of SBA Microlenders across the country that are non profit organizations that receive government grant funding to support small businesses that are not able to get a loan at a traditional bank. So if you get turned down by your bank, you can search for an SBA Microlender in your area. I will show you how in this video.
Not only will these mission oriented lenders be more likely to provide you with capital during a downturn, they will also receive grant funding from the SBA to provide you with “Technical Assistance” which means they probably have business coaches and advisors on staff that can meet with you and help you strategize on how your business can survive and hopefully thrive during a recession. Get the full scoop on SBA Microlenders with our guide - SBA Microloans: Ultimate Guide to Secure a Microloan [2022]
Should I Close my Business?
Sometimes a business loan is not the right answer. Sometimes businesses fail. I spent over a decade as the Executive Director of an SBA Microlender and we often saw loan applications from small business owners that we had to deny because they were too far gone. The loan would be unlikely to save the business, and it would just put the owner in danger of defaulting on a federal loan which can have negative ramifications on your credit for the rest of your life.
I would suggest that you do a careful financial analysis to determine whether you think the business can survive in various scenarios. We offer a library of financial projection spreadsheets for 60+ businesses that can help you do this analysis. Run the numbers, can you make the business cash flow positive? If the answer is no, then you may need to cut your losses and close the business before you take out a federally guaranteed loan that could just make matters worse.
As we enter a potential recession in 2022, please consider your options carefully, and let us know if we can help you in any way!
