Many types of small business funding exist to help business owners react to unplanned expenses or take advantage of opportunities to grow. Between SBA loans, bank loans, and alternative lenders, it can be difficult to understand the sheer number of funding options available, let alone choose the right lender and loan type for your business.
Most websites recommend SBA loans by default because of their longer terms, favorable rates, and larger funding amounts. SBA loans do offer a number of compelling advantages, but there are some significant drawbacks to consider as well—SBA funding is the hardest to obtain with a lengthy approval process that can last months, extensive and invasive paperwork that can be difficult to compile, and the strictest approval requirements. Approval requirements at banks and other traditional lenders can be just as stringent, with both lenders tending to approve only well-established businesses with strong financial histories seeking loans for larger amounts.
What do you do if you need a smaller loan, your business needs funding quickly, or you don’t meet the strict underwriting requirements of the SBA or other traditional lenders? There are a number of alternative lending options available to small business owners in 2021, including direct online lenders, crowdfunding, and more.
Alternative lenders are ideal for businesses that are seeking a small loan, can’t or won’t be approved by traditional financial institutions, or need working capital fast. But what exactly are “alternative lenders”? Let’s take a closer look.
What is alternative lending?
“Alternative lending” is an umbrella term that refers to any lending that occurs outside of a traditional financial institution like a bank or credit union.
These lenders emerged out of the 2008 recession to satisfy a growing need for accessible small business funding. Using new technologies to support the underwriting process, alternative lenders provide a streamlined borrowing process for business owners who were typically underserved by traditional lending institutions, including women-, minority-, and veteran-owned businesses.
Generally, alternative lenders have much more flexibility in the amount of funding they can offer, as well as types of funding and any associated fees. Alternative funding is also typically easier to qualify for, with less stringent approval requirements than the SBA or traditional lenders. As a result, your rates and fees may be higher than traditional lenders depending on your creditworthiness and risk assessment.
There are a number of alternative lending options available to small business owners in 2021, including direct online lenders, private lenders, marketplace lenders, and crowdfunding:
- Direct online lenders like Greenbox Capital®, Kabbage, and OnDeck offer financing directly to small business owners using a streamlined online application. With simpler, more flexible underwriting requirements, these lenders are able to fund more businesses, sometimes in as little as one business day. Many funding options are available, including loans for smaller amounts, asset-backed financing, purchases against future receivables, and more.
- Private lenders use their own money to issue loans rather than funds from investors or depositors. These lenders are not limited by the same regulations as traditional lenders and are able to offer more diverse funding options, including asset-backed loans and bridge loans. Some private lenders even specialize in certain types of funding, such as loans for particular industries or business models such as franchises.
- Marketplace lenders leverage technological platforms to connect borrowers directly with investors without involving a bank. These lenders collect capital from investors and deliver the funding directly to borrowers, collecting commissions and fees on the transaction. Many types of funding are available, including lines of credit, term loans, and more.
- Crowdfunding platforms like Kickstarter or EquityNet allow businesses to raise small amounts of money from a large number of individual investors. There are two primary crowdfunding models: rewards-based crowdfunding sites such as Kickstarter or Indiegogo offers donors products or services in return for small amounts of funding, while equity-based crowdfunding on sites like EquityNet or Crowdfunder offers donors a certain number of shares in the business based on how much they contribute. There is no application process like a traditional lender, but funding is never guaranteed—ultimately, how much money you raise depends on the strength of your offer and how well you can market your campaign.
When does alternative funding make sense for your business?
Whether you need funding quickly, are a younger business, or are still building your business’s credit rating, there are a number of circumstances in which alternative lenders may make more sense for your business. Here are 6 times alternative lenders may be a better funding option than the SBA or a bank:
1. You need funding quickly and don’t have time to apply for funding from the bank or SBA
The SBA and traditional lenders have extensive applications that can take hours to put together and weeks or months to process, all with no guarantee of approval. In some cases, small business owners may not have the time to take on this process, especially if they’re working with reduced staff, under COVID-19 restrictions, or are focused on recovering from the ongoing pandemic. In other cases, a business may have unexpected expenses to cover or a short-lived opportunity to grow, such as investing in a timely marketing opportunity or purchasing inventory in bulk.
Because of their streamlined application process, some alternative lenders are able to approve and deposit funding in as little as one business day, enabling business owners to take advantage of timely growth opportunities or cover unexpected expenses without navigating a complicated and lengthy application process.
2. You don’t meet the strict underwriting requirements of traditional lenders
The SBA and other traditional lending institutions have the strictest approval requirements. Most businesses who apply for funding from the SBA or a bank are rejected, including established businesses with healthy cash flows, good financial histories, strong credit scores. On the other hand, a low credit score can overshadow even the strongest cash flow and financial history, whether you’re rebuilding your credit rating or you’re a new business just starting to build your business’s credit score.
Alternative lenders have more flexible underwriting requirements and are generally more favorable to businesses with a wider variety of financial histories, including businesses with lower credit scores. Instead of focusing primarily on your credit score, these lenders will consider your business’s future potential when assessing your risk, including factors like business revenue, cash flow, and vendor payment history. A lower credit rating may mean higher rates and fees, but it’s not an automatic reason for an alternative lender to reject your funding application.
3. You need a smaller amount of funding
Traditional lenders often prefer to make larger loans because they’ll generate more profit over the lifetime of the loan.
Unlike traditional lenders, alternative lenders have more flexibility and are more likely to approve applications for smaller amounts, in some cases as small as $3,000. If you need a larger loan, some alternative lenders can also grant loans up to $500,000.
4. You don’t have an existing relationship with a lender
Traditional lenders like banks and credit unions often prefer to work with existing clients. If you’ve never received a loan from a bank, credit union, or the SBA before, this may put you at a disadvantage.
Alternative lenders emerged to help underserved businesses get the funding they need and are always open to funding new clients. Successfully paying off a round of funding from an alternative lender may improve your risk assessment and help you get more funding with better terms, but not having an existing relationship with an alternative lender won’t harm your chances of approval.
5. You’ve been in business for less than 2 years
The SBA and other traditional lenders require businesses to be in operation for a minimum of 2 years. Alternative lenders, on the other hand, will often consider businesses that have been operating for a little as 6 months. For startups and businesses in the prototype phase, crowdfunding is a popular alternative funding option.
6. You operate in a “high risk” industry
Some industries present a higher risk to lenders than others. Traditional lenders are much less likely to consider loans for businesses operating in these industries, but alternative lenders focus on a much wider variety of approval criteria when assessing risk, making it easier for businesses in these industries to access the funding they need.
Popular alternative funding options
Alternative lenders offer a number of non-bank and non-SBA funding options, with unique loan and lending types to suit the needs of your business. This includes traditional lending options like lines of credit and term loans, as well as specialized forms of funding such as merchant cash advances, invoice factoring, and equipment financing. Let’s take a closer look at these three specialized forms of funding:
- A merchant cash advance (MCA) is similar to a short-term loan, but is not actually a loan. Technically, an MCA is a purchase of future receivables, which means that a cash advance will be granted in exchange for a percentage of your business future credit and debit card sales until the advance is repaid. Payments are automatically deducted and will fluctuate with your daily sales—if sales are slow, your payments will be lower. It is important to take into consideration that there can be legal complications, particularly in instances where the terms are not clear or seem unfair, which is why consulting with an MCA attorney can be crucial. An experienced MCA lawyer can help navigate these complex agreements and ensure that your business is protected from potential pitfalls.
- Invoice factoring is also not technically a loan—it’s a form of accounts receivable financing known as an asset purchase. With invoice factoring, a business’s unpaid invoices will be leveraged in exchange for fast access to working capital. The exact terms of your funding can take many forms, but most often, the lender will provide a percentage of the value of the outstanding invoice up front and will collect payment from the customer on your behalf. The remaining portion of the invoice will be paid to you when the customer pays, minus any lender fees.
- Equipment or inventory financing are special types of financing designed to fund the purchase of equipment or inventory, such as new store fixtures, heavy machinery, technology upgrades, or seasonal inventory. The equipment or inventory functions as collateral, and the funding can only be used to purchase the equipment or inventory used to secure the loan.
Is alternative funding right for you?
Direct online lenders and other forms of alternative funding are ideal for businesses that don’t have the time to navigate a lengthy application process, don’t meet strict approval requirements of the SBA and other traditional lenders, or need a smaller amount of funding. If you need fast funding, have lower credit, or need a smaller loan, alternative lending options like direct online lenders can provide the financing you need to maintain operations and continue to grow your business.