Alternative financing is a means of obtaining capital outside of the traditional banking system. Online loan marketplaces, crowdfunding platforms, third-party payment providers (such as PayPal), and cryptocurrencies (such as Bitcoin) are examples of alternative finance channels. For most businesses, alternative business financing means applying for a loan from an online lender of some sort. These lenders are sometimes called fintech lenders, a portmanteau of “finance” and “technology.”
The reasons a business might choose alternative business loans are multifold. Online financing can be a lot easier to obtain than a bank loan, especially if you have poor credit or not much time in business. Some businesses look into alternative financing because they have been turned down for a loan by banks or know they don’t meet the minimum qualifications for a traditional loan. Other businesses choose an alternative lender because the online lender is faster and more convenient than a bank.
Note that some types of business financing, such as lines of credit and term loans, can be obtained through traditional (bank) or alternative (online) lenders.
Alternative Business Financing VS Traditional Financing
While alternative financing is a large category that includes numerous types of funding options, the traditional business financing space is more limited. Specifically, traditional business financing refers to term loans and lines of credit from a bank or credit union.
Banks’ approval rate for business financing is much lower than that of alternative lenders, and big banks are less likely to approve your request for financing than small banks. Banks are more risk-averse than alternative lenders, so they have more stringent borrower qualifications. For example, you’ll need at least two years in business to get a bank loan, though you may only need one year to qualify for a loan from an online lender. Another difference between alternative and traditional financing is that traditional loans are harder to access online; often, you’ll have to apply in person at your bank.
Though more difficult to access, a traditional business loan usually comes with a lower interest rate and longer repayment term compared to an alternative loan. That’s because alternative lenders typically charge a premium for the risk they’re taking on by funding less-established small businesses.
Types Of Alternative Financing for Business
Again, there are numerous types of alternative business financing and many different entities that offer alternative business financing products. This space includes online loans and various other types of business financing, such as advances, leases, and credit lines. Before deciding on an alternative financing product, it’s important that you understand what that type of financing entails and whether it’s a good fit for your business.
1) Lines Of Credit
A line of credit (LOC) is a type of business financing you can get from either a bank or an online lender — but as with term loans, business LOC’s are typically easier to get online than from a bank. In case you’re not familiar with the term, a line of credit can act as a financial safety net or source of working capital for a business; in effect, you are granted a sum of money from which you can draw at any time (much like a credit card). You are charged interest only on what you borrow.
An online business line of credit is a good alternative financing choice for a business that doesn’t require a specific amount of money but wants access to extra funding to cover expenses (such as payroll) during lean times.
2) Online Loans
Online lenders sell business financing products similar to those offered by banks, such as term loans and lines of credit. However, online loans differ from bank loans in a few important ways. Generally, online loans come with less stringent requirements regarding your credit score, time in business, and annual revenue. They are also easier to apply for and take less time to be funded. The only caveat is that in exchange for this convenience and accessibility, online loans usually carry higher interest rates and fees than bank loans do.
Online lenders that offer short-term loans (STLs), in particular, have especially lax requirements and high-interest rates. (More on STLs in a bit).
3) Term Loans
A term loan (also called an “installment loan“) is a traditional form of business financing historically obtained from a bank or credit union. The “term loan” designation simply means that the loan is repaid over a set term (for example, six months or five years) with a fixed or variable interest rate. In fact, this describes the structure of most traditional business loans. However, there is a whole new breed of term loans online.
These days, you can apply for a term loan directly from an online lender’s website, using a loan marketplace, or even via a crowdfunding platform (more on crowdfunding later).
Modern SMB term loans are often more user-friendly and customizable compared to the term loans of yore. While they maintain the same basic borrowing and fee structure as a traditional term loan, today’s online term loans have built-in flexibility and transparency, allowing you to receive funds and send payments electronically with as little hassle or confusion as possible. Online term loans can also be easy to qualify for, even if you have bad credit.
4) Short-Term Loans
Short-term loans are alternative business loans that you apply for online rather than from a traditional bank or credit union. An STL is a type of online term loan, but in addition to having a shorter repayment term — almost always within a year or sometimes just a few months — short-term loans differ from traditional term loans in several important ways:
- Factor rate fee structure instead of interest rate
- The lender cares more about your daily cash flow than your credit score
- Faster time to funding (one to two days)
- Higher total loan cost (typically between 10% and 60% of the borrowing amount)
- More frequent repayments (often daily)
While there are some fair short-term lenders out there, beware that the short-term loans market is also rife with predatory lenders that charge exorbitant fees. With that said, if you can find a reputable short-term lender, you can potentially obtain a large sum of cash to fund your small business within a very short time frame.
5) Merchant Cash Advances
Merchant cash advances (MCA) resemble short-term loans in that they are relatively easy to get, have a factor-rate fee structure, and can be a lot more expensive than a regular bank loan. Technically, though, a merchant cash advance is not a loan — it is an advance on your future earnings. A lender fronts you a set sum of money and then starts recouping the advance (plus interest) as a percentage of your daily sales. This means that the amount you pay daily will fluctuate with your sales. There is generally no set deadline to repay an MCA; the MCA company will just keep taking a cut from your daily sales until they are repaid.
Generally, I would not recommend getting an MCA unless you can’t qualify for any other loan product, as these are even more expensive and potentially predatory than STLs. On the other hand, MCAs are one of the few sources of financing available to brand-new, bad-credit, or otherwise struggling businesses that are excluded from the traditional lending market.
If you decide an MCA is your best option, make sure the company giving you the advance does not practice double-dipping (charging you interest on interest). Also, use a merchant cash advance calculator to determine your approximate daily payment and the number of days to repay.
6) Personal Loans
If you haven’t been in business very long and don’t have much business revenue yet, it can be very difficult to get a traditional business loan. Fortunately, many personal loans can also be used for business purposes. With these loans, typically structured as regular installment loans, your eligibility and interest rate are determined by your personal creditworthiness and household income.
With this type of financing, you can expect to have access to a smaller amount of money. Most personal lenders cap their borrowing amounts at $35K or $50K. If you need much more capital than this, a personal loan isn’t for you.
7) Business Credit Cards
Business credit cards can be a useful way to pay for business expenses without having to get a loan. You can use them to pay for large or small-ticket items, all while earning rewards and building your business credit profile. Even if you don’t necessarily need to make a big purchase right now, it’s a smart idea to have a business credit card on hand for when you do need it.
When choosing a business credit card, make sure you pick one that gives you the highest amount of cash back (or miles or other rewards) for the types of purchases your business makes most frequently. For example, some cards are ideal for charging business travel expenses, while others reward common business office expenses, such as utilities and office supply purchases. Some cards also offer a 0% introductory APR for the first year.
The best business credit cards generally require you to have good or excellent credit.
Microloans are alternative small business loans totaling less than $35K (typically closer to $5K–$10K), offered at a low-interest rate. Typically, microloans are given to startups or newer businesses in need of working capital. They often serve under-represented or disadvantaged groups (such as women-owned businesses, veteran-owned businesses, and minority-owned businesses), including those with bad credit.
Banks historically have not been interested in lending such small amounts of money, but alternative lenders, including for-profit and not-for-profit lenders, have entered the microloan space in recent years.
Crowdfunding is a smart way for some types of businesses to raise funds from their peers online. There are four types of crowdfunding: debt, rewards, equity, and charity. With rewards crowdfunding, you don’t have to pay the money back; instead, you agree to give your backers something in return for their donation. With equity-based crowdfunding, someone invests in your business in exchange for a share of your business/product. You may also have to pay a fee to the crowdfunding platform itself. Learn more about the different types of crowdfunding.
Crowdfunding is only appropriate for some types of businesses. Popular crowdfunding sites Kickstarter and Indiegogo are geared toward individuals creating some sort of media (such as a movie or music album) or an innovative, consumer product (such as a new tech gadget). Several others, including GoFundMe, are geared toward charitable projects (though it is technically possible to use GoFundMe for a business). Some sites, such as Fundable, offer crowdfunding to a wide range of business types.
10) SBA Loans
US government-backed Small Business Administration (SBA) loans are an excellent alternative to standard bank loans and can, in some cases, be procured via an online lender. The SBA does not originate loans; instead, it guarantees a portion of a loan issued by a bank, credit union, nonprofit, or other lenders. The guarantee means that the SBA will repay a portion of the remaining debt if you default on the loan. As a result, the bank can offer you lower interest rates than they normally would without the SBA’s backing.
The SBA offers a few different loan programs, but the most popular is the general 7(a) small business loan. It may take up to several months to receive SBA loan funds after approval, but some online lenders use technology to speed up and simplify the process of applying for an SBA loan, so you might get your loan several weeks faster.
To qualify for most SBA loans, you typically need two years in business and good credit, as well as a 10% down payment on the principal and some collateral.
11) Invoice Factoring
Invoice factoring is a type of financing that frees up cash from outstanding invoices. Here’s how it works: The invoice factoring company, or “factor,” will purchase your unpaid invoice and front you typically 85-95% the value of the invoice. The factor then collects payment from your customer and sends you the remaining amount of the invoice, minus a 1-5% factoring fee. Your factoring fee is determined, in part, by how long it takes your customer to pay.
As you might expect, invoice factoring is appropriate for businesses that frequently have unpaid invoices and have cash flow problems as a result. You might pay a sizable factoring fee, but it can be worth it if you need cash right away, especially if you don’t enjoy trying to track down and collect from delinquent customers. Bad credit isn’t typically a concern, as factors are more concerned with your customer’s ability to pay, not your business’s. As such, startups and newer businesses are eligible for this alternative financing option.
The two terms sound alike, but invoice financing is not the same thing as invoice factoring. With invoice financing, the financing company grants you a line of credit, using your unpaid invoices as collateral. The size of the line of credit depends on the dollar amount of your outstanding invoices. The financing company does not actually purchase the invoices, so it is still your responsibility to collect from your customers. (Remember that with invoice factoring, you sell your invoices for immediate cash, and it becomes the factoring company’s job to collect payments on those invoices.)
Invoice financing is a smart solution for businesses with unpaid invoices that don’t necessarily need immediate cash or have a problem with a third-party collecting from their customers. Invoice financing also typically has lower fees than invoice factoring.
13) Equipment Financing
Equipment financing is, well, exactly what it sounds like. That is, it’s money you borrow to get the equipment you need to run your business, whether you need a new computer system or industry-specific machinery.
The term “equipment financing” encompasses both loans and leases. Equipment loans are best for companies that can afford a down payment on equipment with long-term utility. Leases are more appropriate if you can’t afford a down payment or if the equipment needs to be replaced or upgraded frequently.
A few more things to note about alternative financing for your small business:
- If you want to apply for a bank loan rather than an online loan, consider going through the SBA and/or applying to a small bank or a credit union, where you will have a higher chance of being accepted.
- A merchant cash advance should only be used as a last resort — the fees and terms are generally not very merchant-friendly.
- The better your credit score is, the better lending options you’ll have. It is wise to make efforts to improve your credit score before you start applying for loans.
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