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Small business owners who can’t qualify for traditional loans or need cash quickly can turn to alternative lending options like online loans, lines of credit and merchant cash advances (MCAs). While many forms of alternative financing provide flexibility for entrepreneurs, there are some potential risks associated with these methods.
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What Is Alternative Business Lending?
Alternative business lending is a type of financing that provides businesses with access to capital when traditional options, such as bank loans, are not available. It includes various methods of borrowing money, such as online term loans and lines of credit, MCAs, equipment financing and invoice factoring. Alternative financing methods also include things like peer-to-peer (P2P) lending and crowdfunding.
Alternative lenders for small businesses can provide quick and easy access to funds for those who may not qualify for more traditional business financing. These alternative options are often more flexible than traditional bank loans, providing faster approval and funding times for businesses that need money fast.
Notably, however, interest rates are often higher than for other types of business loans. Likewise, repayment terms are typically short, which translates to higher payments that can lead to a cycle of borrowing.
How Does Alternative Business Lending Work?
Alternative business lending works in several ways, depending on the type of loan. In general, business owners must submit an application and demonstrate their ability to repay the loan within the applicable term. Once approved, loan funds are disbursed as a lump sum or on an as-needed basis, as is the case with lines of credit.
- Eligibility. In contrast to traditional financing options, alternative lending may come with more flexible application and qualification requirements. Still, business owners may need a credit score of at least 500 to 600 to qualify for MCAs and higher for other options. Requirements ultimately vary by lender and financing type, and there may be a minimum time in business requirement.
- Funding speed. Alternative lenders may offer faster approval and funding speeds than traditional financial institutions. Some lenders offer approval in minutes, with loans funded as soon as the same day.
- Repayment terms. The repayment terms for alternative business financing are usually shorter than those associated with conventional bank loans, and some borrowers may have to make weekly or even daily payments. This means that businesses must have a well-defined plan in place to repay the loan promptly or risk defaulting on their payments.
- Interest rates and fees. Interest rates vary depending on the lender and borrower qualifications but are typically higher than for traditional bank loans. Additional fees, such as origination fees and prepayment penalties, may also apply.
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Types of Alternative Business Lending
There are several different types of alternative financing available, each with its own unique benefits and drawbacks. Take time to understand each option before selecting the best lender for your needs.
Term Loans
Term loans—especially from online lenders—provide short-term financing to businesses without requiring extensive paperwork or lengthy approval processes. The best small business loans may go up to $500,000 or more, with annual percentage rates (APRs) starting around 9%. Repayment terms typically range from three months to 10 years, so these term loans may come with lower monthly payments than other forms of alternative financing.
Lines of Credit
Business lines of credit provide businesses with a preapproved amount of money they can draw from as needed—anywhere from $1,000 to more than $250,000. Interest only accrues on the outstanding balance, rather than the entire borrowing limit, and business owners can repay and reuse their credit line during the draw period. Interest rates typically range from 4% to 60%.
Peer-to-peer Lending
Peer-to-peer (P2P) business loans involve borrowing money from individual investors rather than banks or other traditional lenders. The repayment terms offered through P2P lenders are typically shorter than those for bank loans, but interest rates may be lower—usually between 6% and 36%. For that reason, P2P lending may be a good option for businesses looking for fast access to capital.
Merchant Cash Advances
An MCA is a short-term loan that pays businesses a lump sum of money upfront in exchange for future credit card sales. Borrowers pay a factor rate—the cost of a business loan represented as a decimal and multiplied by the loan amount—between around 1.1 and 1.5, which depends on the borrower’s creditworthiness. Payments must typically be made on a daily or weekly basis, rather than monthly. This structure makes MCAs a good fit for retail businesses with a high sales volume.
Equipment Financing
Equipment financing allows businesses to pay for equipment over time—often through a vendor or manufacturer that offers in-house financing or partners with a lender. Loans are secured by the equipment being financed, and borrowers make payments over time rather than paying the entire cost upfront. This can help conserve working capital while allowing companies to acquire the necessary equipment for their operations.
Invoice Factoring
Invoice factoring is a method of financing in which a business sells its invoices to a third party at a discounted rate to access funds quickly. The third party then collects payments on the invoices from the debtor and pays back the business minus any fees. This type of financing can be beneficial for companies with a steady stream of incoming invoices that need to access capital quickly.
Crowdfunding
Crowdfunding is another popular form of alternative business financing. It allows companies to raise funds from large groups of people, usually in exchange for equity shares in the company or rewards. This type of funding can be a great way to generate awareness around your product or service and attract potential customers.
Pros and Cons of Alternative Business Lending
Before selecting an alternative lender, consider the pros and cons of these financing options.
Pros
- Easier qualification requirements: Compared to traditional bank loans, alternative financing typically has more accessible qualification requirements, including lower credit score, financial history and time in business prerequisites. Approval for some forms of financing, like invoice factoring, depends more on the financial stability of a borrower’s customers than on the business itself.
- Less rigorous applications: Depending on the type of financing and the lender, the application process for alternative forms of financing may be less demanding than with a traditional financial institution. Applicants may not have to provide as much financial documentation or other information as part of the process.
- Faster approval and funding speeds: Alternative lenders often provide capital faster than traditional banks—sometimes within days of application. In some cases, same-day funding may be available.
Cons
- High interest rates for some borrowers: In some cases, particularly with MCAs and P2P lending, interest rates can be high.
- Short repayment periods: Many alternative lenders require repayment over short time frames, usually one year or less. In some cases, payments are required weekly or daily.
- Collateral requirements: Depending on the type of financing, some lenders may require collateral to secure the loan. This may include personal assets such as real estate or vehicles. Alternative financing options also may require a personal guarantee from the business owner.
- May lead to a cycle of borrowing: Alternative lenders often make it easy to roll over or renew loans, which can lead to a cycle of borrowing and limit the business’s ability to save money and invest in other areas.
- Limited customer support. Small, nontraditional lenders often provide alternative financing options with less customer support available than a traditional financial institution.
Is Alternative Business Lending Right for Me?
Alternative business lending can be an excellent option for companies facing cash flow issues, as it provides quick access to capital without requiring extensive paperwork or lengthy approval processes. However, alternative lenders typically charge higher interest rates than traditional banks and may require collateral or a personal guarantee from the business owner.
Still, alternative business lending may be a good fit if you:
- Need quick access to capital
- Want to borrow a small amount
- Have sufficient monthly revenue
- Can’t qualify for a traditional bank loan
- Have been denied traditional financing
- Can pay back the loan on time
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