Alternative lending for small businesses
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Obtaining a small business loan can be challenging, especially when banks start to tighten their purse strings. As of April 2023, big banks approved only 13.5 percent of small business loan applications. What is a small business to do when they have a great idea but can’t get approved for a traditional loan?
Not every business can meet the qualifications for a traditional loan, such as a credit score of 700 or annual revenue of at least $200,000, but alternative lending is a viable option that may offer flexibility and fast funding.
Read on to learn more about using alternative lending to avoid traditional business loan requirements.
What is an alternative lender?
Most small businesses get financing through a traditional small business loan, SBA loan or line of credit.
Alternative lending is any type of financing that falls outside of traditional bank and credit union lending. This may include microloans, crowdfunding or private direct lending. Alternative lending may allow a small business to get more financing or avoid some of the fees associated with traditional banks.
Some alternative lenders provide traditional loans, while others offer money to small businesses for equity or provide a platform for fundraising. And they often do it without the strict credit requirements banks have.
Alternative lending vs. traditional lending
Alternative and traditional loans each have their pros and cons. They differ in terms, interest payments, credit check requirements and more.
|Alternative lenders||Traditional lenders|
|May not require credit checks||Require credit check and a minimum score for approval|
|Often allow investors to pool money together||Offer an all-or-nothing approval from a single source|
|May offer flexible terms||Offer loans with preset terms|
|May or may not require you to pay the money back||Always require you to pay the money back with interest|
|Can take time to accumulate and disperse funds||Often disperse funds quickly once the loan is approved|
|Are often better for small to medium size loans||Ideal for small to large size loans|
Types of alternative lenders
Here are some of the most common types of alternative lenders.
Loans from online lenders work like business loans from traditional banks and credit unions. Online lenders often have more flexible qualification requirements than big banks and frequently fund faster. But you may pay higher interest rates and see shorter repayment periods.
Online lenders offer many types of business loans, including the ever-popular term loans and lines of credit, plus less-standard options such as invoice factoring and merchant cash advances.
Since online lenders offer a variety of small business loans with flexible qualification requirements, you may have better odds of approval than you would with a traditional lender.
Popular online lenders offering business loans include:
Popular crowdfunding platforms like Kickstarter and Indiegogo allow small businesses to collect donations from individual donors. When crowdfunding, you have your pick between the four different types: donation, equity, reward or debt.
- Donation: Donors contribute whatever amount they want to the campaign, but they don’t receive anything in return for their contributions.
- Equity: Donors receive shares of the company in exchange for their contribution.
- Reward: Donors receive a product or service in exchange for their financial offering.
- Debt: Donors contribute a certain amount in donations as a loan that is repaid with interest in a certain timeframe. However, Kiva is one platform that doesn’t charge interest on its loans.
Of these types of crowdfunding, businesses commonly use reward- or equity-based crowdfunding. The SEC allows businesses to raise up to $5 million annually via Regulation Crowdfunding. With most fundraising types, you don’t have to pay back crowdfunding money. However, many crowdfunding platforms won’t pay out if you don’t meet your fundraising goal.
Direct private lenders
You may also be able to find an angel investor for your business. These investors use their private funds to offer you a loan for your company. A direct private loan typically has fewer restrictions than a traditional loan, but they may also want a fast return on their investment.
Common ways to connect with a private lender include through an attorney or through an online platform designed for angel investors.
Peer-to-peer lending, often abbreviated P2P lending requires you to request money via an online platform, which then offers the loan to individual lenders. Investors can choose to fund all or part of your loan. Often, several anonymous lenders are responsible for your loan.
Some sites also have peer-to-business loans designed for small and medium businesses.
You typically pay interest on the loan. In some cases, interest rates can be comparable to traditional business loans.
What kinds of loans can you get from alternative lenders?
Alternative lenders offer several types of business loans, with the max loan amount varying by the lender.
|Loan type||Average amount||Purpose|
|Term loan||Over $1 million||Operating costs|
|Microloan||Up to $50,000||Startup and operating costs|
|Lines of credit||Up to $250,000||Improve cash flow and cover short-term expenses/purchases for business|
|Merchant cash advance||Over $300,000||Quick cash to cover short-term expenses/purchases for business|
|Invoice factoring or invoice financing||70 percent to 90 percent of an outstanding invoice amount||Quick cash to cover short-term expenses/purchases for business|
|Equipment financing||Up to $5 million||Purchase of equipment, including machinery or vehicles|
Pros and cons of alternative lending
Using alternative funding instead of a bank loan comes with pros and cons.
Pros of alternative lending include:
- Flexible terms
- Funds may not have to be repaid
- Faster funding
Cons of alternative lending include:
- May have to invest time in marketing to attract private investors
- Lack of large-sum loans
- Potentially higher-than-average loan rates
The bottom line
Alternative lending can be a good option for businesses that don’t qualify for a traditional loan or can’t find favorable terms. Be aware that it may take longer to assemble your funds if you are getting funding from multiple sources, such as through crowdfunding.
Frequently asked questions about alternative lenders
Alternative lending is technically any funding outside of traditional banking institutions. This includes online lenders, crowdfunding platforms, direct private loans and peer-to-business loans. Alternative lenders often offer more flexible terms and may be better for startups, businesses with bad credit and businesses in need of small loans.
Loans from online lenders are popular, but so is crowdfunding. The global crowdfunding market is expected to grow to more than $28 billion by 2028. Crowdfunding allows small businesses to get small investments from individual donors that normally don’t require repayment.
Alternative lenders offer a range of interest rates. They are often competitive with traditional loans and may depend on your credit score. However, many direct private lenders will base your interest rate on additional factors, including the perceived potential of your business.
If you don’t want to work with a bank, borrowing from individuals is possible. Using peer-to-peer lending, direct private loans or crowdfunding donors allow you to circumvent traditional loans.