Obtaining a small business loan can be challenging, especially when banks start to tighten their purse strings. In 2022, just big banks 14.5 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? Alternative lending may be helpful. 

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. An alternative lending scheme may allow a small business to get more financing or avoid some of the fees associated with traditional banks. 

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 or line of credit. The U.S. Small Business Administration (SBA) backs loans for small businesses, including 7(a) loans and 504 loans, but you still have to get a lender to approve your application to take advantage of these funds. 

Alternative lenders work outside of this space. Some 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.

Here are some of the most common types of alternative lenders. 

Online lenders

Business 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, too. 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.

Crowdfunding platforms

Popular crowdfunding platforms like Kickstarter and Indiegogo allow small businesses to collect donations from individual donors. Businesses commonly use offer reward- or equity-based crowdfunding. 

If your fundraiser is reward-based, donors receive a product or service in exchange for their financial offering. In equity-based crowdfunding, businesses give away shares of the company. The SEC allows businesses to raise up to $5 million annually via Regulation Crowdfunding. With most fundraising types, don’t have to pay back crowdfunding money. However, if you don’t meet your fundraising goal, many crowdfunding platforms won’t pay out.

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. 

You may be able to connect with a private lender through an attorney or through an online platform designed for angel investors.

Peer-to-peer lenders

Peer-to-peer lending, often abbreviated P2P lending, is similar to crowdfunding — except you have to pay the money back. You 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, a number of 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

  • Bridge loans. A bridge loan is a short-term loan that often spans between two and three years. It bridges the distance between when you start your business and when you’ve built cash flow or secured other funding. 
  • Microloans. As the name suggests, microloans are smaller than traditional loans. They are typically under $50,000 in value. Some major banks are unwilling to offer loans this small. 
  • Lines of credit. A line of credit allows your business to take out money as needed, up to a fixed amount. You will pay interest on the money you borrow from your line of credit. 
  • Merchant cash advance: MCAs offer you an advance on credit sales but often require repayment with a steep factor rate.
  • Invoice factoring: You sell unpaid invoices to a company, which gives you an advance on the owed amount and keeps a percentage of the collected invoices.

Alternative lending vs. traditional lending

Alternative and traditional loans each have their own 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 checks and minimum scores 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

Pros and cons of alternative lending for small businesses

Using alternative funding instead of a bank loan comes with pros and cons

Potential advantages include more flexible terms and the potential for funding that doesn’t have to be paid back. Disadvantages to using alternative funding can include the time and marketing required to attract private investors, a lack of large-sum loans and 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. 

FAQs about alternative lenders

  • Alternative lending is technically any type of 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. So is crowdfunding. The global crowdfunding market is expected to grow to $5.5 billion by 2030. Crowdfunding allows small businesses to get small investments from individual donors.
  • 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.