Alternative Lending: A Small Business Guide

What is alternative lending?

Alternative lending is any lending that occurs outside of a conventional financial institution. Alternative loans tend to be more flexible than conventional loans, and they often have a faster application turnaround. Many types of alternative loans are available, so there is likely an alternative loan out there that suits your business’s needs.

Many banks and conventional lenders take weeks to process a loan application, but alternative lenders can deliver funding in a few days. The loan application process for alternative loans is often simpler, requiring only a credit score, tax returns, and bank statements.

Editor’s note: Need a loan for your business? Fill out the below questionnaire to have our vendor partners contact you with free information.

Alternative lenders also are more likely to offer loans in smaller amounts than banks, which often include minimum lending terms that are often too high for a small business. Alternative lenders also offer unconventional lending options that allow companies to leverage assets, such as their accounts receivable or credit card sales, rather than borrowing on credit.

What are the different types of alternative loans?

Alternative lending is a diverse space with many types of loans available. Here’s a look at some of the most common alternative loans for small businesses.

Lines of credit

A line of credit is a fixed amount of money that an alternative lender extends to a borrower, similar to a line of credit from a bank. You can draw from the line of credit up to the fixed amount, paying interest on the amount you borrow.

Short-term loans

Short-term loans are generally paid back in a year or less. Most banks don’t offer short-term loans, but they’re a common offering from alternative lenders. Short-term loans are useful when your business needs working capital or funding for a one-time expenditure. 

Installment loans

Installment loans provide a lump sum of money to a borrower, which is then repaid at regular intervals. Many installment loans from alternative lenders feature a fixed payment amount, which means the interest rate will not fluctuate during the life of the loan. Installment loans are commonly used to finance the purchase of real estate, vehicles, and the equipment a business needs to operate.

Merchant cash advances

A merchant cash advance offers a business funding in exchange for a cut of future sales. This financing option, based on future credit card receivables, can provide a quick infusion of cash up front. Once the advance is issued, the borrower pays it back over time through a percentage of the business’s daily receipts. 

Microloans

Microloans, as the name suggests, are low-value loans — typically $50,000 or less. Since many banks don’t offer loans below a minimum funding threshold, alternative lenders can fill the gap for small-scale needs. Microloans often feature shorter repayment periods, sometimes as little as a few months. 

Invoice factoring

Invoice factoring is a type of financing in which a business sells its outstanding accounts receivable to a third party (referred to as the “factor”) in exchange for a cash payment. Typically, a company can expect to receive about 90 percent of its accounts receivable value up front. 

Bridge loans

A bridge loan is a short-term loan backed by a hard asset. If a business owner is moving from one location to another and is in the process of selling the first location, for example, they can use a bridge loan to purchase the new property and cover all closing costs. In this case, the new property would act as collateral for the bridge loan. These loans are typically very short-term, often taking less than a year to repay.

Equipment financing

Equipment financing is used to purchase equipment your business needs to operate. This differs from other types of loans, which can be used for any purpose (such as a working capital loan used to pay staff wages). Equipment financing relies on the equipment itself as collateral. That enables lower rates and more application approvals because the loan is tied to the equipment rather than your personal credit or annual revenue. 

[Find out about farm equipment loans.]

What are the pros and cons of alternative lending options?

Alternative lending pros

Alternative lending solutions offer some major advantages over bank loans and other conventional financing options. Here’s where alternative lenders outshine banks and credit unions.

• Simple application process: The requirements of an alternative loan application tend to be far less rigorous than those of traditional bank loans. Sometimes alternative lenders simply require access to your digital bank statements to return a verdict on your application.
• Fast turnaround: In addition to their simplicity, alternative lenders tend to be much faster than banks or credit unions in terms of both approval and funding delivery. Conventional lenders may need weeks or months to make a determination and extend the capital, but alternative lenders often can provide small business funding in a matter of days.
• Flexible loans: Alternative lenders, particularly direct private lenders, have more freedom in how they package loans and financing options. That has allowed alternative lenders to create unique financial products, such as invoice factoring and microloans, that may better meet your needs.

Alternative lending cons

Banks and credit unions naturally have their own advantages over alternative lenders. You may have to deal with the following issues if you choose an alternative lending option instead of a traditional bank loan.

• Higher interest rates: The less strict requirements, shorter terms, and unconventional nature of alternative loans often translate to higher interest rates than conventional lenders charge. In some cases, it’s due to a business’s annual revenue and credit score; in others, it has to do with the type of financing a business requires.
• Short-term loans: Short-term loans can be useful to businesses in some cases, but alternative lenders often set short repayment terms even on high-value loans. That means you could end up making higher installment payments to an alternative lender for the same amount of capital you could borrow from a bank. 

Mike Berner and Adam Uzialko contributed to this article.