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Small Business Guide to Alternative Lending

Adam Uzialko
Adam Uzialko

Looking for funding? When banks let you down, consider an alternative loan.

  • Traditional bank loans have lower interest rates and longer terms than alternative financing but stricter requirements for approval.
  • Alternative lending options include direct private lending, marketplace lending and even crowdfunding platforms.
  • Alternative loan types include lines of credit, short-term loans, microloans, factoring, equipment financing, bridge loans and merchant cash advances.

Every business needs funding. While you might have initially financed your business with your own money or loans from family and friends, there comes a time when institutional capital is necessary for sustained growth. Many small business owners rely on bank loans or loans from the U.S. Small Business Administration (SBA).

Sometimes, though, small business owners can't qualify for these loans or need something shorter term or more flexible. In these cases, alternative lenders offer various ways to access the capital you need to grow your small business. Alternative loans come in many shapes and sizes, so you can generally find the right one for your current needs.

This guide will introduce you to the concept of alternative lending and explain some of the most common types of alternative loans. It also introduces some of the major players in the space to help you start your research into the right lender for your business. If you're looking for more detailed information on business loans, see our best picks page for in-depth reviews on alternative lenders.

Alternative lending industry overview

Alternative lending refers to the process of turning to nontraditional lenders to invest in your company. According to Morgan Stanley, alternative lending streamlines the process for borrowers who may be underserved by traditional lending institutions. Initially, alternative lending was borne out of P2P unsecured loans. However, with the rise of technology and the expansion of online lending opportunities, alternative lending's definition has evolved. Besides P2P unsecured loans, alternative lending sources now includes crowdsourcing and marketplace lending.

The growth of alternative lending is projected to continue. According to a recent study from Oracle, over 40% of consumers feel that non-banks can offer more than a traditional bank. Small to medium businesses, in particular, are experiencing a funding gap—leading them to search for non-traditional sources of money. A survey from Richmond’s Federal Reserve Bank found that banks have an approval rate of approximately 58% from small business applications. In comparison, alternative lenders have a 71% approval rate for small businesses.  

  

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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 often have faster application turnaround as well. There are many different types of alternative loans available, so there is likely an alternative loan out there that suits your small business's circumstances.

While most banks and conventional lenders could take weeks to approve or deny a loan application, many alternative lenders can deliver funding in a few days. The loan application process for alternative loans also tends to be simpler, requiring only a credit score, tax returns and bank statements rather than a detailed pro forma or business plan.

In addition, alternative lenders are more likely to loan smaller amounts than banks, which often include minimum lending terms that are too high for a small business. Alternative lenders also offer unconventional lending options that allow businesses to leverage assets like their accounts receivable or credit card sales, rather than borrowing on credit.

What are alternative lenders?

Organizations that offer alternative small business loans are called alternative lenders. "Alternative lender" is an umbrella term for several alternative lending models, including direct private lending, marketplace lending and even crowdfunding platforms.

Direct private lenders

Direct private lenders use their own money to issue loans, rather than relying on depositors or investors. This allows direct private lenders to be extremely flexible in granting applications. Direct private lenders tend to offer diverse types of loans, including asset-backed ones such as bridge loans. Direct private lenders can also be more flexible in the amount of money they lend per loan. Some direct private lenders offer low-value loans that many conventional financial institutions won't consider.

Marketplace lenders

Marketplace lenders – also called peer-to-peer lenders – leverage a technological platform to circumvent banks and connect borrowers directly with investors. While banks make loans with deposited money, marketplace lenders simply package loans from investors and deliver the funding to borrowers, collecting commissions and fees to make their money. Marketplace lenders typically determine whether or not to award a loan based on a borrower's credit score.

Crowdfunding platforms

Crowdfunding platforms are especially popular for businesses in the prototype or startup stage. A crowdfunding platform offers borrowers a place to raise small amounts of money from a large number of individuals. Generally, the borrower sets a goal and then markets their campaign to appeal to potential investors. The benefit of crowdfunding is that it eliminates the application process. However, success is not guaranteed in a crowdfunding model; it comes down to how well you market your campaign and how many people invest in your cause. [Read related article: Equity Crowdfunding: A Primer]

What types of alternative lending are available?

The alternative lending space is innovative; it regularly introduces new types of small business loans and other forms of financing. As such, it is a diverse space with many different 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, just like 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 any loans scheduled to be paid back in a year or less. Most banks do not offer short-term loans, but they are a common product from alternative lenders. Short-term loans are useful when your business needs working capital or has to quickly cover a one-time cost.

Installment loans

Installment loans provide a lump sum of money to a borrower, which is then repaid to the lender at regular intervals until the principal plus interest is paid off. Many installment loans from alternative lenders have a fixed payment amount, meaning 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 equipment a business needs to operate.

Merchant cash advances

A merchant cash advance offers a business cash upfront in exchange for its future credit card sales. Merchant cash advances provide a lump sum of money quickly – sometimes within one day – based on a business's expected daily credit card receipts. Once the advance is issued, the borrower must pay it back through a percentage of their business's daily credit card revenue.

Microloans

Microloans, as the name suggests, are low-value loans, typically of $50,000 or less. Alternative lenders devised these small loans because conventional lenders like banks typically don't consider them at all. For many small business owners, $50,000 is more than enough to open their doors or acquire new equipment. They can also be incredibly short-term, with some repayment periods lasting just 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 at a slight discount. Typically, a business can expect about 90% of the value of its accounts receivable upfront. The "factor," as the third party is known, is then responsible for collecting the payments; the 10% the factor saved on the discounted purchase of the business's accounts receivable represents its potential profit.

Bridge loans

A bridge loan is a short-term loan backed by an asset, rather than by a credit score. For example, if a business owner is moving from one location to another and is in the process of selling the first location, they can use a bridge loan to purchase the new property and cover all closing costs. The new property would be the 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 the use of a loan to purchase the equipment your business needs to operate. This differs from other types of loans, which can be used for more abstract purposes (for example, a working capital loan for staff wages). Equipment financing relies on the equipment itself as collateral; this enables lower rates and more application approvals because it is tied to the equipment rather than your personal credit or annual revenue.

When is alternative lending a good idea for your business?

Alternative lending is a good option for your small business when conventional lenders either don't offer the financing you need or won't approve you for a loan. It's telling that alternative lending took off following the 2008 financial crisis, when banks were hesitant to lend to virtually anyone; they fill the gaps where conventional financial institutions will not.

Alternative lending is also a good option for your business if you have an immediate need for capital, especially in low amounts. Whether that's working capital to keep a seasonal business afloat in the offseason or financing for an equipment purchase, alternative lenders can provide fast funding and a short repayment term where banks will not.

While alternative lending offers key advantages for small business loans, of course, there are some drawbacks. To minimize risk and ensure you can repay any loan you accept, it's essential to know the advantages and disadvantages of alternative lending options before partnering with a lender.

What are the advantages of alternative lending options?

Alternative lenders 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 for 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 simplicity, alternative lenders tend to be much faster than banks or credit unions, both in terms of approval and funding delivery. While conventional lenders often need weeks or months to determine and extend the capital, alternative lenders can often get a small business funding in a matter of days.

  • Flexible loans: Alternative lenders, particularly direct private lenders, have more free rein in how they package loans and financing options. This has allowed alternative lenders to create unique financial products such as invoice factoring and microloans.

What are the disadvantages of alternative lending options?

Banks and credit unions naturally have their own advantages over alternative lenders. Traditional bank loans tend to beat alternative lending options when it comes to the following:

  • Higher interest rates: The less strict requirements, shorter terms and unconventional nature of alternative loans often translates to higher interest rates than conventional lenders charge. In some cases, this is 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: While short-term loans can be useful to businesses in some cases, even high-value loans often have short repayment terms with alternative lenders. This means that, for the same amount of money you could get from a bank, you could make higher installment payments to an alternative lender.

The best alternative lenders and business loans of 2020

Here's an overview of our best picks for alternative lenders and business loans of 2020. Check out our best picks page to read the complete reviews for each of our best picks and other key players in the alternative lending space.

Noble Funding – Best for Invoice Financing

Noble Funding is an alternative lender and broker organization – it provides some loans and arranges loans with other industry leaders. It can arrange two invoice financing options: invoice factoring and A/R lines of credit. Noble Funding can arrange various other types of loans, including term loans, cash advances and unsecured business loans. The company will assess your business's financial situation and then recommend a type of financing. It has favorable fees and can pair you with an ideal lender for your business.

Fora Financial – Best Small Business Lender

Fora Financial is a solid funding option for small businesses. Interested business owners can take out term loans and merchant cash advances. What separates Fora from the crowd is its fixed interest model. Business owners pay a set total based on their financial stability as opposed to a fluctuating interest rate. It's possible to pay off Fora's loan at any time with no prepayment penalties.

Rapid Finance – Best Lender for Merchant Cash Advances

Rapid Finance can provide merchant cash advances on up to 250% of your company's monthly credit card sales. It provides one of the most compelling merchant cash advance offerings of any company we reviewed. It has fairly relaxed terms, granting loans to companies that have been established for two years or more and have at least $5,000 in credit card sales each month.

Balboa Capital – Best Alternative Small Business Lender

Balboa Capital provides a wide range of small business loans, including term loans, equipment leasing, vendor financing, franchise financing and business cash advances. Both its term loans and business cash advances are ideal for small businesses. Business owners interested in term loans can get up to $250,000 on terms from three months to two years. It has a simple online application process.

Crest Capital – Best Lender for Equipment Financing

Crest Capital provides equipment financing of up to $500,000 for small businesses. The company has been lending to small businesses since the late '80s and has an online reputation of reliability. Crest can provide financing for equipment you've already selected, or it can match you with one of its vendors so you can get the equipment you need. It has relaxed qualifications and attractive terms.

SBG Funding – Best Lender for Working Capital

SBG Funding offers working capital loans with simple qualifications and appealing rates. It provides loans ranging from six months to five years, and it has a solid online reputation. Its standout aspect is its lenient credit requirement: SBG says it grants loans to applicants with credit scores as low as 500. The company is more concerned with your monthly income and profitability than your credit score. This makes it an ideal lender for business owners with rocky credit history.

Alternative lending fills the gaps in business financing

When bank lending isn't possible or desirable, alternative business lending options are worth considering. Whether your annual revenue or personal credit score isn't up to the bank's standards or you just need an amount of money that conventional lenders won't offer, alternative lenders fill in the gaps with a variety of funding options.

Before you choose to partner with an alternative lender, carefully review the terms of the loan. Your ability to repay the loan on time is key to your small business's continued success. When you need funding that the banks won't provide, alternative lenders can help, but it's always important to borrow responsibly.

Alternative lending FAQs

What is the cost of alternative lending?

Review the loan terms with the alternative lending provider. Depending on the alternative lending source, you may or may not be subject to an annual percentage rate (APR). Some providers may charge a monthly fee for the loan instead, which is beneficial for those who plan on quick repayment.

If, however, the lender charges an APR and the APR seems low, confirm the fees associated with the loan. For example, the lender may charge an organization fee. An organization fee represents the cost of processing your loan and may cost upwards of 3% the loan amount. Other lenders may charge a set dollar amount for closing costs. At the time of the loan, ask for a breakdown of the total loan costs to understand what you'll be paying in full to borrow the money.

Is alternative lending better than traditional lending?

Alternative lending isn't necessarily better than traditional lending, but it offers distinct advantages. Primarily, alternative lending provides the opportunity to harness funding for small to medium businesses that may not qualify for traditional loans. Also, alternative lending provides more flexibility, including faster processing and shorter payment terms.

Alternative lenders are also versatile in the amounts that they are able to provide businesses. In some cases, businesses borrow a moderate amount from an alternative lender in addition to a standard bank loan. Another benefit of alternative lending is the industry relies on different risk assessments to approve loans. Alternative lenders look beyond a credit score to decide whether or not to lend funds.

When did alternative lending begin?

According to Funding Circle, the first alternative lenders entered the marketplace around 2005. The two credited with launching the alternative lending trend are Prosper and LendingClub. These lenders specialize in P2P loans. Alternative lending companies were launched to aid small and medium-size businesses due to banks preferring larger corporations for loan funding. Corporations are considered less of a financial risk for traditional banks.

Can I get an alternative loan with bad credit?

Yes, some lenders provide lending options to those with bad credit. Instead of looking at a credit score, the lender will have different qualifications, such as a minimum annual revenue. The alternative lender also reviews the experience of the applicant. For instance, the lender may request that applicants have an established business for at least a year or more.

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Adam Uzialko
Adam Uzialko,
business.com Writer
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Freelance editor at business.com. Responsible for managing freelance budget, editing freelance and contributor content, and drafting original articles. Also creates product and service reviews to assist business.com readers in buying decisions for their businesses. VP and co-founder of CannaContent, a digital marketing company dedicated to the cannabis, hemp, and CBD industries. Focused specifically on the content marketing arm of the company, creating blogs, press releases, and website copy for clients spanning the entire supply chain. Avid fan and indispensable ally of the feline species. Music lover, middling guitarist, and unprompted vocalist. Miniature painter who loves sci-fi and fantasy. Armchair political philosopher with a tendency to read old books written by men with unusually large beards. Ask me about all things writing!