Alternative lending refers to the practice of lending money or providing an advance outside of traditional means such as a bank. Typically, the process of alternative lending takes place online and over the phone.
How did Alternative Lending Begin?
In the early 2000s, if a business owner needed money to expand their company or obtain working capital, their options were very limited. It was either apply for a business loan with a bank, or fund their business using personal resources, such as a second mortgage on the house.
After the latest financial crisis of 2007 – 2008 began to blow over, and business owners began to look towards making their business profitable again, a serious funding problem became evident. Banks were no longer as eager to help business owners, and poor credit ratings resulting from the recession limited a business’s funding choices.
Seeing that there was an increased need for funding options for businesses, a number of alternative options were created by lenders. These options focus more on the business and its vision and profitability rather than on the owner’s credit score, affording him or her the opportunity to build their business without having to go through the long drawn out bank loan process only to be rejected in the end.
Common Misconceptions Regarding Alternative Lenders
There are some common misconceptions when it comes to alternative lending. If you buy into this, you could be missing out on a funding opportunity which could end up being a costly mistake. Here are three of the most common misconceptions:
1 – Alternative Lending is a Higher Risk than Traditional Financing
False. The fact is alternative lending may be less risky for a business owner because most of the funding options are unsecured. Meaning you don’t need to put up any collateral as part of your agreement.
Conversely, a traditional bank will require some form of collateral for you to even be considered for a loan.
2 – Alternative Lending Have Higher APR’s Than Traditional Financing
Again, this is a common misconception. Alternative lenders have multiple funding options, and yes, some of those options will have a higher APR or payback cost than a bank, but other options will be comparable.
One such product that has a higher payback is a Merchant Cash Advance (MCA) or Working Capital Advance. This funding option is not technically a loan but an advance of future receivables. But other options, like an SBA Working Capital Loan or Equipment Financing may be comparable to a bank.
3 – Alternative Funding is ONLY for Business Owners with Bad Credit
While it’s true that alternative lenders have funding options that you may be eligible for if your personal credit score is bad, it’s not the only funding available. If your credit score is bad, your options will be limited. If fact, any score under 600 may limit your options to an MCA or Working Capital Advance. However, if you have excellent credit score and your other business qualifying factors are good, then you may have multiple funding options available to you.
Most business owners who have an excellent credit score typically choose to go with an alternative lender instead of a bank for several reasons, some of which include a quicker process and less paperwork.
Qualification Factors with Alternative Lenders
Alternative lenders look beyond a business owner’s credit score and consider the stability of the business by looking at factors like its daily transactions, revenue and growth potential. This gives a business owner who has flawed personal credit the chance to still build their business with the help of a loan or advance.
Types of Funding Options with Alternative Lender
Even large successful businesses rely on working capital business loans to help cover costs, purchase inventory, expand operations, make payroll, and more.
When looking into the various funding options an alternative lender offers, make sure that you completely understand the terms and rates that accompany them. Not all options are the right fit for every business type.
Also, the funding options available may vary by alternative lender. Here are the most common types:
Line of Credit
With a business line of credit, you get approved for a specific amount of capital. You are then able to withdraw, or borrow, from that approved funding when you need the cash and you will only need to pay interest on the amount that is withdrawn.
Many business owners find this type of financing advantageous as it provides a great deal of flexibility, since you only withdraw what you need, when you need it. Plus, the terms are structured with a fixed APR with monthly payments.
An SBA loan is a type of funding provided by a lender but is guaranteed by the Small Business Administration. This guarantee helps reduce the risk for the lender thus making it easier for small businesses to get a loan.
Many business owners find this type of financing advantageous as it’s a low interest funding option.
Equipment financing is just that, a lender provides you a loan to purchase a business-related piece of equipment. The terms are usually a fixed APR with monthly payments. The purchased equipment will is than used as collateral against the loan.
Many business owners find this type of financing advantageous since the terms are reasonable and they are able to get the necessary piece of equipment without any cash out of pocket.
Invoice financing is when a lender provides you an advance, generally up to 90% of an unpaid or pending invoice. The full invoice from your customer is paid to the lender.
Many business owners find this type of financing advantageous since they receive cash in hand earlier compared to when the invoice would actually be paid.
A term loan is similar to a traditional bank loan where you have a fixed Annual Percentage Rate (APR) with monthly payments. The main difference between a term loan from an alternative lender and a traditional bank loan comes down to the requirements. Typically, an alternative lender may have lower requirements when it comes to factors such as annual revenue, time in business, and credit score. This may lead to a slightly higher APR compared to a bank.
Many business owners find this type of financing advantageous as it’s structured like a traditional loan with an APR and monthly payments and, in most cases, will receive funding quicker than a bank.
Not all of your business’ sales are going to be paid the moment the product is delivered or the service is completed. If unpaid invoices are hurting your cash flow, then invoice factoring is worth considering when thinking about getting working capital business loans.
Rather than taking on a whole new loan debt, you “sell” those unpaid invoices to an alternative lender. This essentially gives you the cash you would have if the bills were paid on time, minus a fee for the service. So long as this fee does not exceed your profit margin on the invoices, you are not losing any of your business equity, just a percentage of your profit.
Business Cash Advance
There are a couple different types of business cash advances, like a merchant cash advance or working capital advance. They are similar in that, you are provided lump-sum of money (an advance) in exchange for an agreed upon payback or percentage of daily sales. The repayments are made either daily or weekly via a business’ merchant processor or via a daily ACH debit from you company bank account.
Many business owners find this type of financing advantageous if they have difficulty getting funding due to poor credit or need a large sum of money quickly.
When a Business Cash Advance Makes Sense
A Business Cash Advance looks at the likelihood of future sales and takes its payments directly from them and is associated with alternative lending. But when does this type of funding make sense to a business owner?
This is more of a cash advance than a loan, as there is no written contract defining terms for when the money lent must be paid back and for how much. Instead, you and the merchant reach an agreement as to the percentage of your credit card sales they will deduct daily towards repaying the advance. A fee is added to your balance and becomes a part of the money that you must pay back. The business owner is actually “selling” future revenues at a cost so he/she can use those future revenues today.
There is no debt as this is not a loan, but as the business owner you are responsible to repay the lender as they paid for those future revenues. There are no collateral requirements at all which can make this an enticing option.
Take into consideration the same factors you would for factoring before committing to a merchant cash advance. Is the amount you must pay as a fee greater than your profit margin? Also, will deduction in revenue from your future receivables make you unable to meet your business needs? If you are able to work out terms where neither of those points are an issue, then you are not creating a cycle of dependency by using this alternative loan solution.
Merchant Cash Advances can be paid via your daily credit card receivables or as a daily payment directly from your business account. The latter is referred to as a revenue-based business advance or revenue based working capital advance. Either method is still considered a “purchase” of future revenues and is not a loan.
Why Alternative Lending Instead of a Traditional Bank
There are a number of factors that have made it very difficult for small businesses to get working capital and other types of loans. For one, they simply don’t have the kind of collateral that many banks are now requiring to back up business loans. They also don’t always have the luxury of time to wait for approval while the bank lender demands a countless number of documents before even looking through the application.
Then there is the issue of credit ratings. Banks are still wary about extending loans to anyone who does not have a stellar credit history dating back years. This requirement is very difficult for most business owners to meet, causing them to need to look elsewhere to help solve their business financing problems.
It takes years to repair a bad credit history. For them, alternative lenders provide a way to continue building their business, despite any blemishes on their credit report.
What to Look for With an Alternative Business Lender
Quick and easy is not the only thing to look for when searching for an alternative business lender. Although that does help, you also want an alternative business lender that:
Understands Your Specific Industry Needs
Traditional bank loans are of the cookie cutter variety, where one size is meant to fit any business structure. With alternative lenders they should be eager to help you to find a loan product that is designed for your industry.
For example, if you are a large manufacturer who uses expensive machinery, a good alternative business lender will be able to show you how using that machinery as collateral could help you to secure a business loan with better terms than other products.
The lender you choose should be willing to work with you and help in finding the loan product that will provide your business with the most benefits.
Provides Easy to Understand Terms
Loan terms are not always cut and dry, and if you don’t understand what the repayment requirements are, you could end up paying a lot more for a loan than it is worth. Worse, you may find yourself in a position where repaying your loan is hurting your business.
Find a company that is not afraid to show you the same type of details you would find in a truth in lending document. This outlines all the costs to you, as well as the total amount you will have paid for the loan once it has been paid back in full.
Gives You Multiple Loan Options
Not every business has the same needs, and there are different types of loans available to suit different business structures and goals. An alternative lender of merit should be able to provide you with choices, and details for which ones are appropriate for different circumstances.
For example, while an online business with a high number of credit sales could benefit from a merchant cash advance, an alternative lender should be able to offer a substitute to the small coffee shop owner whose daily sales are almost entirely made in cash.
If you deal with an alternative lender who is only offering one or two types of business financing solutions, you could end up with a loan that doesn’t help you to move your company forward.
Has Terms You Can Work With
Most importantly, you want to find an alternative business lender who provides you with loan terms that will not harm your business.
Going back to the merchant cash advance for example, if your business is making almost 100% of its sales through credit, you may not be able to afford to pay back the loan using the majority of that money. Otherwise, you will soon find that you are once again lacking in working capital to keep your business running. Terms should be flexible to meet your specific business structure and needs if an alternative lender is going to be of value to you.
Has a Speedy Approval Process
Small business owners typically seek a loan because they need cash today, not a couple of months from now. Look at the type of documentation needed and average wait time it takes before you have the cash in hand.
Already has Built a Good Reputation
You are within your rights to check into the background of the lender to see if there are any complaints lodged against them or questions about their integrity. This type of business is popping up all over the place, and each new company is not always going to be a reputable one. Do your homework first in order to ensure that you are dealing with a lending company of good standing.
Should you go with an Alternative Lender?
An alternative lender is a logical option for any business owner in need of funding. As long as you study the terms carefully and ensure that your business goals and profits are not being impacted, funding from an alternative lender will do exactly what it is meant to, provide you with the money you need today, in order to ensure that you are still in business tomorrow.
Many small businesses have the money to keep up with daily costs, but it is tied up in their inventory or unpaid invoices. Getting working capital business loans helps to liquidate that money in a matter of days, so that the business can continue to grow and prosper.
If you have any questions or would like to apply for funding, you can call 800-742-2995 or complete the business funding request form.