Small business funding comes in all shapes and sizes. From loans to lines of credit, traditional banks are often a go-to source of capital, and they certainly have their perks. If you meet their lending requirements, they can unlock competitive interest rates and generous loan amounts.
But not every small business can qualify for traditional business funding. That’s where alternative lenders come in. They’ve become increasingly popular in the small business community, but there are some critical differences you’ll need to understand if you plan to tap them as a resource.
1. Most alternative lenders are online
Traditional banks often have brick-and-mortar locations. This allows potential borrowers to visit a local branch and meet with a representative in person to ask questions about the loan application process. Alternative lenders are predominately online, and they can facilitate lending in a few different ways. Some provide funding themselves, while peer-to-peer lending platforms connect businesses with individual investors. As with any business lender, it’s wise to read the fine print before committing to a loan product.
2. Alternative lenders offer a variety of loan products
Much like big banks, alternative lenders offer a variety of loan products to help meet the needs of small business owners. That includes:
- Term loans: This is a lump-sum loan that businesses can use for all kinds of expenses. Online lenders generally offer anywhere from $5,000 to $500,000. Terms and interest rates can vary widely.
- Lines of credit: This provides a line of credit that business owners can draw on as needed. You’ll only pay interest on the amount you borrow. Credit limits usually range from $1,000 to upwards of $250,000. As you pay down your balance, you’ll free up more space to borrow in the future.
- Equipment financing: This type of financing is ideal for businesses that need money to purchase equipment, which can include cars, computers and machinery. The equipment itself is used as collateral. Equipment financing generally provides up to 80% financing. Limits can be up to $1 million or more.
- Invoice factoring: This allows businesses to sell unpaid invoices to a factoring company at a discount. The factoring company then collects payment from customers and takes out a fee before funneling the remainder back to the business.
- Merchant cash advance: This provides upfront funding that the business pays back with future revenue. The lender typically takes a cut of future credit card transactions.
3. Credit score requirements are usually looser
Traditional banks often have strict eligibility requirements, making it hard for some businesses to receive the funding they need. This can be especially challenging for new businesses or owners with a limited credit history because they may be seen as risky borrowers in the eyes of a bank. Alternative lenders, on the other hand, usually have looser credit score requirements. Some will provide funding with a minimum score of 500, which FICO considers a poor credit score. Just keep in mind that a lower credit score may translate to a higher interest rate.
4. Your time in business may not be an issue
SBA 7(a) loans, which are backed by the Small Business Administration, can be attractive to small business owners. Borrowing limits are often high, terms are usually flexible and interest rates tend to be on the lower side. The problem is that borrowers generally need to be in business for at least two years to qualify. That can present a real problem for startups. Alternative lenders can be a viable option for younger businesses. Some have no time in business requirements, while others require as little as six months in business.
5. Interest rates are typically higher
Interest rates for SBA loans are based on the federal prime rate, which is 8.25% at the time of this writing. Lenders then add a spread to the prime rate to come up with a loan’s total interest. Typically, the total interest rate from traditional banks tends to be lower than that from alternative lenders. In fact, it isn’t uncommon for alternative lenders to charge anywhere from 11.00% to 44.00% or more. Also, not every alternative lender is transparent about their interest rates and repayment terms.
6. You can receive funding quickly
When compared to traditional banks, alternative lenders typically provide much quicker funding — sometimes in a matter of hours. With a conventional bank, funding can take weeks. Alternative lenders can be appealing to small business owners who need financing quickly, especially if they’re up against a financial emergency.
How to get the most out of an alternative loan
- Research different lenders: No two alternative lenders are the same. It pays to shop around and compare interest rates, fees, repayment terms, customer service accessibility and more.
- Understand why you need the funds: This involves getting to the root of your business’s cash flow issues. Is it due to a seasonal dip in revenue or a deeper issue like unsustainable manufacturing costs. You don’t want a new loan to simply be a Band-Aid for a bigger problem.
- Make sure you can afford a new loan: Look closely at the repayment terms to ensure your business can comfortably absorb a new loan payment. If not, it could create a debt cycle that’s hard to keep up with.
- Always read the fine print. As mentioned above, alternative lenders aren’t always as transparent about interest rates and repayment schedules. Make sure you have a clear, concrete understanding of what you’re getting into before signing on the dotted line.