Introduction to Alternative Business Loans

For many years, traditional banks and lenders have been the go-to for business loans. But as the landscape shifts, technology improves, and more people try to enter the entrepreneurial world, other options have become necessary and available. The idea of alternative business loans has made it easier for some people to get funding and start a business, but not everyone knows that these loan options exist for them.

What is an alternative business loan?

An alternative business loan usually refers to any type of financing that comes from sources other than traditional banks.

Accessibility

Where banks usually have stringent loan application processes, high requirements for a minimum credit score, long approval processes, and other barriers, alternative loans are a more accessible route to small business financing and capital.

Alternative business loans are usually designed with at least some of these obstacles removed. Certain loan programs remove the need for extensive family history, high credit scores, and long timelines.

Source of funding

One of the other main differences with alternative business loans is the source of the business funding. Where traditional banks have a large pool of funds from their customers that is used to facilitate loans and secure them, other organizations that are non-banks have found unique routes. Some include:

• Microloans: These loans are for smaller amounts of money and have short-term repayment options, requiring less capital from the lender.
• Peer-to-peer lending: Individuals invest in your business, either directly through an online platform or through pooled funding.
• Donations: Non-profit organizations may collect donations from the public and use the money to fund businesses as a part of their efforts.
• Crowdfunding: Platforms like Kickstarter allow people to directly donate or invest in return for perks like products or stock.
• Venture Capital: Organizations backed by investors may use their capital to fund loans.

There are no specific terms or eligibility requirements that make an alternative business loan qualify as such – any loan outside of a traditional financial institution can qualify, so it’s important to find one that fits your needs.

Check out our guide on the Small Business Loans

Who uses alternative business loans?

Alternative business loans are often the go-to choice for a diverse set of entrepreneurs and small business owners who find traditional bank loans less accessible or less suitable for their needs. Specific types of businesses that use alternative business loans include:

Startups

Startups and newer businesses are prime candidates for alternative business lending, primarily because they may not have the established financial history or credit scores that traditional banks require. For these emerging companies, alternative loans offer an invaluable lifeline for initial setup costs, inventory, and other startup expenses, allowing them to get off the ground more quickly.

Established businesses

Established businesses facing cash flow issues are another significant group that benefits from alternative loans. Whether it’s the seasonal nature of the business, a slow-paying client, or an unexpected expense, these organizations often need quick access to cash. Traditional loans, with their lengthy approval processes, don’t usually meet this immediate need. In contrast, alternative lenders can offer rapid approval and disbursement of funds, often within a matter of days or even hours.

Niche businesses

Additionally, businesses in niche or high-risk industries may also find alternative loans more accessible. Traditional lenders often shy away from industries considered risky, either due to the nature of the business or economic volatility. Alternative lenders are generally more willing to take on such risks, albeit usually at a higher cost. Overall, alternative business loans serve those who need quicker, more flexible alternative financing options, whether due to the type of business, its stage of growth, or a specific financial need.

Types of alternative business loans

Alternative business loans come in a variety of forms, often catering to certain types of businesses or entrepreneurs. This means a loan that works for one business perfectly may not fit another’s needs at all. Some of these loans look similar to a traditional loan, while others take on completely different forms. These are some of the most common.

Term loans

Term loans are another way to refer to traditional loans: the business applies for a loan, is approved, and is issued the funds, which they pay back over a set period of time with interest. These are usually used for one-time cash infusions and can range from very small loan amounts to millions of dollars. Alternative loans for small businesses often have lower minimums and potentially better terms than what a big bank may offer.

Merchant cash advances

In a merchant cash advance, the business receives a lump sum of working capital upfront and agrees to give the lender a percentage of their daily credit card sales plus a fee. This form of alternative financing is particularly beneficial for businesses with strong credit card sales but limited options for traditional loans. However, merchant cash advances can be expensive, with higher fees and shorter repayment terms compared to other funding options. It’s crucial to calculate the annual percentage rate (APR) to understand the true cost of the advance.

Equipment financing

Equipment financing allows businesses to purchase essential machinery, vehicles, or technology without paying the full cost upfront. In this arrangement, the equipment itself serves as collateral for the loan, which often makes approval easier even if the business has a less-than-stellar credit history. The loan is then paid off in installments over a period, typically corresponding to the expected lifespan of the equipment. Once the loan is fully repaid, the business owns the equipment outright.

Lines of credit

A business line of credit operates much like a business credit card, providing companies with a set amount of capital they can draw from as needed. Interest is only paid on the funds that are actually used, making it a flexible option for covering short-term expenses or unexpected costs. Lines of credit can be secured or unsecured, with secured lending options usually offering higher limits and lower interest rates, albeit at the risk of losing the collateral if repayments are not made.

Invoice factoring

Invoice factoring involves a business selling its unpaid invoices to a third party, known as a factor, at a discount. This provides the company with immediate cash flow without having to wait for customers to pay their invoices. The factor then takes on the responsibility of collecting the unpaid invoices at a factor rate. While invoice financing can be a quick way to resolve cash flow issues, it does come at a cost, as the factor keeps a percentage of the collected invoices as their fee, reducing the overall revenue for the business.

Pros of alternative business loans

• Accessibility for people who would not otherwise quality
• Shorter, faster application processes
• Usually available online
• Fast funding is possible
• Options for short-term business loans

Cons of alternative business loans

• Higher interest rates than traditional loans
• Less flexible repayment options
• Could require collateral or access to customer payments
• Not all lenders are trustworthy, so due diligence is important

Choosing the right loan for you

Choosing the right alternative lending choice involves a careful assessment of:

• Your business needs
• The cost of the loan
• Your ability to repay the loan

Start by clearly identifying why you need the financing and how much capital is required. This will help you determine which type of loan best suits your situation. For instance, if you’re facing short-term cash flow issues, a line of credit or invoice factoring might be more appropriate. On the other hand, if you need to finance a large, one-time purchase like equipment, then an equipment loan could be a better fit.

It’s also crucial to compare different business lenders and loan products to find the most favorable terms. Consider factors like interest rates, repayment terms, and any additional fees when making your decision. Remember, while alternative loans are generally quicker and easier to obtain, they often come with higher costs. Use tools like annual percentage rate (APR) calculators to understand the true cost of the loan, and consult financial advisors if necessary. By doing your due diligence, you can secure an alternative business loan that aligns well with your financial objectives and operational needs.