At one time or another, most small and medium-sized businesses (SMBs) have experienced the frustration of dealing with traditional financing institutions when it comes to applying for loans, whether for startup capital, refinancing, expansion, or operational needs. In this article, we will explore some of the best alternative lending options for SMBs.
The marriage of finance and technology (FinTech) is revolutionizing the loans industry. Businesses that need access to capital can now obtain alternative financing through online platforms that use technology to match lenders and borrowers. Alternative lenders (who are typically individuals or groups of investors who are looking for high yields) are filling the void left by traditional lending institutions. Alternative financing is often referred to as Peer to Peer (P2P) or Business to Business (B2B) lending.
As the following graph shows, the alternative financing market in the U.S. tripled in size from 2014 ($11 billion) to 2016 ($34 billion):
The Rise in Alternative Financing in the U.S.
Pros and Cons of Alternative Financing
Flexibility of comparison shopping.
Instant access (as little as one day) as compared to traditional banks.
Relatively lax qualification criteria compared to banks.
Higher interest rates
Less options for prepayment
What Are the Advantages of Alternative Lending Options?
- Flexibility- Online platforms make it easy for borrowers to comparison shop for the best rates, terms, maturity dates, etc.
- Rapid response- Alternative financing can be obtained in as little as one day, whereas banks can take weeks or months to approve loan applications, particularly if there are issues around the evaluation of collateral. The documentation requirements for bank loans are substantially greater than for alternative financing.
- Less stringent qualification requirements - According to estimates, banks typically reject three-quarters of all small business loan requests, preferring to lend only to established businesses with solid credit ratings. Alternative lenders do not have the same requirements for lending and are consequently much more likely to extend credit to new businesses or businesses with lower (or no) credit scores. Loan approval rates from some alternative lenders are as high as 95 percent.
- Collateral - Banks are reluctant to extend financing unless the business owner has adequate business or personal assets as collateral to secure the loan. Alternative lenders are much more flexible and will often provide loans without collateral providing the business is sound and can demonstrate the ability to make repayments.
What Are the Disadvantages of Alternative Lending Options?
- Higher interest rates - In exchange for quicker approval processes and lower eligibility requirements alternate lenders demand a higher rate of return. While banks may offer business loans at annual percentage rates (APRs) of from 4% to 10%, alternative lending rates range from 13% to as high as 70%.
- Additional fees - Some alternate lenders tack on additional fees that may be buried in the fine print of the lending contract. Borrowers are wise to closely scrutinize any such agreement before signing.
- Less prepayment options - Banks are typically more flexible than alternate lenders when it comes to early repayment. Some alternate lenders do not offer prepayment discounts.
What Types of Alternative Lending Are Available?
Business to Business (B2B) Lending
B2B lenders offer term loans similar to banks and other financial institutions. A typical example is Fundera, which acts as an online broker of loans. Fundera itself does not make loans; rather, it matches lenders and borrowers and charges a fee of between 1.5 to 3% of the loan amount. Term loans of up to $500,000 are available, with repayment periods ranging from one to five years. Other examples of companies that offer B2B loans include Lending Club, Prospa and OnDeck.
Term loans typically have higher qualification requirements. Fundera's typical minimum requirements for a term loan are:
- 1+ years in business
- 600+ credit score
- $90,000+ in annual revenue
Equity-based crowdfunding platforms enable entrepreneurs and startups to raise early-stage capital in exchange for equity in the business. Shares are valued according to the total share count and the estimated valuation of the business and are issued to investors on a proportional basis. Investors may be individuals, angel investor groups, or venture capitalists. Examples of crowdfunding platforms include AngelList, CircleUp, Fundable, Localstake, MicroVentures, OurCrowd and AppsFunder. Note that unlike debt financing, relinquishing equity dilutes ownership which may be unacceptable to entrepreneurs wishing to retain total control of their businesses.
Lines of Credit
Business lines of credit are generally used to handle temporary cash flow gaps, seasonal credit demands, emergency funding, or unexpected opportunities. Once the line of credit is established with the lender, funds can be withdrawn at any time (up to the borrowing limit) and interest owing is typically calculated based on the average daily outstanding balance. Interest rates range from 7% to 25% or more, depending on whether the business is established, the credit score, etc. Startups or businesses with poor credit scores may require collateral. Note that proper use of a line of credit is an excellent way to build or improve a credit score. Fundera and many other online lending sites provide business lines of credit.
Invoice Financing (Also Known as Invoice Trading or Invoice Factoring)
Invoice financing allows a business to borrow amounts equivalent to a percentage of the value of outstanding invoices (up to a maximum of 95%, depending on the industry and creditworthiness of the business). The unpaid invoices serving as collateral for the loan. Invoice financing is useful for businesses who don't wish to wait for invoices to be paid. Fees vary widely by the lender so due diligence is required. Examples of invoice financing vendors include Fundera, Platform Black, MarketInvoice, InvoiceFair, etc.
Merchant Cash Advances (MCAs)
Merchant cash advances are funds provided to businesses in exchange for a portion of future sales. Repayments are typically made via daily or weekly debits from the business bank account or credit card sales until the advance is paid in full. MCAs are typically unsecured and have less stringent qualification requirements, but are generally an option of last resort for businesses due to the high-interest rates/fees and the lack of discounts for early repayment. Examples of MCA providers include RapidAdvance, Credibly, and Fora Financial.