What is Alternative Lending and When Does It Make Sense for Your Business?

Many people consider business funding from banks and the Small Business Administration (SBA) to be the best source of financing for small businesses. While these lenders do offer small business owners some compelling advantages—typically the best terms and the lowest fees—there are some serious drawbacks to consider as well.

The SBA and other traditional lenders like banks and credit unions are well-known for being the most difficult funding to acquire, tending to approve only well-established businesses with strong financial histories seeking loans for larger amounts. They have the most arduous application process, with lengthy and intrusive paperwork that takes weeks or months to process, all with no guarantee of approval. They also have the strictest approval requirements, including factors like length of time in business and rigid financial requirements that many businesses don’t meet, even if they have healthy cash flow and strong financials.

What do you do if your business needs funding quickly and you don’t have the time to undergo such a rigorous application process or your business does not meet the strict underwriting requirements of these lenders? There are a number of alternative lending options available to small businesses in 2021, including direct online lenders, crowdfunding, and more.

These alternative lending options are ideal for businesses that are seeking a smaller loan, can’t or won’t be approved by traditional financial institutions, or for when they need working capital fast. But what exactly is alternative lending?

What is Alternative Lending?

“Alternative lending” is an umbrella term that is used to describe any lending that occurs outside of a traditional financial institution like a bank or a credit union. There are a number of alternative lending options available in 2021, including direct online lending, private lending, marketplace lending, and crowdfunding.

Alternative lending emerged out of the 2008 recession in response to a greater need for accessible funding. Using new technologies to support the underwriting process, alternative lending streamlined the borrowing process for business owners who were typically underserved by traditional lending institutions, including women-, veterans -, and minority-owned businesses.

Because these loans are easier to qualify for with less stringent approval requirements, rates and fees are typically higher than loans granted by traditional lending institutions. However, alternative lenders have much more flexibility in the amount of funding they can offer, as well as types of funding and any associated fees.

There are four main types of alternative lenders:

1. Direct online lenders:

Direct online lenders like Greenbox Capital®, Kabbage, or OnDeck offer to finance directly to small business owners using a streamlined online application. With simpler and more flexible underwriting requirements, direct online lenders enable more businesses to receive the funding they need, sometimes in as little as one business day. Many funding options are available, including loans for smaller amounts, asset-backed financing, purchases against future receivables, and more.

2. Private lenders:

Private lenders use their own money to issue loans, rather than funds from investors or depositors. These lenders are not limited by the same regulations and restrictions as traditional lenders, offering more diverse financing options including asset-backed loans and bridge loans. Private lenders also have a faster application process than traditional lenders, as well as more flexibility in the amount of funding they can offer, with many providing smaller loans that traditional lending institutions won’t consider. Some private lenders even specialize in certain types of funding, particular industries, or even specific business models such as franchising.

3. Marketplace lenders:

Marketplace lenders leverage technological platforms to connect borrowers directly with investors without involving a bank. These lenders collect loans from investors then deliver the funding directly to borrowers, collecting commissions and fees on the transaction. Many types of financing are available from marketplace lenders, including lines of credit, term loans, and more.

4. Crowdfunding:

Crowdfunding is especially popular for startups or businesses in the prototype phase. Using an online platform like Kickstarter or EquityNet, crowdfunding enables a business to raise small amounts of money from a larger number or individuals. There is no application process to contend with, but funding is not guaranteed—ultimately, the amount of funding you receive will depend on how compelling your offer is and how well you are able to market your campaign.

There are two common models of crowdfunding a business can use to support its goals:

1. Rewards-based: A business offers donors products or services in exchange for small amounts of funding, typically through websites like Kickstarter or Indiegogo.
2. Equity-based: A business offers donors a certain number of shares in your business based on how much they contribute. Equity-based crowdfunding is typically administered through sites like Crowdfunder, EquityNet, or Fundable.

Hybrid crowdfunding models are also available.

When Does Alternative Lending Make Sense for Your Business?

Sometimes, a business needs funding quickly or may not meet the strict requirements of the SBA and banks. In these cases, alternative lenders can provide the funding these businesses need to maintain operations or continue to grow.

Every business’s needs and circumstances are unique, but there are a number of common instances when alternative lending makes sense for your business:

1. You don’t have time to apply for funding from the SBA or a bank:

The SBA and traditional lenders like banks and credit unions require business owners to complete an extensive application that can take hours to put together, and approval is never guaranteed.

In some cases, busy small business owners may not have the time to navigate this process, especially if they’re focusing on reopening, recovering, and adjusting to changing COVID-19 restrictions. In other cases, a business owner may have a short-lived opportunity to grow, such as buying another business, purchasing inventory in bulk, or investing in a timely marketing opportunity.

Alternative lenders have streamlined the application process and funding can be approved and deposited in as little as one business day, allowing business owners to take advantage of timely growth opportunities without navigating a complicated and intrusive application process.

2. You don’t meet the strict underwriting requirements of the SBA and other traditional lenders:

The SBA and other traditional lending institutions have the strictest approval requirements, and a business can still be disapproved even if they have healthy cash flow and a strong financial history. On the other hand, low credit can overshadow even the strongest business financials, whether you have low personal credit or haven’t had a chance to build a strong credit score for your business.

Alternative lenders have more flexible underwriting requirements than are more favorable to businesses with a wider variety of financial histories, including lower credit businesses. Instead of focusing on credit score, alternative lenders will factor in other criteria such as business revenue, cash flow, vendor payment history, and other indicators of the overall health and potential of your business when evaluating your loan application.

3. You need a smaller amount of funding:

Most loans for smaller amounts are rejected because traditional lenders typically prefer to grant larger loans that will generate more profit over the lifetime of the loan. Unlike traditional lenders, alternative lenders have much more flexibility and are more likely to approve applications for smaller loans, sometimes as small as $3,000.

4. You’ve been in business for less than 2 years:

The SBA and traditional lenders require applicants to have been in business for a minimum of 2 years, while alternative lenders will often consider businesses that have been operating for as little as 6 months. Crowdfunding is also a popular funding option for businesses in the startup phase.

5. You operate in a high-risk industry:

Some industries represent a higher risk than others. Traditional lenders are much less likely to grant loans for businesses that operate in these industries, but alternative lenders focus on a much wider variety of approval criteria, making it easier for businesses in high-risk industries to access the funding they need.

Popular Alternative Funding Options:

Alternative lenders offer a variety of non-bank and non-SBA funding options, with the unique loan and funding types to suit the needs of your business, including business lines of credit, term loans, and other specialized forms of funding. Here are three of the most common alternative funding options:

1. Merchant cash advance:

A merchant cash advance (MCA) is similar to a short-term loan, but it is not actually a loan. An MCA is technically a purchase of future receivables, which means that a cash advance will be granted in exchange for a percentage of a business’s future credit or debit sales until the advance is repaid. Payments are based on credit and debit card transitions and will fluctuate along with your daily sales.

2. Invoice factoring:

Invoice factoring is also not technically a loan—it’s a form of accounts receivable financing known as an “asset purchase”. With this type of alternative funding, a business’s unpaid invoices are leveraged in exchange for fast access to working capital. This can take many forms, including:

Invoice factoring:

A lender will provide you with a percentage of an outstanding invoice, usually up to 85%, and will collect payment from the customer. The remaining portion of the invoice will be paid to you when the customer pays, minus the lender’s fees.

Invoice financing:

A lender will grant you a line of credit using unpaid invoices as collateral. The borrower (the business owner) is still responsible for collecting payment.

Invoice discounting:

A percentage of an unpaid invoice is paid to the small business up front, with the loan to be repaid along with accumulated interest and fees when you collect payment.

3. Equipment or inventory financing:

Equipment and inventory financing are special types of financing that are designed specifically to help purchase equipment or inventory, such as new store fixtures, technology upgrades, heavy machinery, or seasonal inventory. The inventory or equipment is used as collateral to secure the loan, but a down payment may also be required.

Is Alternative Funding Right for You?

Many business owners don’t have the time to navigate the lengthy process of applying for funding from the SBA or a traditional lending institution like a bank or credit union, and many others don’t meet these institutions’ strict lending requirements. If you need fast funding, don’t meet the approval requirements of these institutions, or need a smaller amount of funding, alternative lending options like direct online lenders can provide the financing you need to maintain operations and continue to grow your business.

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