What we will cover in this article>
What Makes Accessing Traditional Financing Challenging for Small Businesses
What are the Advantages of Alternative Small Business Financing
What are the Main Alternative Small Business Financing Options?
What are the Key Benefits of Alternative Small Business Financing?
What are the Fundamental Criteria to Qualify for Alternative Small Business Funding?
How Do You Choose the Right Financing Option for Your Business?
From invoice financing to crowdfunding, merchant cash advances, to peer-to-peer lending, alternative small business financing provides entrepreneurs many opportunities to access the capital they need to propel their ventures forward.
This article will explore the various forms of alternative small business financing available, highlighting their benefits, risks, and potential impact on business growth.
Discover alternative small business financing and learn how it can drive your success in today's competitive marketplace.
What Makes Accessing Traditional Financing Challenging for Small Businesses
Financing plays a significant role in the growth and expansion of businesses. Whether investing in marketing and social media or expanding production, businesses need capital to fuel their growth.
Traditional financing options like bank loans have long been the go-to solution for businesses seeking capital. However, these options often have stringent eligibility criteria, lengthy approval processes, and collateral requirements.
For example, banks frequently assess criteria many younger firms struggle to meet:
Stellar credit scores
A substantial operating history
Impressive revenue metrics
Tangible assets for collateral
Extensive paperwork and long wait times
For startups and entrepreneurs, these criteria can be overwhelming. This is where alternative business financing bridges the gap and provides accessible funding options for entrepreneurs.
For businesses unable to qualify for traditional loans or needing funding faster, alternative options help fill the gap.
What are the Advantages of Alternative Small Business Financing
Alternative small business financing encompasses diverse funding options catering to different businesses' needs and circumstances.
Unlike traditional financing, which relies heavily on credit history and collateral, alternative financing focuses on other factors such as cash flow, invoices, and future revenue potential.
Alternative financing provides more accessible capital tailored to modern businesses:
More flexible requirements than bank loans.
Faster access to capital in days or weeks.
Innovative online fintech solutions.
Diversified funding sources to enable growth.
For example, Online lenders' approval rates average about 73%, compared to around 50% for traditional bank loans. Their automated underwriting processes facilitate higher approval chances.
This can be a game-changer for businesses that need immediate capital to seize growth opportunities or overcome unexpected challenges.
What are the Main Alternative Small Business Financing Options?
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Below are eight alternative financing options. We provide a brief overview of each option and its pros and cons.
1. Revenue-Based Financing
Revenue-based financing provides funding in exchange for a fixed percentage of future revenue over a set period, usually between 6 months to 3 years. The exact repayment amounts fluctuate each month based on the actual revenue generated.
For example, a business may secure $100,000 in revenue-based financing in exchange for a repayment cap 1.5. A repayment cap is used instead of interest to determine the total repayment amount. So, the total repayment would be $150,000.
The business will then repay a fixed percentage of each month's revenue. If the repayment percentage is 3% of monthly revenue and the business' monthly revenue is $50,000, the monthly payment would be $1,500. If revenue jumps to $75,000 the next month, the repayment will increase to $2,250. This structure aligns repayments with cash flow.
Businesses only pay back more when they are earning more revenue. There are generally fewer eligibility requirements than loans, making revenue-based financing relatively easy to qualify.
The maximum amounts funded range from $10,000 up to $250,000.
Pros: Repayment aligns with revenue, easy to qualify, no collateral needed.
Cons: Can be more expensive than traditional loans, revenue is required, and lower levels of financing.
2. SBA Loans
SBA small business loans are partially guaranteed by the Small Business Administration, which reduces the risk and exposure for banks' lending to riskier startups and smaller businesses.
This enables businesses to access more favorable loan terms and higher approval chances than conventional bank loans.
Standard SBA loan terms are up to 25 years for real estate and equipment purchases and 7-10 years for working capital. Interest rates are fixed and based on the federal prime rate, which currently is 8.5%.
However, businesses still need strong credit scores and solid financials to qualify. The application process also involves extensive paperwork.
However, SBA loans provide an important alternative for those not approved for regular bank loans. Typical SBA 7(a) loan amounts range from $50,000 to a few million.
According to the Federal Reserve Banks' report, SBA loans have an average 64% approval rate.
Pros: Favorable interest rates, longer repayment terms, can be used for a variety of purposes
Cons: It may be challenging to qualify, the process is lengthy, and collateral may be needed.
3. Equipment Financing
Equipment financing allows small businesses to secure funding quickly to purchase essential equipment like machinery, vehicles, and technical systems.
Rather than a large upfront payment, the cost is divided into fixed monthly installments over the loan term. Loan terms range up to 10 years or longer.
Equipment financing annual percentage rates range from 6-20%.
The equipment purchased serves as the collateral for the loan, so few additional business assets are required for qualification.
This preserves capital while still allowing the business to access the equipment it needs. Predictable installment payments also make financial planning easier.
Equipment financing is often the most accessible funding option when acquiring depreciating assets. Loan amounts match the cost of the equipment purchased.
Pros: Quick funding, no collateral required, offers flexible financing.
Cons: Limited to financing equipment, may require down payments, and could be expensive.
4. Invoice Factoring
Invoice factoring gives businesses access to capital based on the value of their unpaid customer invoices.
An invoice factoring company purchases the accounts receivable, funds up to 80-90% of the invoice value, and then collects on those invoices directly from your customer.
The factoring company then pays the business the remaining 10-20% of the invoice, less a small factoring fee.
This provides the business with immediate funds for operating expenses.
For example, the invoice value is $100,000. The initial cash advance is 90% or $90,000. The business receives the remaining $10,000, less a factoring fee of 2% or $2,000. The total amount received will be $98,000.
The invoice factoring company collects the full payment directly from the customers when the invoices are due. These outsourced collections also save the business time and effort chasing payments.
However, customers know their invoices have been sold to a factoring company, which some may not like. And the discount fees make invoice factoring more costly than business loans.
However, as a short-term financing option to bridge cash flow gaps, invoice factoring can benefit companies with outstanding invoices waiting to be paid.
Pros: Provides immediate funding, easier approval than traditional loans, no collateral required.
Cons: Customers are aware of financing fees of 2-5% of invoice values.
5. Crowdfunding
Crowdfunding allows small businesses to raise capital by collecting small investments from many individuals. It leverages online platforms like Kickstarter, Indiegogo, and GoFundMe to market to potential backers and process payments.
The business sets a fundraising goal and timeline and promotes the campaign to drive traffic and investor pledges. In exchange for capital, businesses can offer crowdfund rewards, products, or equity.
This enables tapping into a wide pool of investors beyond traditional lending institutions. It also builds an engaged community invested in the success of the business.
However, successful crowdfunding requires extensive promotion, marketing, and press outreach.
There is no guarantee the target raise amount will be met. Equity-based crowdfunding also means giving up ownership stakes.
However, for some startups, a well-executed crowdfunding campaign can be the critical funding needed to get off the ground.
Funds raised typically range from a few hundred dollars up to several thousand. According to Fundera, the average successful campaign has raised $28,656.
Indiegogo projects have raised, on average, $41,634, the highest of any platform.
Most crowdfunding platforms charge a 5% fee on funds raised, but fees vary, so you need to ask.
Pros: Funds come from many investors, build an early customer base, maybe no credit check.
Cons: Extensive promotion is required, fees may be steep, and your idea may be copied.
6. Merchant Cash Advances
Merchant cash advances provide quick access to a lump sum of capital in exchange for a fixed percentage of a business's future credit card sales.
Repayment amounts fluctuate based on monthly sales volumes until the total quantity advanced plus fees are repaid.
The advancer is reimbursed by automatically deducting a percent daily or weekly from the business's credit card sales until repaid in full.
Compared to loans, merchant cash advances have fewer eligibility requirements and can be funded much faster, often in a matter of days.
However, the repayment terms are costly, with fees ranging from 1.1 to 1.5 times the amount advanced.
The cash advance will depend on how much the business needs and how qualified they are for the advance. Advances can range from 50% of monthly sales and up.
According to the Federal Reserve Bank 2023 Report, the merchant cash advances loan approval rate is 90%. This is probably due to the minimal eligibility requirements.
While easy to qualify, merchant cash advances should be used cautiously as a short-term bridge financing option rather than a recurring funding source.
Pros: Straightforward to qualify, fast funding, no collateral required.
Cons: Expensive with high fees, temporary solution, unregulated industry.
7. Peer-to-Peer Lending
Peer-to-peer lending connects business borrowers directly with individual lenders via online platforms. This enables accessing loans from individual investors rather than financial institutions.
By expanding the pool of potential lenders, peer-to-peer networks can assess risk in a more customized way and offer competitive interest rates. The application process is streamlined online, and loans can be funded within 1-2 weeks.
Maximum loan amounts are lower, usually $1,000 up to $50,000. The business' credit rating will influence how much they can borrow.
However, for small businesses that cannot secure traditional lending, peer-to-peer lending offers more choices and better rates than other alternative options.
Direct loans between business borrowers and individual lenders are facilitated through online platforms like LendingClub.
Pros: For borrowers, it is a fast way to obtain a loan, may have lower interest rates than banks or credit cards, and allows them to borrow for various purposes.
Cons: Borrowers may be charged additional fees and interest rates may be higher than those of traditional lenders.
8. Grants
Grants provide small businesses with funds that do not need to be repaid. A wide range of government agencies, nonprofit foundations, corporations, and more offer grants.
Applications involve extensive proposals detailing how the business will use the grant funds and describe how the funds will benefit the local community or public at large.
Competition is high, and grant writing can be complex. Awards sizes vary greatly in amount.
The strict proposal process and restricted uses make grants challenging. However, the zero-repayment requirement makes grants desirable financing if a small business can win an award.
Government grants have no fees or charges.
Pros: Free money that requires no repayment.
Cons: Highly competitive, strict application process, limited availability.
What are the Key Benefits of Alternative Small Business Financing?
The flexibility, ease of access, and speed of alternative financing provide advantages:
Faster funding: Faster funding means capital in days or weeks rather than months. On average, approval happens in less than five days.
Growth capital: Finance growth plans rather than just daily operations
Operational agility: Respond quickly to opportunities or challenges.
Improved cash flow: Smoother cash flow to run the business.
Credit constraints: Wider access for businesses with limited credit history.
According to the Small Business Administration, alternative lending increased by 120% in 2020, while bank lending fell by 30%.
What are the Fundamental Criteria to Qualify for Alternative Small Business Funding?
Each lender and product has specific eligibility standards, but in general:
Time in business: Most require at least 6-12 months of operations.
Revenues and cash flow: Current and projected financials should demonstrate repayment ability.
Credit score: Higher scores typically receive better terms.
Collateral: Some options leverage business assets and equipment.
Industry: Startups in high-growth sectors often gain more interest.
Showcasing business growth prospects is key to getting approved.
How Do You Choose the Right Financing Option for Your Business?
With the variety of options, here are some tips on choosing:
Evaluate needs: Amount required, use of capital, urgency, and goals.
Compare options: Costs, fees, eligibility criteria.
Get advisor insights: Consult those knowledgeable on financing.
Learn from reviews: Feedback from other borrowers.
Review terms: Read all fine print before committing.
Thoroughly assessing your needs and researching options leads to an informed decision.
Top Alternative Online Lenders
If exploring alternative financing, compare offers from multiple online lenders:
Kickstarter: One of the largest crowdfunding platforms, Kickstarter allows entrepreneurs to raise funds for creative projects, products, and services.
Kiva: Kiva is a nonprofit organization facilitating microloans for entrepreneurs worldwide in underserved communities.
Fundera: Fundera is an online marketplace that connects small businesses with various financing options, including loans, lines of credit, and equipment financing.
Lending Club: LendingClub is a peer-to-peer lending platform that connects borrowers with individual investors looking to fund loans.
Fundbox: Fundbox offers invoice financing solutions, allowing businesses to receive immediate payment for outstanding invoices.
Steps to Getting Funded by Alternative Lenders
Here are the typical steps involved in getting funded by alternative lenders:
1. Initial Eligibility Assessment
Many alternative lenders have online quick eligibility quizzes or forms to evaluate if your business meets the basic requirements. This initial check is fast and doesn't impact your credit.
2. Complete Application
Eligible businesses can proceed to the full application, which requests information like company financials, the amount required, the intended use of funds, personal credit scores, etc.
3. Documentation Submission
Documentation needed often includes business formation documents, bank statements, tax returns, profit/loss statements, accounts receivable aging, and identification.
4. Review and Verification
The lender will review the application and verify all submitted documentation to underwrite the request. Many lenders use automated scoring algorithms.
5. Funding Decision
If approved, the lender will present the financing offer and terms. This may require being able to accept funds within 24-48 hours.
6. Accept the Offer and Sign the Agreement
If the business accepts the offer, it will complete legal agreements and disclosures through digital signature.
7. Funding Disbursement
Once all signatures are completed, the lender will quickly disburse the financing funds into the business's bank account.
Being prepared with the required documents and reviewing all terms before signing can streamline the process of getting funded smoothly.
Tips for Managing Financing
Once secured, here are tips for properly managing financing:
Set up autopay through a bank account to avoid missed payments.
Build payments into cash flow projections.
Monitor revenue closely and defer payments if income dips.
Avoid taking on too many different financing products at once.
Use capital only for intended growth purposes.
Have an early repayment strategy for expensive products.
Takeaways on Alternative Small Business Financing
Traditional lending often falls short for newer and smaller companies needing quick and easy access to capital.
Alternative financing provides fast, flexible solutions tailored to modern businesses.
Options like revenue-based financing and invoice factoring enable growth.
Each type of financing has pros and cons to weigh. Thoroughly assessing needs and options is key.
Wise use and management of capital secures the long-term success and stability of the business.
Alternative financing platforms provide small and medium-sized businesses capital to innovate and adapt in competitive markets.
By delivering fast, accessible funding tailored to small businesses, alternative options fuel entrepreneurial growth and success.
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