Small business owners commonly use bank loans as a financer. However, banks have strict policies compared to alternative lenders. This makes it challenging for small business owners to receive crucial funding. Alternative lending is a way of financing businesses and people, not through a traditional bank setup.
More and more businesses are resorting to sourced of this lending for the reasons:
- Alternative lenders work with borrowers with short track records
- There is no collateral involved
- They receive funding almost immediately
Here’s a list of different alternative funding types and why they might be the right one for your business.
Invoice Financing
Invoice financing, called invoice factoring, is the oldest and most popular alternative lender.
An invoicing financing company will agree to buy receivables generated by the invoices. This makes it an asset transfer rather than a loan. After paying the lender a small fee, the business receives the payment upfront through this method. The receivables are treated as collateral. Since no loan is generated effectively, the company’s credit rating is not affected.
Pros
- Invoice factoring funds are received quickly, within a week or less.
- Businesses with poor credit ratings can receive funding through this method.
Cons - It is an expensive option
- The lender can interfere in the day-to-day business of the company
Equipment Financing
This is a method of financing where any equipment such as a vehicle or anything is held as collateral against the loan.
Equipment is necessary for operations, and if it fails, the entire business can get derailed. Small businesses often lack funds to maintain their equipment. Since the equipment is usually of high value, the loan amount may be a large percentage of the cost of the equipment.
Pros
- Easier to obtain funding
- Secure loans
- Low rates of interest
Cons
- If the loan is not repaid, the business might lose the equipment
- Down payment may be high
- If the equipment becomes obsolete, it might be challenging to get a loan against it.
Non-Bank Lenders
Financial institutions without a banking license still loan money to borrowers. Some have high-interest rates, while some have a one-time fee.
Pros
- Longer loan periods
- Less restrictive
- Flexible for new businesses
Cons
- High-interest rate
Lines of Credit
Best for short-term credit, LOC, or Line of Credit is a fixed amount of money that any business can use when it requires cash. It requires collateral if it is secured, not otherwise.
Pros
- Flexible option
- Reduces shortage of cash flow
Cons
- ROI may be high
- Businesses might overextend if they rely heavily on the LOC
Once the amount borrowed from the LOC is paid off, It frees up the amount to be used in the future.
Peer-to-Peer (P2P) Loans
This originates from P2P lending platforms. It arranged for loans between borrowers and investors. This is like a marketplace where lenders can choose who they want to invest with and diversify their portfolios in the process.
Pros
- Easy access to loans for businesses
Cons
- No requirement for a track record
R&D Advance Funding
This is a relatively new financial instrument. A business’ future tax credit payments form the collateral.
Pros
- Using the funds earlier helps businesses net a more considerable R&D credit by the year-end.
Cons
- Slow process. It might take months to access the money.
Wrapping Up
The slow and proper format of traditional banks contributed to the high demand for alternative lending sources in the market. Alternative lending is flexible, and approval rates are higher. With a boost in fintech, it is difficult for traditional banks to keep up, unlike these alternative lending methods.
