What is alternative lending?
To run a successful business, it’s crucial to understand the fundamentals of business financing. Whether you’re a new or veteran business owner, you’ll likely need extra capital at some point to help grow your operations. That might involve moving to a new location, for example, or temporarily doubling your inventory to meet customer demand.
Whatever your situation, it’s a good idea to review your financing options. Instead of poring over the ins and outs of bank loans, though, try familiarizing yourself with alternative lending. It could be the solution that best suits your business’ needs.
What is alternative lending?
Alternative lending refers to any lending practice that happens outside a traditional banking institution. Some non-bank lenders operate online using a peer-to-peer model. This system, also referred to as marketplace lending, connects business owners seeking capital with established investors willing to provide it.
The first major alternative lenders in the United States, Prosper and LendingClub, came onto the scene in the mid-2000s offering peer-to-peer personal loans. This introduced a new way of lending that eventually expanded into the business realm as well.
Banks have historically viewed small businesses as greater financial risks, choosing instead to finance large corporations — after all, large corporations requesting hefty loan sizes mean more money for the lender.
For new business owners who need help getting started and don’t yet have a proven track record of sales, it can be extremely difficult to qualify for a bank loan. Not only do you usually need excellent personal and business credit, but you also need proof of revenue, a healthy cash flow situation, and at least a few years of experience running your business. And oftentimes, banks prefer to lend to those looking for upwards of $1 million, an amount smaller businesses rarely need.
After the 2008 recession, financing for small businesses dropped significantly, leaving room for alternative lenders to fill the gap. According to the Wall Street Journal, business lending amounts decreased 38% over a span of eight years; 10 of the largest banks granting small business loans collectively lent $72.5 billion in 2006, but just $44.7 billion in 2014. Alternative lending companies began offering business loans as a way to assist small businesses overlooked by banks.
How alternative lending differs from traditional lending
Alternative lending is usually a faster, more accessible financing option than traditional lending. Unlike banks, which usually require you to submit a detailed business plan and slew of financial documents, all of which can take months to compile, alternative lenders typically only need your credit score and most recent tax returns and bank statements.
Thanks to advanced underwriting programs that marry human expertise with cutting-edge tech, alternative online lenders can expedite the underwriting process and return a decision much more quickly. As a result, lenders can issue responses within days, or sometimes even hours.
Applying for a bank loan, on the other hand, is often a much longer and more rigorous process. The standard wait time is three months to receive a response. And once you do hear back, you could have to schedule an in-person meeting and provide hard copies of your financial documents as part of the approval process. These extra steps can take valuable time away from running your business.
Alternative lending also tends to be more flexible with lending terms and amounts. While banks don’t generally see it as financially prudent to lend amounts smaller than $250,000, some alternative lenders offer loans as small as $5,000.
Advantages of alternative lending
Alternative lending was designed to give small businesses easier access to capital, and therefore more opportunities to grow, create jobs, and drive profits. Here are the main benefits:
1. Easy application process
You can upload all your information in just a few clicks at your convenience without wasting time organizing physical papers, drafting a business plan, or going to a bank meeting during normal business hours.
2. Higher approval rates
You’re twice as likely to get approved by an alternative lender. According to Biz2Credit’s Small Business Lending Index for August 2018, loan approval rates for big banks hovered around 26%, while rates for alternative lenders were more than double that figure at 56.6%.
3. Fast funding
Whether you need to put a down payment on a new office building, replace damaged equipment, or restock high-selling inventory, alternative lenders work fast to get you your funds, sometimes delivering money in just a few hours. A short wait time means you never have to stall your plans and risk losing business in the process.
With alternative lenders, you can choose from a handful of financing options to find the one that works best for you. Whether you want $5,000 to upgrade to energy-efficient office lighting, need to use outstanding invoices as collateral to secure your loan, or need $30,000 for building renovations, alternative lenders can help.
Disadvantages of alternative lending
The downsides to alternative lending are few, but important to note. Here are two factors to consider:
1. Higher interest rates
Banks don’t accept nearly as many applicants as alternative lenders, so they can afford to charge lower interest rates. Think: 3-6% APR for traditional bank loans versus 10-30% APR for non-bank lenders, depending on the loan type and particular company.
If you don’t budget carefully with an alternative lender, you could end up spending money paying off interest instead of figuring out how to improve profits. However, not all alternative lenders will return outrageous rates, and many offer a no-obligation application so you can check what you qualify for at no cost.
2. Shorter lending terms
Alternative lenders typically have shorter lending terms than banks — around one to five years. Lending to less established businesses is inherently a riskier investment, but the shorter terms are also due to the fact that alternative lenders usually lend smaller amounts than banks do.
With less time to pay off your loan, you might have bigger monthly payments, which means you could be forced to put certain business plans on hold or end up with a shortage of cash flow.
Types of alternative lending
Banks typically offer lines of credit, term loans, and business credit cards, but alternative lending can also take many forms. These are four of the most common types:
1. Term loan
A term loan is a set amount of money you borrow for a set period of time, like one to five years. The average lending amount for alternative lenders is between $60,000 and $80,000, but Funding Circle term loans let you borrow anywhere from $25,000 to $500,000 over a period of six months to five years.
A term loan is great for businesses that have bigger financial investments, like buying equipment or renovating a building.
2. Line of credit
With a line of credit, you have a set amount of money available to you on an ongoing basis to cover temporary cash flow shortages or help with recurring expenses, like payroll and utility bills. With most lines of credit, as long as you pay down your balance, you can use the funds over and over again.
3. Invoice factoring
If your business has a large number of accounts receivable at any given time, invoice factoring can be a good solution. Instead of waiting for your clients to pay you, you get an advance on your unpaid invoices, which you then pay back (plus fees) once the money comes in.
4. Merchant cash advance
A merchant cash advance is fast and easy to obtain — approval is usually only a few hours away — but the APRs can be steep, often exceeding 70%. You typically repay the funds you borrow on a daily or weekly basis, and the lender takes a portion of your sales.
Whether you have plans to renovate, relocate, or hire, alternative lending can help. Get started by checking out Funding Circle’s term loans. Learn more about us or see how we compare to other lenders.