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Small Business Guide to Alternative Lending
Looking for funding? When banks let you down, consider an alternative loan.
A business.com editor verified this analysis to ensure it meets our standards for accuracy, expertise and integrity.
Shari Weiss,Senior Editor
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Table of Contents
While every business owner aims for growth, securing capital through traditional banks or the SBA isn’t always feasible due to strict requirements or slow processing times. For those needing faster, more flexible financing options, alternative lenders offer a path forward. This guide dives into the world of alternative lending, exploring common loan types and key lenders to help you find the perfect fit for your small business.
Alternative lending refers to financing secured through non-bank institutions. These fintech companies and private lenders emphasize speed and accessibility over the rigid criteria used by traditional banks. Alternative loans tend to be more flexible than conventional loans, and they often have a faster application turnaround. Many types of alternative loans are available, so there is likely an alternative loan out there that suits your business’s needs.
Many banks and conventional lenders take weeks to process a loan application, but alternative lenders can deliver funding in a few days. The loan application process for alternative loans is often simpler, requiring only a credit score, tax returns, and bank statements.
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Alternative lenders also are more likely to offer loans in smaller amounts than banks, which often include minimum lending terms that are often too high for a small business. Furthermore, these lenders frequently provide asset-based financing, allowing companies to leverage accounts receivable or daily credit card sales rather than relying solely on creditworthiness.
What are the different types of alternative loans?
Lines of credit
A business line of credit functions similarly to a credit card but provides access to actual cash.An alternative lender extends a fixed amount of money to the borrower. You can draw from the line of credit up to the fixed amount, paying interest on the amount you borrow.
Short-term loans
Short-term loans are generally paid back in a year or less. Most banks don’t offer short-term loans, but they’re a common offering from alternative lenders. These loans are ideal for addressing immediate cash-flow gaps or covering emergency expenses, though they often carry higher annual percentage rates (APRs).
Installment loans
Installment loans provide a lump sum of money to a borrower, which is then repaid at regular intervals. Many installment loans from alternative lenders feature a fixed payment amount, which means the interest rate will not fluctuate during the life of the loan. Installment loans are commonly used to finance the purchase of real estate, vehicles, and the equipment a business needs to operate.
Merchant cash advances
A merchant cash advance (MCA) offers a business funding in exchange for a cut of future sales. This financing option, based on future credit card receivables, can provide a quick infusion of cash up front. Instead of fixed monthly payments, the provider automatically deducts a percentage of your daily credit card sales until the advance, plus fees, is repaid.
Microloans
Microloans, as the name suggests, are low-value loans — typically $50,000 or less. According to the U.S. Small Business Administration, the average microloan is approximately $13,000.Since many banks don’t offer loans below a minimum funding threshold, alternative lenders can fill the gap for small-scale needs. Microloans often feature shorter repayment periods, sometimes as little as a few months.
Invoice factoring
Invoice factoring is a type of financing in which a business sells its outstanding accounts receivable to a third party (referred to as the “factor”) in exchange for a cash payment. Typically, a company receives about 80 to 90 percent of the invoice value immediately, with the remainder paid (minus fees) once the customer settles the bill.
Bridge loans
A bridge loan is a short-term loan backed by a hard asset. If a business owner is moving from one location to another and is in the process of selling the first location, for example, they can use a bridge loan to purchase the new property and cover all closing costs. In this case, the new property would act as collateral for the bridge loan. These loans are typically very short-term, often taking less than a year to repay.
Equipment financing
Equipment financing is used to purchase equipment your business needs to operate. Unlike general working capital loans, the equipment itself serves as collateral for the loan. This structure often results in more favorable approval odds and interest rates, as the lender assumes less risk.
Before you apply for a business loan or alternative funding, think about what you need the cash for. If it's to bankroll an expensive piece of equipment, a long-term loan or equipment financing may make the most sense. If you need to deal with a cash-flow issue or purchase more inventory, a short-term loan is better.
What are the pros and cons of alternative lending options?
Alternative lending pros
Alternative lending solutions offer some major advantages over bank loans and other conventional financing options. Here’s where alternative lenders outshine banks and credit unions.
Simple application process: Alternative lenders utilize automated underwriting technology, making their applications far less rigorous than traditional bank loans. Sometimes alternative lenders simply require access to your digital bank statements to return a verdict on your application.
Fast turnaround: In addition to their simplicity, alternative lenders tend to be much faster than banks or credit unions in terms of both approval and funding delivery. Conventional lenders may need weeks or months to make a determination and extend the capital, but alternative lenders often can provide small business funding in a matter of days.
Flexible loans: Alternative lenders, particularly direct private lenders, have more freedom in how they package loans and financing options. That has allowed alternative lenders to create unique financial products, such as invoice factoring and microloans, that may better meet your needs.
Alternative lending cons
Banks and credit unions naturally have their own advantages over alternative lenders. You may have to deal with the following issues if you choose an alternative lending option instead of a traditional bank loan.
Higher interest rates: The less strict requirements, shorter terms, and unconventional nature of alternative loans often translate to higher interest rates than conventional lenders charge. While bank loans may offer single-digit interest rates, alternative financing options like MCAs can carry equivalent APRs ranging from 20 percent to over 100 percent depending on risk factors.
Short-term loans: Short-term loans can be useful to businesses in some cases, but alternative lenders often set short repayment terms even on high-value loans. That means you could end up making higher installment payments to an alternative lender for the same amount of capital you could borrow from a bank.
Tip
When it comes to small business funding, alternative lenders are more willing than their bank counterparts to approve a loan. With any financing provider, however, it's critical to understand the fine print of your loan agreement before signing on the dotted line.
Alternative lending FAQs
The cost of alternative lending depends on the loan terms and the provider. Depending on the lending source, you may be subject to an annual percentage rate (APR). Some lenders may charge a monthly fee or factor rate for the loan instead, which is beneficial for those who plan on quick repayment but can be expensive if the debt drags on.
If, however, the lender charges an APR that seems low, confirm the fees associated with the loan. The lender, for example, may charge an organization fee, which represents the expense of processing your loan and may cost upward of 3 percent of the loan amount. Other lenders may charge a set dollar amount for closing costs. During the loan negotiations, ask for a breakdown of the total loan costs to understand what you'll be paying in full to borrow the money.
Alternative lending isn't necessarily better than traditional lending, but it offers distinct advantages. Primarily, alternative lending provides the opportunity for small and midsize businesses to harness funding when they may not qualify for traditional loans. Alternative lending also provides more flexibility, including faster processing and shorter payment terms.
Alternative lenders are also more versatile than traditional lenders in the amounts they can provide to businesses. In some cases, businesses borrow a moderate amount from an alternative lender in addition to a standard bank loan. Another benefit of alternative lending is the industry relies on risk assessments beyond a credit score to approve loans. If any of those scenarios or needs apply to your circumstances, then alternative lending may be the better option for your business.
Alternative lending began in the early 2000s. The first alternative lenders entered the marketplace around 2005. Companies specializing in peer-to-peer loans are credited with launching the trend, though the definition has expanded significantly since then. Alternative lending companies started out to aid small and midsize businesses due to banks' preference for funding corporations, which they consider less of a financial risk, instead of smaller enterprises.
Yes, you can likely get an alternative loan with bad credit. Some lenders even specialize in providing lending options to those with bad credit. Instead of looking at a credit score, the lenders will consider qualifications such as your company's minimum annual revenue. The alternative lender also usually weighs the applicant's experience. The lender, for instance, may request that applicants have operated their business for at least a year before applying. That longevity may indicate your worthiness to the provider even if your credit score doesn't.
Mike Berner and Adam Uzialko contributed to this article.
Donna Fuscaldo, who has 25 years of experience navigating the convergence of business, finance, and technology, is a trusted advisor to small business owners. Her expertise in business borrowing, funding, and investment strategies equips her to provide reliable counsel on everything from business loans to accounting and retirement benefits.
At business.com, Fuscaldo covers business grants and other financing options, business credit cards and retirement funds.
Her analysis has also graced publications like The Wall Street Journal, Dow Jones Newswires, Bankrate, Investopedia, Motley Fool, Fox Business and AARP, solidifying her authority in the field. Beyond her contributions to the financial landscape, Fuscaldo also lends her wisdom on employment matters, with her expertise sought after by platforms like Glassdoor and others.
Armed with a bachelor's degree in communication arts and journalism, Fuscaldo has the unique ability to simplify complex business and career-related topics into actionable insights. This makes her a valuable resource for professionals seeking practical solutions in today's dynamic business environment.
Armed with a bachelor's degree in communication arts and journalism, Fuscaldo has the unique ability to simplify complex business and career-related topics into actionable insights. This makes her a valuable resource for professionals seeking practical solutions in today's dynamic business environment.
