Pros and Cons of Alternative Business Lending

Qualifying for business funding may be challenging if you’re a startup or don’t have a prime financial profile such as having bad credit or low revenue. In these cases, instead of applying in person at a traditional bank or credit union, you can now consider a range of alternative business lending options.

Alternative lending often relaxes eligibility requirements, helping you get funding even with less-than-ideal business qualifications. Many alternative lenders will also fund your loan within days through a streamlined online application versus the week or more that traditional lenders take to approve a loan. This approval process allows you to receive funding to quickly cover a financial need or emergency.

Read on to learn how alternative lenders operate and find out alternative lending pros and cons.

Pros and cons of alternative lending

Alternative lending comes with its ups and downs: they generally have more relaxed eligibility but may come with higher interest rates and short terms. Consider the pros and cons of alternative lenders below and then continue reading to dive deeper into each one.

Pros

• Flexible eligibility requirements
• Some options don’t require a personal guarantee
• Easy application process
• No restrictions on how you use funding
• Get the money your business needs quickly

Cons

• Higher costs of borrowing
• Some loans don’t build business credit
• Shorter loan terms
• Research required

What are alternative lenders?

Small business financing can come in many different forms. Beyond the traditional business loan and business credit card options you already know about, alternative business finance options include business loans from online lenders and payment processing companies, crowdsourced business loans, merchant cash advance loans and invoice factoring.

Many reputable alternative lenders use their platforms and technology to approve small businesses that wouldn’t normally qualify with a traditional lender. But business owners should know that these financing options all work differently, and they need to read the fine print before they borrow.

Types of alternative lenders

Business owners can look for alternative lending through a variety of lenders that usually host their platforms online. Alternative lenders include:

Online lenders

Business loans from online lenders work similarly to business loans from traditional banks and credit unions. Online lenders offer many types of business loans, including the term loans and lines of credit you’ll find at banks. But they also offer some of the loan types listed below, like merchant cash advances and invoice factoring.

Online lenders tend to accept fair or bad credit and low revenue such as $100,000 or less, making their loans more accessible for small business owners. Be aware that, to offset the risk of lending to riskier businesses, these lenders often charge high interest rates. And since online lenders don’t have physical locations, they can’t offer the face-to-face experience of traditional banks.

Peer-to-peer lending

Peer-to-peer lending allows your business to get financing through multiple private investors. Lending usually occurs through a platform similar to a crowdfunding platform, such as Kickstarter or Honeycomb Credit. You will then pay back the loan within a specified time period and possibly with interest.

Peer-to-peer lending gives you the chance to get a business loan without needing strong credit or finances to get approved. The platform may not consider your credit or may accept poor credit when approving you for the investor-funded loan.

Crowdfunding

Online platforms offer crowdfunded loans funded with small investments from individuals such as family, friends or individual investors. A company called Kiva falls into this category, offering small, zero-interest loans to startups and established small businesses alike.

These loans must be repaid, but other types of crowdfunding do not. You may instead reward investors with merchandise or equity in your company.

Merchant cash advance

Merchant cash advances let businesses get an advance on their credit card sales. MCA lenders will look at your sales to determine the amount of the advance. Then, you repay the lender from a percentage of your sales until the loan is paid off. Like other types of bad credit loans, MCAs have flexible requirements, often accepting businesses with credit scores under 600.

But since MCAs aren’t technically loans, they bypass usury laws that protect borrowers from exorbitant interest rates. Since they don’t have to stay within a maximum interest rate, rates for MCAs can reach the triple digits.

Plus, MCAs tend to require daily or weekly payments, an aggressive payment schedule that can lead you into a cycle of debt. You may want to use an MCA as a last resort for your company.

Invoice factoring or financing

With invoice factoring, a business owner sells outstanding invoices to a company. You’ll receive up to 90 percent of the total invoice amount. From there, the invoice factoring company will collect payment from your customers. The lender will send you the remaining amount minus fees.

You can also choose a similar option through invoice financing. Invoice financing advances a portion of your outstanding invoices to you. But with this loan, you collect the invoices from your customers and pay the company its fee once invoices are paid.

Alternative business lending pros

If you’re considering an alternative business finance option, you should know about all the benefits you could get. Here’s an overview of the alternative business lending pros.

Flexible eligibility requirements

Alternative business financing makes it possible to get the funding you need — even when you cannot get approved for a business loan from a traditional bank. Alternative lenders often approve business owners with a personal credit score in the 600s, at least six months in business and annual revenue of $100,000 or less. By comparison, most traditional banks require stricter criteria, such as having two years in business.

With many available options, you can check the business financing requirements from each lender and apply for funding you’re likely eligible for.

Some options don’t require a personal guarantee

Because some loan options like invoice factoring involve selling a percentage of future profits, they can often be acquired without a personal guarantee.

No personal guarantee means the business owner does not put their personal credit at stake when they receive funding. Business owners worried about defaulting on a traditional loan might find that reassuring.

Easy application process

Many alternative lending companies offer an application process with minimal paperwork, and many can be applied for online within minutes. This process means that you won’t have to apply for a business loan in person, and you can easily compare loan offers from multiple lenders all from the comfort of your office.

Many alternative lenders also offer the ability to prequalify for the loan. Prequalification helps you see the loan amount and rates you’re eligible for without a hard check on your credit. It can protect your credit while you’re shopping around with different alternative business loans.

No restrictions on how you use funding

Many alternative business finance options don’t require you to submit a comprehensive plan detailing how to spend the funds. This flexibility means you can get approved for funding and use your loan funds for whatever purposes suit your business needs best.

Get the money your business needs quickly

Loan funds from banks may take weeks to arrive. Approval for U.S. Small Business Administration loans can take 30 to 90 days, and even then, you still have to wait for disbursement.

By comparison, many online lenders will make a loan decision within hours. They can also get you your money within 24 to 48 hours of getting approved. This fast funding speed can help you cover emergency costs or immediate needs, such as equipment repairs or inventory.

Alternative business lending cons

While the advantages can make alternative business financing options a good choice, you should consider some of the disadvantages as well.

Higher costs of borrowing

Many alternative lenders charge high interest rates, such as 30 percent or higher, to offset the risk of lending to subprime borrowers or because of the convenience of its fast funding. Other alternative loan types are both complicated and costly, especially if you’re applying for a loan designed for someone with bad credit or a fast business loan.

As an example, merchant cash advance loans charge something called a “factor rate” instead of an interest rate. A factor rate is represented as a decimal, such as 1.15. To calculate the total cost of borrowing, you multiply the amount borrowed by that decimal (such as $50,000 x 1.15). Using a business loan with a factor rate tends to cost more than business loans that calculate an APR. To help you compare loans, you can convert the factor rate to an interest rate.

Some don’t build business credit

With some loan options like merchant cash advances, certain business lines of credit or crowdfunding, the companies offering these options don’t report payments to the business credit bureaus. Ultimately, this means some types of business funding will not help you build your business credit score.

Shorter loan terms

Alternative lending is often offered in shorter terms, usually falling within three to 18 months. In some cases, loan terms may only be a few weeks long. Alternative lenders may also require an aggressive payment schedule of daily or weekly payments. These payment terms can lead to higher payments, making it difficult for small businesses to keep up.

Research required

Because alternative business funding options work differently and offer varied features, you’ll need to do plenty of research before you move forward and apply. You’ll want to compare the different rates and fees charged by each lender and loan option. You’ll also want to make sure the type of loan suits your funding needs, and you should read through the loan agreement to fully understand the loan terms.

You should also spend time reading lender reviews to ensure you’re working with a trustworthy company. Once you find a reputable alternative lending option, you can apply with the lender and sign the agreement to receive your funding.

The bottom line

While you can still get a business loan from a traditional bank or apply for a business credit card, alternative lending can help you get faster funding or expand your loan options when your personal credit is poor or in a gray area.

But alternative lending comes with pros and cons. They often come with higher borrowing costs and shorter loan terms than traditional bank loans, leading to higher payments. You’ll want to consider multiple options that you’re eligible for and prequalify with the lenders if possible to compare loan offers.

Frequently asked questions

• What is alternative business lending?

  Alternative business lending is a type of business finance secured from sources other than a traditional bank or credit union. These can include online bank lenders, peer-to-peer financing, crowdfunding platforms, invoice factoring companies or merchant cash advances.

• Why is alternative lending important?

  Alternative lending is important because it gives businesses a way to secure funding when they normally wouldn’t qualify for a business loan from a bank or credit union.

• What are the disadvantages of alternative lending?

  The disadvantages of alternative lending include higher costs of borrowing, no building of business credit in some cases, shorter loan terms and required research to find loans.