As a business owner, getting access to traditional bank loans to expand or start your business can sometimes be a roller-coaster. That’s why you should seek alternative financing to get the funds you need to keep running your business operations.
Short-term credit is essential for day-to-day cash management, while longer-term credit is essential for capital investments. Yet less than half of small businesses report that their credit needs are being met.
This blog post will walk you through the different alternative financing options available to you, as well as how and where to get them, their advantages, and their shortcomings. Here’s what we’ll cover:
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What is Alternative Financing?
In simple terms, alternative financing refers to the means and process of obtaining funding for your business apart from the traditional financial system, such as banks and regulated capital markets. You can access most of these alternative funding options online. Some include reward-based crowdfunding, equity crowdfunding, peer-to-peer lending to consumers and businesses, online lenders, etc.
You can consider resorting to this source of financing if your company has not obtained a loan in the past. Alternative financing is also an option if you have bad credit or don’t have a clear idea of the amount you need to finance your business. However, if you still want to benefit from a traditional bank loan, you will need to build business credit.
Why is Alternative Financing Sometimes the Best Option for Your Business?
First, a clarification on why banks may not be the best option for obtaining business credit or loans: Most banks prefer to grant loans to businesses that have been in existence for at least two or three years and have sufficient cash flow to meet monthly payments or a significant guarantee.
To obtain a bank loan, you will have to show that your company is financially well off to get a loan. If your business is just starting up, the chances of you getting a loan are much lower.
However, if you are applying for a small business loan and your application fails, find out why. Understanding the reason will help you know what your next step will be. Before choosing the right type of alternative financing for your business, there are a few things to consider:
- the reasons you need the funds
- the level of development of your business
- the scope of the market your business will serve
- the growth you plan to achieve
- the profitability of your business
In order to help businesses find the best alternative sources, we break down the top options and the pros and cons of each of them.
What Are the Best Alternative Financing Options?
In the past, alternative financing providers were hard to find and specialized in a specific product or industry. Today, there are many lenders and dozens of products, so you can find the financing that is right for you. These options are much faster than going through the bank. Here are the best alternative funding options you can consider.
Business Credit Cards
Business credit cards are cards issued in a company’s name and used only for business purposes. The approval for the card depends mainly on the business owner’s previous financial and credit situation.
A business credit card sets a credit limit for you based on your company’s credit rating, which then determines the maximum agreed-upon amount that can be charged to the card.
Obtaining a business credit card is a relatively simple process and can be done online or at a bank branch. It is important to remember that if you apply for a business credit card with a bank, that means you’re already an existing customer.
Even though establishing the card is quick, it can take some time to process as the lender must verify your identity and eligibility. You must also answer questions such as your desired credit limit and the number of cards you wish to have.
Lenders will also review your bank statements. In exceptional cases, they may also look at your credit rating.
When establishing a business credit card, be sure to negotiate the lowest possible interest rate with lenders. Most credit card companies offer interest-free periods on their business credit cards. In other words, you will only pay interest on the remaining amount if you exceed this period. To estimate how long it will take you to pay off your balance with different interest rates and payment plans, use a credit card payment calculator.
Merchant Cash Advances
A merchant cash advance is alternative financing that helps businesses access the cash they need. The amount borrowed is then reimbursed with a fee, regularly based on a percentage of the business’s daily credit card or debit sales.
In other words, the lender advances a sum of money to the merchant or business, which in turn repays the loan by letting the lender take a percentage of the card payments made by its customers through a card terminal.
Merchant Cash Advances are suitable for businesses that use a card terminal. It is a type of financing that can be easily and quickly accessed. A merchant cash advance is typically requested when a business urgently needs cash to meet convenience issues or when it needs a loan and has a limited credit score.
However, the merchant cash advance has some downsides that you should prepare for if you consider it an option. Not only are the fees and approval rates high, but this type of financing is available to businesses with limited lending options. In addition, the repayment schedule is tied to daily sales.
Also known as royalty-based financing (RBF), revenue-based financing is a type of alternative funding that allows small or growing businesses to access capital from investors in exchange for a percentage of the company’s total gross revenues.
Revenue-based financing is an alternative investment model to more conventional equity investments, such as venture capital, angel investing, and debt financing.
Investors do not participate in the business in an RBF investment and do not take an initial stake in the company, but rather a small warrant.
Also, the advantage of this form of financing is that investors do not require the loan to be secured by the company founder’s assets. The investors expect the company to repay the loan within 3 to 5 years after the initial investment.
The US Small Business Administration (SBA) is a federal cabinet-level agency that supports small businesses. It provides them with advice, capital, and contracting expertise as the nation’s only resource and voice for small businesses.
The agency offers a variety of loan programs to assist small businesses but is not itself a lender. Instead, it works with a variety of lenders willing to provide loans. There are two special SBA programs: 7(A) and 504 loans.
The 7(A) loans are intended to finance any project. Express and small loans are special categories included in the 7(A) program with lower principal limits but faster turnaround times.
On the other hand, 504 loans finance large purchases of fixed assets such as equipment. A separate SBA micro-loan program offers up to $50,000 in financing for start-up businesses.
Be aware that the lender sets the interest rates when you receive financing through the SBA. However, these interest rates are capped by the SBA. It should also be noted that SBA loans are mostly granted to small, established businesses. In addition, one faces a longer and often slower application process.
You Might Also Want To Read: What Is The Work Opportunity Tax Credit
Invoice financing is another form of alternative financing that involves taking advantage of financing provided by an invoice financing lender to businesses.
This form of financing aims to help business owners pay their unpaid invoices by giving them an instant cash injection into the business. In other words, you sell your unpaid invoices to a lender in exchange for a percentage of the payment due upfront. Once the customer pays the invoice, the lender deducts the final amount, fewer fees.
There are several types of invoice financing: invoice discounting, selective invoice discounting, invoice factoring, debt factoring, and accounts receivable factoring and spot factoring. The choice of these different types of invoice financing options depends on the level of control to collect their unpaid invoices.
Crowdfunding is another source of financing that consists of collecting funds from many people via the Internet during a relatively short period. As aforementioned, crowdfunding is done online, and thanks to the explosion of social networks, it allows supporters to share and support a project or a cause. There are three primary forms of crowdfunding.
Donation-based crowdfunding is a form of crowdfunding where donors participate fully in financing a new project. The counterparty often promised is the product or service that will be developed with the revenues generated by the crowdfunding campaign.
Crowdfunding, or crowdsourcing, enables you to leverage the investment capital you need from a large number of investors, in exchange for rewards. While this method provides a reward to donors, it is generally considered a subset of donation-based crowdfunding because there is no financial return or equity.
Unlike donation and reward-based methods, equity crowdfunding allows contributors to become part-owners of your company by exchanging their equity for shares. This way, your contributors receive a financial return on their investment and, ultimately, a share of the profits in the form of a dividend or distribution.
Popular crowdfunding platforms include Kickstarter, Indiegogo, GoFundMe, Kiva, and many more.
Also abbreviated as P2P lending, peer-to-peer lending is an alternative financing solution that involves making loans to businesses or individuals through online services that connect lenders and borrowers.
Peer-to-peer lending sites connect businesses directly with lenders, called investors, who lend money to applicants whose projects they find most promising or exciting.
In return, investors can earn higher returns than the savings and investment products offered by banks, while borrowers can borrow money at lower interest rates. The best peer-to-peer lending sites offer several loans and have low-interest rates and fees.
Each peer-to-peer lending platform has its own specificities. Peerform is one of the platforms to consider if you want the best rates.
For businesses with limited credit history, they may consider using Prosper. Funding Circle might be a good option if you are a small business owner. Finally, Payoff is considered the best platform in terms of fair credit.
Business Line of Credit
A business line of credit allows a business to borrow funds up to a maximum amount as needed. This reserve fund can solve cash flow problems, particularly useful in emergencies or to meet temporary or seasonal expenses.
The main advantage of a business line of credit is its flexibility, mainly because interest only accrues on the amount drawn. In addition, you can also negotiate with the lender the terms of the contract, including maximum credit, interest rates, and repayment schedule. The business line of credit is much more favorable to companies with good credit ratings.
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FAQs: Alternative Financing Options for Businesses
There are several examples of alternative financing such as crowdfunding, microloans, merchant cash advance, P2P loans, invoice finance, SBA loans, business line of credit, revenue-based financing, asset finance, and property finance. Note that alternative funding is any source of funding of a company other than the traditional means of funding that we know, such as bank loans.
There are two main types of financing for businesses: debt financing and equity financing. Debt financing involves borrowing money that you pay back with interest within a period agreed upon with your lender. However, equity financing is raising capital through the sale of shares. Equity crowdfunding is an example of equity financing.
Alternative lenders, also known as non-traditional lenders, are private companies that operate like banks by providing loans to businesses. The difference between these alternative lenders and traditional banks is the flexibility in the application process and the speed and ease of obtaining loans.