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Every business eventually finds itself in a situation where it needs to secure additional capital. It doesn’t matter if it’s a startup trying to get itself off the ground or an established company looking to cover a cash flow gap. The point is that having reliable access to working capital is crucial to your business, and its success.
Unfortunately, banks have become notoriously stingy when it comes to giving businesses the money they need. Given the difficulty of securing a bank loan for small and medium-sized businesses (SMBs), it makes sense that so many of these businesses are looking to alternative lending solutions to solve their cash crises. Because of this, the world of alternative lending solutions has exploded. While this plethora of options is helpful for SMBs, it also makes it difficult for businesses to understand all of their options. FundThrough has put together this list of nine types of alternative lending solutions to help simplify the process of knowing what’s out there.
1. Lines of Credit
One of the first places people tend to look during a financial emergency is a line of credit. Lines of credit come in many forms. These range from your average credit card (with varying credit limits and interest rates) to larger lines of credit through established banks. Lines of credit are helpful because they allow businesses to access the cash they need quickly. This can also be done without the same sort of lengthy approval process that is typically seen with a bank loan.
The main problem that SMBs experience when trying to secure a line of credit is that these still require strong credit scores in order to qualify. This can make things difficult for startups or businesses that lack the financial history necessary to make banks feel comfortable. Also, the approval process for a line of credit can take weeks, valuable time that most businesses can ill afford.
2. Merchant Cash Advances
A merchant cash advance (MCA) is another alternative lending option that is gaining traction with small businesses for some time. The way a merchant cash advance operates is that a business is advanced a loan against its future credit card sales. Basically, the business agrees to sell a fixed percentage of its future sales (with interest) for an immediate cash advance.
Many businesses like MCAs because they are available to companies with less than stellar credit scores or little credit history. Also, because the advance is being made against the company’s sales, there’s little need for additional collateral. That said, the convenience of an MCA comes at a price. MCAs have high interest rates that make them much more expensive than if a business were to take out a traditional bank loan. On top of that, the industry isn’t well regulated. That means businesses must be careful with whom they borrow from. Also, because you’re paying the money back directly through your sales, this is incoming cash to which you’ll no longer have access, which can create its own problems.
3. Unsecured Business Loans
Unsecured business loans, like merchant cash advances, are popular because they often require little to no personal or business assets to serve as collateral. The catch is that, because you’re not having to put up collateral to qualify for the loan, the business must demonstrate a robust financial history as well as a positive forecast of its future cash flow.
In addition to needing an outstanding credit score, unsecured business loans come with a few additional caveats of which businesses need to be aware. Nothing comes for free, and unsecured business loans apply high interest rates that can quickly turn a blessing into a curse for small and medium-sized businesses.
4. Working Capital Loans
Working capital loans are a type of short-term loan specifically designed to cover the daily operating costs of a business. This isn’t the kind of loan that a business is going to use to fund ongoing inventory or other long-term assets. Examples of what a working capital loan is used for include making payroll, covering rent, or making sure bills are paid on time. These sorts of loans are useful for businesses that have a lot of seasonal sales but need a loan to get through leaner parts of the year.
Drawbacks of working capital loans come in the form of high interest rates. As with any loan where collateral is minimized, lenders offset risk by applying high interest rates that can cover their bases. This is in addition to requiring an exceptional credit score from a business owner. These loans are often tied to the business owner’s credit, which means they’ll bear the responsibility should anything happen.
5. Microloans
Microloans are another type of alternative lending that has been gaining traction within the small business community. This is particularly true among self-employed people as well as businesses that are in the startup phase of their lifecycles.
As the name suggests, microloans provide small amounts of money to businesses in need. As such, microloans are short-term loans that also feature reasonable interest-rates. This makes them attractive to SMBs not looking for the commitment necessary with a larger bank loan. More than 74 million borrowers around the world have secured nearly $40 million in loans from microlenders. While the accessibility of microloans contributes to their popularity, it also limits the effectiveness of microloans for businesses looking for more than $50,000.
6. Crowdfunding
The popularity, success, and variety of crowdfunding platforms has led to a rise in its application as a funding option for small businesses. Through online platforms such as Kickstarter, GoFundMe, Patreon, and others, crowdfunding is being used to fund everything from personal loans to charities to pet projects and even businesses themselves.
Examples of crowdfunding include both rewards-based crowdfunding and equity crowdfunding. In rewards-based crowdfunding, a business offers a certain reward (whether goods or services) in exchange for donations of different amounts. During equity crowdfunding, a business offers percentages of the company in exchange for donations. While crowdfunding can be a great way for small businesses to raise money, it often doesn’t happen quickly. Furthermore, once a business offers rewards or equity, they’re on the hook to make sure they deliver.
7. Invoice Factoring
For businesses doing well that are simply waiting to be paid for services rendered, another type of alternative lending has emerged as a popular option. Invoice factoring is seeing a new renaissance among SMBs thanks to the ease and accessibility of online platforms. In invoice factoring, a small or medium-sized business sells its existing, outstanding invoices to a third-party lender in exchange for the invoiced amount. Thanks to these online services, invoice factoring is an expedient way for businesses to get paid, receiving up to 95 percent of the value of their invoices in as little as 24 hours.
Another advantage of invoice factoring that separates it from invoice financing is that a business is removing itself from the process of collecting payment for the outstanding invoice. The third-party lender purchases the entire invoice; and will undergo the process of ensuring that the invoice is paid. This frees up valuable time and resources to allow owners to focus on their business itself, rather than getting paid. In an age where it can take months to receive payment for existing invoices, invoice factoring provides a lifeline for businesses relying on those invoices to fund their operations. Of course, this reliance on existing invoices as collateral limits the usefulness of invoice factoring to businesses actually have invoices to speak of. It’s not going to be a viable option for B2C companies, such as restaurants.
8. B2B Lending
B2B, or business to business, lending is when one business chooses to loan funds to another. In many ways, B2B lending operates in much the same manner as a traditional bank loan, with similar terms and conditions. Often, B2B lenders aren’t the ones making the loans themselves, instead, they facilitate transactions between small businesses and their lenders.
Because B2B loans are term loans much like a bank, they also have many of the same requirements. While these requirements are often not as stringent as those seen with a bank, they do ask that businesses have high credit scores, established business histories, and a specific amount of annual revenue.
9. Venture Capital
Venture capital, or VC funding, can be a springboard to catapult many startups into the upper stratosphere. While this is definitely true, those companies you see raising millions are exceptions, rather than the rule. Finding venture capital is easier said than done, and isn’t necessarily a reliable option for many small businesses.
The process of raising VC funding involves a lot of time and effort courting employees at VC firms from the low-level analysts to the partners themselves. SMBs must arrange convincing presentations that can convince potential investors of the long-term growth potential of their company. If everything goes well, venture capital funding provides everything a startup needs to get themselves off the ground. However, the odds of actually getting funded are a crapshoot. They are hardly something that can be relied upon to provide working capital or bridge a cash flow gap.
Alternative Lending Solutions are Important Options for SMBs
For many small and medium-sized businesses, alternative lending solutions are some of the only options available for finding the capital they need. Thanks to their accessibility, flexibility, and improved speed, they often work even better for an SMB’s purposes than traditional bank loans.
Still, before exploring alternative lending solutions, it’s always important for businesses to carefully review interest rates and terms to ensure they’re getting the best deal for their business. Once an SMB determines that alternative lending is its best option to get working capital now, it’s ready to begin the process of working with some of the most exciting developments in the world of lending.