Looking for funding? When banks let you down, consider an alternative loan.
Traditional bank loans tend to have lower interest rates and longer terms than alternative financing methods, but banks also have stricter requirements for approval.
Every business needs funding. While you might have initially financed your business with your own money or loans from family and friends, there comes a time when institutional capital is necessary for sustained growth. Many business owners rely on bank loans or loans from funding schemes like those offered by the Department of Trade and Industry (DTI).
Sometimes, though, business owners can’t qualify for these loans or need something shorter term or more flexible. In these cases, alternative lenders offer various ways to access the capital you need to grow your business. Alternative loans come in many shapes and sizes, so you can generally find the right one for your current needs.
This guide will introduce you to the concept of alternative lending and explain some of the most common types of alternative loans.
What is alternative lending?
Alternative lending is any lending that occurs outside of a conventional financial institution. There are many different types of alternative loans available, so there is likely an alternative loan out there that suits your business’s circumstances.
While most banks and conventional lenders could take weeks to approve or deny a loan application. The loan application process for alternative loans also tends to be simpler.
In addition, alternative lenders are more likely to loan smaller amounts than banks. They also offer unconventional lending options that allow businesses to leverage assets like their accounts receivable or credit card sales, rather than borrowing on credit.
What are alternative lenders?
“Alternative lender” is an umbrella term for several alternative lending models offered by different organizations, which include direct private lending, marketplace lending and even crowdfunding platforms.
Direct private lenders
Direct private lenders use their own money to issue loans, rather than relying on depositors or investors. This allows direct private lenders to be extremely flexible in granting applications. Direct private lenders tend to offer diverse types of loans, including asset-backed ones such as bridge loans. Direct private lenders can also be more flexible in the amount of money they lend per loan. Some direct private lenders offer low-value loans that many conventional financial institutions won’t consider.
Marketplace lenders – also called peer-to-peer lenders – leverage a technological platform to circumvent banks and connect borrowers directly with investors. While banks make loans with deposited money, marketplace lenders simply package loans from investors and deliver the funding to borrowers, collecting commissions and fees to make their money. Marketplace lenders typically determine whether or not to award a loan based on a borrower’s credit score.
Crowdfunding platforms are especially popular for businesses in the prototype or startup stage. A crowdfunding platform offers borrowers a place to raise small amounts of money from a large number of individuals. Generally, the borrower sets a goal and then markets their campaign to appeal to potential investors. The benefit of crowdfunding is that it eliminates the application process. However, success is not guaranteed in a crowdfunding model; it comes down to how well you market your campaign and how many people invest in your cause. A relatively new method called equity crowdfunding allows you to directly sell micro-shares of your business to investors.
What types of alternative lending are available?
The alternative lending space is innovative, regularly coming up with new types of small business loans and other forms of financing. As such, it is a diverse space with many different types of loans available.
Here’s a look at 12 of the most common alternative loans for small businesses.
1. Invoice factoring or Invoice Discounting
Invoice factoring/discounting is a type of financing in which a business sells its outstanding accounts receivable to a third party at a slight discount. Typically, a business can expect about 80% of the value of its accounts receivable upfront. The “factor,” as the third party is known, is then responsible for collecting the payments; the 20% the factor saved on the discounted purchase of the business’s accounts receivable represents its potential profit.
2. Structured Finance
Structured finance is an asset-backed facility designed for growing businesses. It enables a business to increase its working capital by funding the operational cycle, i.e. from the time payment is made to a supplier until receipt of funds from customers, thereby leaving internal funds free for other more productive uses, such as sales growth.
3. Purchase Order Funding
Purchase order funding is a facility designed for growing businesses where your business requires funding to supply goods or services upfront to your client. This enables your business to obtain new orders without the stress of obtaining funds to service your client.
4. Lines of credit
A line of credit is a fixed amount of money that an alternative lender extends to a borrower, just like a line of credit from a bank. You can draw from the line of credit up to the fixed amount, paying interest on the amount you borrow.
5. Short-term loans
Short-term loans are any loans scheduled to be paid back in a year or less. Most banks do not offer short-term loans, but they are a common product from alternative lenders. Short-term loans are useful when your business needs working capital or has to quickly cover a one-time cost.
7. Instalment loans
Instalment loans provide a lump sum of money to a borrower, which is then repaid to the lender at regular intervals until the principal plus interest is paid off. Many instalment loans from alternative lenders have a fixed payment amount, meaning the interest rate will not fluctuate during the life of the loan. Instalment loans are commonly used to finance the purchase of real estate, vehicles and equipment that a business needs to operate.
9. Merchant cash advances
A merchant cash advance offers a business cash upfront in exchange for its future credit card sales. Merchant cash advances provide a lump sum of money quickly – sometimes within one day – based on a business’s expected daily credit card receipts. Once the advance is issued, the borrower must pay it back through a percentage of their business’s daily credit card revenue.
Microloans, as the name suggests, are low-value loans. Alternative lenders devised these small loans because conventional lenders like banks typically don’t consider them at all. For many small business owners, these loans are more than enough to open their doors or acquire new equipment. They can also be incredibly short-term, with some repayment periods lasting just a few months.
11. Bridge loans
A bridge loan is a short-term loan backed by an asset, rather than by a credit score. For example, if a business owner is moving from one location to another and is in the process of selling the first location, they can use a bridge loan to purchase the new property and cover all closing costs. The new property would be the collateral for the bridge loan. These loans are typically very short-term, often taking less than a year to repay.
12. Equipment financing
Equipment financing is the use of a loan to purchase the equipment your business needs to operate. This differs from other types of loans, which can be used for more abstract purposes (for example, a working capital loan for staff wages). Equipment financing relies on the equipment itself as collateral; this enables lower rates and more application approvals because it is tied to the equipment rather than your personal credit or annual revenue.
Flex Capital offers Invoice Discounting, Structured Finance and Purchase Order Funding solutions that inject cash flow into your business.
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The source of this article can be found here.