Alternative Lending 101: A Guide To Small Business Loans

As a small business owner, you may have experienced the difficulty of getting traditional bank loans. But now, there are many financing options available to help you secure the funds you need for your business.

Alternative business lending, including crowdfunding, peer-to-peer lending, venture capital, and angel investment, has seen significant growth in recent years. According to a report from the Cambridge Centre for Alternative Finance, the global online alternative finance market reached $114 billion in 2020, with P2P/Marketplace Consumer Lending as the largest model (31% of the global market share).

This guide will provide you with a comprehensive overview of alternative lending options and their pros, cons, and risks. Learn more!

Related: How To Get A Loan To Buy A Business: All You Need To Know

What is an alternative business loan?

Alternative lending is the practice of obtaining small business loans from non-bank lenders. These alternative lenders are typically not regulated by traditional banking institutions and offer alternative financing options to small businesses.

Alternative lending has gained popularity among small business owners in recent years due to the ease of accessing funds and the flexibility of repayment terms that traditional banks and credit unions don't usually offer. Alternative lenders are a great option for small businesses that are unable to qualify for a traditional business loan due to a minimum credit score or lack of collateral.

Differences between traditional and alternative lending

Traditional lending and alternative lending differ in many ways, including their sources, requirements, processes, and terms. Here's a breakdown of the main differences between the two:

Category: Funding Options

• Traditional Lending: Banks, credit unions, and other financial institutions.
• Alternative Lending: Non-bank lenders, online platforms, crowdfunding, peer-to-peer lending.

Category: Requirements

• Traditional Lending: Strong credit scores, collateral, detailed business plan, annual revenue history. Lengthy approval process.
• Alternative Lending: Flexible requirements focusing on cash flow, business performance. More willing to work with less-than-perfect credit scores.

Category: Speed and Convenience

• Traditional Lending: Slow approval process, taking weeks to months.
• Alternative Lending: Quick processing, potential funding in a few days.

Category: Loan Amounts and Terms

• Traditional Lending: Higher loan amounts, longer repayment terms.
• Alternative Lending: Lower maximum loan amounts, shorter repayment terms, more flexibility.

Category: Interest Rates and Fees

• Traditional Lending: Lower interest rates and fees for strong credit.
• Alternative Lending: Can vary widely, may be higher for higher risk profiles.

Category: Use Cases

• Traditional Lending: Large, long-term investments (real estate, equipment financing, business expansion).
• Alternative Lending: Short-term needs (working capital, inventory purchases, bridging cash flow gaps).

Category: Risk and Security

1. Traditional Lending: Often require collateral (real estate, equipment).
2. Alternative Lending: May not require collateral but charge higher interest rates to offset risk.

6 Types of alternative lenders

1. Peer-to-peer (P2P) lending

Peer-to-peer lending, also known as P2P lending, is a type of non-bank lending where individuals lend money to other individuals or businesses through online platforms. P2P lending has become an increasingly popular alternative financing option due to its flexibility and fast approval process.

Pros

P2P lending offers lower interest rates compared to traditional bank loans, making it an attractive financing option for small businesses. The application process is also quick and easy, and funds are disbursed within a few days.

Cons

P2P lending has a high risk of default, and the borrower's credit score heavily influences the interest rate. P2P lending platforms also charge a fee for their services.

2. Crowdfunding

Crowdfunding is a type of alternative business lending in which a large number of individuals contribute small amounts of money to finance a project or business idea. It can take several forms, including equity crowdfunding, reward-based crowdfunding, and donation-based crowdfunding.

Pros

Crowdfunding provides an opportunity for small businesses to access capital without incurring debt. It also allows businesses to validate their business idea and build a community of supporters.

Cons

Crowdfunding is time-consuming and requires significant effort to create a compelling campaign. It is also not suitable for all types of businesses, as some may not have a strong enough brand or business idea to attract supporters.

3. Business lines of credit

A business line of credit is a flexible financing option where a lender extends a credit limit to a borrower, which can be drawn upon as needed. Interest is only charged on the amount borrowed, and the business owner may repay and redraw funds as needed.

Pros

Business lines of credit offer flexibility and can help small businesses manage their cash flow and unexpected expenses. They may also have lower interest rates than credit cards and other types of financing.

Cons

Business lines of credit may have higher interest rates than a traditional business loan, and non-alternative lenders may require collateral or a personal guarantee. The borrower's personal credit score may also heavily influence the interest rate.

Read: Effects Of Inflation on Lenders & Borrowers: Who Benefits?

4. Alternative business loans

Alternative small business loans that are offered by a non-bank lender such as an online lender, private lender, and microlender. These alternative lenders offer flexible repayment terms and may require less stringent credit score requirements compared to traditional bank loans.

Pros

An alternative lender offers quick access to funds, and the application process is fast and easy. They also offer flexible repayment terms and lower interest rates than traditional bank loans.

Cons

Alternative business loans have higher interest rates compared to traditional bank loans. The repayment terms of traditional loans may also be shorter, and some lenders may require collateral or a personal guarantee.

5. Revenue-based financing

Revenue-based financing (RBF) is a type of alternative financing that has gained popularity in recent years. In RBF, investors provide capital to a business in exchange for a percentage of the business's future revenue. The repayment of the financing is tied to the business's revenue, and the investor is repaid through a percentage of the business's revenue until the agreed-upon amount is reached.

Pros

RBF offers alternative financing methods versus traditional debt, and the repayment is based on a percentage of revenue, which provides flexibility for the business. Additionally, RBF investors are typically not involved in the business's operations, unlike equity investors who may require control or decision-making power.

Cons

RBF may have higher interest rates compared to traditional bank loans and may require a larger percentage of revenue to be repaid to the investor. RBF may also limit the business's ability to raise future financing or attract new investors.

6. Fixed term loans

A fixed-term loan is a type of loan also used by traditional financial institutions where a borrower receives a lump sum of money upfront, which is repaid over a fixed term with interest.

Boopos offers experts adivce on financing options for you to consider.

How to choose the best option for my business?

Finding small business financing can be a tedious process, but focusing into a couple variables such as your inancial situation, credit history and funding needs can help you find the right choise.

• Credit History: If you have a strong credit history and can meet the requirements of traditional lenders, you may be able to secure a loan with lower interest rates and favorable terms. However, if your credit history is less than ideal, alternative lenders may be more willing to work with you.
• Funding Needs: Consider the amount of funding you require and the purpose of the loan. Traditional lenders may be more suitable for large, long-term investments, while alternative loans may be better for smaller, short-term funding needs.
• Speed of Funding: If you need funding quickly, alternative lenders often have faster approval processes and can provide funds in a shorter timeframe compared to traditional lenders.
• Flexibility: Nontraditional lenders may offer more flexible terms and repayment options compared to traditional lenders, which can be beneficial for businesses with fluctuating cash flows.
• Cost: Compare the interest rates, fees, and overall cost of borrowing between traditional and alternative lenders to determine which option is more cost-effective for your business.
• Collateral: Consider whether you are willing and able to provide collateral to secure the loan. Traditional lenders often require collateral, while some alternative lending companies may offer unsecured loans.
• Risk Tolerance: Evaluate your risk tolerance and comfort level with different types of lenders. A traditional lender is often perceived as less risky, but it may have stricter requirements and longer approval processes.

Find the right financing model

Alternative lending options offer small business owners access to financing that may not be available through traditional banks. Ultimately, the best option for your business will depend on your specific circumstances and priorities. It may be beneficial to explore both traditional and alternative lending options to determine which one aligns best with your needs.

If you are a business owner considering alternative lenders, explore different options. With careful consideration and planning, an alternative business loan can be a valuable tool for your business's growth and success.

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