The Good, the Bad and the Ugly About Alternative Lending for Small Businesses
Every business starts small. During the early stages of your business, things are bound to seem difficult. Unless you have enough of a bank balance to support your dream, there is a chance that your start-up will struggle financially in the beginning. Owners of small businesses are bound to find themselves in a tough spot where they require assistance from outside sources.
What can you do to ensure that your product or service idea materializes? Well, you can take loans to fund your small business. While there was a time when traditional loans were the only way out for small business owners, now you are provided with the option of alternative lending as well.
Traditional vs Alternative Lending
When you think of loans, you may imagine asking a local bank or a credit union for money. These methods come under traditional funding options. It is still one of the most popular forms of funding. However, there is a huge problem with using traditional funding.
Sometimes, business owners may fail to qualify for these loans. This is because traditional loans are accompanied by strict and particular requirements. Moreover, this method takes quite a long time to process and hence is not the best option if you are in dire need of cash.
Compared to traditional methods, alternative lending has managed to deliver a quick and easy way to get loans. The two methods differ in the following ways:
While banks allow you to take a loan at some of the lowest interest rates available for small businesses, alternative lending is generally more expensive. This can be viewed as one of the cons of using alternative funding. The high borrowing cost finds its root in the fact that alternative lenders give you loans from their own funds, which increases the risk and hence the interest rate.
Time of the process
The two methods differ in the speed of loan delivery as well. Here, alternative lending emerges victorious. When you apply for a loan in a bank, the process can seemingly take forever. You collect and submit the form. The bank assesses your profile and credit rating, interviews you and then takes at least three weeks before you can receive the loan.
Meanwhile, alternative lenders give loans at a much faster pace. Everything can be submitted online and you can get funds within a day or two. This is because everything is done online, via accounting and invoicing software. Even if it takes time, you can expect your loan to be processed in 3-4 days.
Apart from the cost of borrowing, there are various other costs associated with lending. For instance, application fee and origination fee are almost always charged by traditional banks. Since there is no guarantee that you will end up with the loan, this makes traditional loans expensive. When it comes to alternative funding, some of these costs don’t exist. This makes this mode of lending cheaper as far as fees are concerned.
While it is harder to qualify for loans when opting for traditional methods, when you use alternative funding such is not the case. This can also be viewed as a good part of using alternative funding.
It is not clear why traditional banks have strict and particular requirements. However, if you are a small business, they might only lend you the money if you have a good credit rating, have enough collateral and have been operational for a given number of years.
Alternative lenders do have requirements as well. However, they are less stringent and hence qualifying for their loans is easier. You might be asked to have a certain minimum credit score. This credit score will be significantly less than the one required by a traditional bank. Rather than showing that your business has been up and running for years, an alternative lender is satisfied with a few months of operation.
What Do We Exactly Mean by Alternative Lending?
Alternative Lending is an umbrella term for an array of loan options. As the name suggests, it refers to all types of lending options other than a traditional bank loan. The question is if the borrowing cost of such loans is significantly high, why would one choose an alternative funding option?
Well, they are usually used when your small business does not qualify for a traditional loan, for whatever reason. As the comparison of the two suggests, it can also be taken when you need money quickly. If you choose wisely, you can find alternative lenders that are flexible about repayment schedules and methods. This flexibility makes them popular among small business owners.
Different Alternative Lending Options
There are various types of alternative lending options. Each of these methods is equipped with the good, the bad and the ugly. Let us analyse each option and then you can decide which alternative lending method, if any, is best for you.
Credit cards allow you to spend more than your income. In the context of a small business, a credit card allows you to take care of your cash flow issues in a swift manner. However, if not used wisely, this funding option can leave you distressed.
Credit cards generally come with a high interest rate. Therefore, if you chew more than you can swallow, you can end up with more debt than you can pay off. This, in turn, creates a bad credit history. The next time you try to apply for a traditional loan, a bad credit history can work against you.
The worse credit rating you have, the higher the cost of borrowing will be for you in alternative funding options. Unless you use a credit card carefully, we will advise you against using this method of funding.
This is one of the good forms of alternative lending. Rather than asking for money to buy equipment, you can just lease the equipment. This won’t be much different from taking loans since you will be required to make regular payments. However, the only problem with this method is that it is only viable if you wish to use the cash you get from the loan for purchasing equipment. However, if your task is to improve your cash flow situation, this method is not very useful.
Are your account receivables piling up? For an established business, this may not lead to problems. However, such instances can lead to cash flow problems for small businesses, which then get translated to a problem in sustainability.
If your business needs instant payments rather than account receivables, you can consider invoice factoring. Invoice factoring is an alternative lending option that allows you to get instant cash. You do this by selling your accounts receivable to another party at a lower cost than the original one. As you can see, the problem with this method is you get less money than you would have gotten from the receivable. However, this does ensure that you are not plagued with being short on cash.
The three options mentioned above are the most popular types of alternative lending methods. However, there are various other options as well. For example, medical practice loans are available which will aid you if you wish to start a medical practice. Similarly, for export businesses, a specific export loan exists. These type of particular loans (according to the small business concerned) are seldom found in traditional banking.
Why Choose or Not Choose Alternative Lending?
When you talk about alternative lending, there is good news and bad news. Just like any other form of funding, it comes with benefits and some flaws. Here is a run-down of the pros and cons:
There are three major reasons why your small business can benefit by choosing alternative lending as its source of funding.
Firstly, such loans are easily accessible. This is the only type of traditional loan out there. However, on the other hand, there are various options for alternative funding to choose from. Additionally, since most alternative lenders use online platforms, ease of accessibility is further enhanced.
Secondly, the speed of getting the cash, as mentioned above, is very high. Generally, you end up getting your chosen amount of cash in less than a day. When you add the technical functions delivered by such lenders, you are bound to feel satisfied with the process. For instance, in alternative lending, mobile accessibility is offered that lets you apply as well as monitor the status of your loan without having to physically visit any place.
Thirdly, unlike traditional funds, small business loans offered via alternative funding feature small denominations. Therefore, if you need money but don’t want to take too big of a loan, alternative lending succeeds in being the perfect option.
Fourthly, the approval rates are significantly high in alternative lending. As discussed above, this is because the requirements are low. Therefore, the chances of your loan getting accepted are high.
All in all, there are quite a lot of benefits you can reap if you opt for alternative funding for your small business.
The Bad and the Ugly
Is alternative lending free of all vices? No. It also exhibits quite a few flaws. Here are some of the major flaws of this type of lending:
Problems of Reliability
Many believe that alternative lenders are not completely transparent about their transactions, or their business model. People tend to take their lack of requirements as an evidence of their unreliability. Moreover, currently, most alternative funding methods are protected from government regulations. These regulations are subjected to banks and credit unions. Therefore, there is no guarantee when you use alternative funding methods if the loaner is following legal methods or not.
Cost of Borrowing
Some find the swift speed of cash distribution to be not worth the exuberant cost of borrowing that alternative lenders charge as a catch. Sometimes it is understandable as to why such lenders charge a high price. After all, they give low denomination loans without checking your credit history as thoroughly as traditional loans. However, the fact that even within the industry of alternative lending, some lenders charge very high rates compared to others shows that a lack of regulation may lead to exploitation.
What to do?
As you can see, no financing option is free of flaws. What does this mean for small business owners? Well, it just means that on top of all the other things you need to decide, it is time you add the decision of choosing a financing option to it as well.
There is no correct answer regarding which financing option you should select. After all, both options come with a wide array of features, pros, and cons. It all boils down to your business situation, need, and capabilities. For those of you who qualify for a traditional loan, we would advise you to go for them unless you need quick cash. This is because it is a tried-and-tested method which features a low-interest rate.
On the other hand, if you don’t qualify for these loans, need quick money, or wish for a low denomination loan, alternative lending is your best option. While there are a few issues with this type of financing, if you choose your lender wisely, you can avoid quite a few of the pitfalls of alternative lending.
Individuals who wish to choose alternative funding, ensure you select a lender that is reliable and trustworthy. Search and read up on the various methods within the umbrella term of alternative lending. Pick one which best suits your need.
In the long-run, traditional bank loans are the way to go. However, starting a small business is very hard. If you find a quality lender, there is no harm in choosing alternative lending.
You are free to decide for yourself. Analyse whether the good outweighs the bad and ugly. If it does for you, then go ahead. Use your funds wisely. Watch as your small business grows into a not-so-small business.