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Guide to Alternative Lending for Small Businesses

Liberty Capital Group | Small Business FundingSmall Business AdviceGuide to Alternative Lending for Small Businesses

Feb

6

Guide to Alternative Lending for Small Businesses

Do you see all the big, successful businesses around you? Do you know most of them were started by entrepreneurs who did not have any money and had to borrow from various sources to make the company what it is today? When you are an amateur and do not have much money but have a big business idea that has the potential of taking you up the ladder of success, you will find it surprising that the bank may not be willing to give you a loan for your startup for multiple reasons. Plus, you may find its interest rate to be quite high.

When such a situation arises, you look for other lending options available to you. These options are called alternative lending. Alternate lending options are usually available online and allow new business owners to get in touch with investors who are willing to lend a good amount of money for a new business. Of course, you will need to repay the money within a specified time or allow the investors to have a share in your company.

Before you actually choose an alternative lending method, you need to know many ins and outs that are associated with it. Keep reading and you will find everything you need to know about this method.

Getting Started

A few years ago, this method practically did not exist and people did not even know much about it. However, as the world, networking, and technology evolved, so did the types of lending methods. Now, it has become an integral part of the finance industry as the world is now witnessing the rise of entrepreneurs and the need for borrowing money. If this did not exist, many businesses that you know today would not exist either. Can you imagine a world without Google?

Alternative lending has allowed businesses to expand, grow and become successful. If this method did not exist, many economies around the world would not have risen and there would not be as many businesses as there are now.

A few things that you need to know about alternative lending are as follows:

  • This option is usually provided by nonbank lenders who give/invest their money in small and new businesses and take a special interest in startups.
  • The approval rating of alternative lending is much higher than that of banks. Whereas the bank’s approval rating varies from 15 to 20 percent, alternative lending can have a rating between 61 and 64 percent.
  • It is a fast-growing industry. In 2013, the amount of money lent through these channels amounted to $3 billion, and that was the double of what it was in 2012. It is thought to increase at least tenfold in the next few years.
  • There are many benefits associated with alternative lending which includes the likes of increased flexibility, quicker funding, and less paperwork. However, one downside that you may witness is that these methods can have a slightly higher interest rate.

Online Lending and Alternative Lending

As mentioned earlier, you will usually find alternative lending options online. Though there may be some firms operating via retail outlets as well, it is usually done on the internet, for example, through Fundera.

Even though it is sort of like a bank, there are major differences including the fact that these channels are more flexible and faster. Online lenders will use algorithms to underwrite a loan and will allow their software to analyze your business and sync your accounts. There are some peer-to-peer models as well. All in all, you will find these online options to be more adaptable, faster and even smarter.

Difference Between Alternative Lending and Bank Lending

There are a few major differences between the way a bank works and alternative lending works.

  • Speed – You will find alternative lending to be much faster and quicker in terms of processing, payment, and everything else. This is mostly because alternative lenders are not bound by the many regulations imposed by the government, such as those on banks. Also, less paperwork is required for alternative lending and you don’t need to provide complex business plans and full financials. Also, the technology related to alternative lending is more advanced which makes it even quicker. The software and programs are far more complicated and efficient than that of a bank.
  • Flexibility – Banks are only limited to offering their customers lines of credit, business credit cards or term loans. However, alternative lenders can actually look into other types of sources for startups. Plus, you can get almost any size of loan you want with alternative channels.
  • Accessibility – Applying for an alternative loan is much quicker and easier than applying for a bank loan. You can easily do it online, whereas for banks you have to go to the branch and have the loan processed and evaluated. Also, there will be a lot of meetings and paperwork that will need to be filled with a bank, which is not needed with alternative methods.
  • Affordability – Banks are very picky about the people they give a loan to. They thoroughly analyze one’s background and records before deciding whether to give them a loan or not. As a result, they have the liberty to charge lower interest rates. On the other hand, alternative lenders will be willing to accept people who have a low credit score or not much of a background. Hence, to secure themselves, the lenders will charge higher interest rates.

Types of Alternate Lending

There are various types of alternate lending that you can get for your startups or small businesses. These techniques have been used by many people who have managed to start successful businesses. They are quite simple to understand and can actually prove to be better than getting a loan from the bank. Some of the types are mentioned below.

Angel Investors

These are the types of investors who you will ask for help when you have a new business (either a fresh startup or one in its early stages). However, like all investors, they will want their share in the business and their money back as well. Usually, the exchange rate for angel investors varies between 20% and 25%. If you are wondering about some examples of businesses that had angel investors, you will be surprised to know that Costco and Google are on the list.

It is best to go through the profile of your angel investor before taking their money. This way, you will have a fair idea whether they actually believe in your business. Plus, some strategic experience on their side might come in handy for you.

Venture Capitalists

Small firms that specialize in the area of venture capital have the main aim of providing new startups with money so that they can build themselves. They are more interested in investing in businesses that have a high-risk potential as well as high growth. This means that they will evaluate every business thoroughly before deciding whether to invest in it or not.

If you have a fast-growing company with a strong exit strategy, you are in luck as it can help you get a lot of money to help you grow, network and invest as frequently as you want.

It is true that venture capitalists usually have a specific industry in mind, for example, the food industry, and would like to focus their attention wholly on companies that are promoting this industry. Plus, as they have experience in the sector, they are in a position to help new entrepreneurs set up a successful business and strategize according to their needs.

The only downside about venture capitalists is that they do not have much patience and look forward to getting their money back as soon as they can. At times, you may only get a short window of 3 to 5 years.

Factoring/Invoice Advances

This is a slightly different process of lending as you will need to show receipts, invoices or bills that have accumulated against your business. You will show them to the finance provider, and they will lend you the money, but you will have to pay them back as soon as you have managed to settle the bill with your customers.

With this method, you can get the money necessary to help your business grow while managing to pay back the advance as soon as you get the money back from your customers.

The best part about this type is that you get to close the pay gap that tends to occur between the payments that need to be made to your partners and your billed services have. It also allows you to get your hands on new projects and start working on them as soon as possible. Once you have a steady cash flow, the business will grow and you will even be able to get new employees. Both the lender and the borrower will be happy in this situation.

Crowdfunding

You must have already heard of crowdfunding as it is one of the most sought-after alternates. It is usually carried out on digital mediums via the use of websites such as Indiegogo and Kickstarter. On these websites, you get to promote your business and explain what you are all about in a way that can attract as many investors as possible.

These potential investors pour in a small sum each, which can grow out to be a large one once the entire investment has poured in. Hence, you get to have a number of investors in your business instead of just one.

A word of caution is that you should read all the details, especially the fine print, on the crowdfunding websites so that you have a clear idea of how they operate and what you will get out of them. For example, you will need to check the payment process, the fees associated with using the website, and how to keep the money raised until you reach your goal.

Grants

Grants are usually provided by the government, and the amount of money offered is quite high. However, you have to fit the profile and fulfill the requirements completely before you can actually get your hands on a grant. Such grants are usually only provided to people participating in some form of research or scientific work. Some of the programs included in this type of lending consist of STTR and SBIR. If you get such a loan, you will have to meet the federal research and development criteria and there is a very high potential for your project to get commercialization.

Pros and Cons of Alternative Lending

Summing up the entire guide, we have listed down a few pros and cons of this method in order to help you summarize the basics.

Pros

  • Alternative lending is faster and easier to apply for than other methods. This is especially true thanks to the advanced technology. It takes around 30 minutes or less to apply for such loans online, and you almost never have to make a physical presence.
  • The turnaround time associated with this lending is very quick. The applications will be processed quicker and the funding will be provided sooner as well.
  • The underwriting with these channels is quite flexible. You do not need a whole bunch of paperwork to get your loan processed or approved.
  • You get the chance to experience a diversity of loans and new types of financing. You can get paid for invoices or the whole amount. It is up to you to choose the type that suits you best.

Cons

  • Alternative lending can be more expensive with higher interest rates as the investor is taking a risk with your business.
  • You get a smaller amount of money which needs to be returned in a shorter time.
  • The payments need to be more frequent to keep the investors happy.

Guide to Alternative Lending for Small Businesseskazaa 8:35 am February 5th, 2018