Alternative Finance Guide

By Ram - Apr 12 2024

Lending options for businesses are increasing, providing businesses with more flexible and accessible funding options for entrepreneurs. The world of alternative lending hosts many benefits for entrepreneurs looking to bring their ideas to life. However, many might find this line of lending a bit mysterious.

In this guide, we break down the basics of providing business owners with a comprehensive understanding of the benefits and considerations to have in mind when opting for alternative financing.

What is Alternative Financing?

Alternative financing refers to financing outside the institutional finance system of banks and capital markets. The Fintech ecosystem also falls within the realm of alternative finance.

Generally, alternative financing tends to be more flexible than conventional loans and often have a faster application and turnaround time. Many alternative loans are available, so an alternative loan is likely suited to your business.

On average, most banks and conventional lenders take weeks to approve or deny loan applications. Alternative lenders, on the other hand, can deliver funding in a few days. Alternative financing application processes also tend to be simpler, only requiring a credit score, tax returns and bank statements rather than a detailed business plan and pro forma.

Alternative financing is also more likely to offer loans in small amounts than banks, which often have minimum lending terms that are too high for small businesses. These unconventional lending options allow businesses to leverage assets like their accounts receivable or credit card sales instead of borrowing on credit.

What are Alternative Lenders?

Organisations offering alternative financing are called alternative lenders. This is an umbrella term that refers to various lending models, which include the following:

Direct Private Lenders

These lenders use their money to issue loans rather than relying on depositors or investors. Direct private lenders are extremely flexible in granting applications. They tend to offer diverse types of loans, including asset-backed ones like bridge loans.

Direct lenders can also be more flexible in how much they lend per loan. Some can offer low-value loans that many conventional banks won’t consider.

Marketplace Lenders

These are also called peer-to-peer lenders. They use a technological platform to bypass banks and connect borrowers directly with investors.

Marketplace lenders simply package loans from investors and deliver funding directly to the borrowers, collecting commissions and fees to make their money. These lenders typically decide whether to award a loan based on your credit score.

Crowdfunding Platforms

Crowdfunding platforms are popular for businesses in the startup or prototype stage. The platform allows borrowers to raise small amounts of money from many individuals.

Ideally, the borrower sets a goal and markets their strategic campaign to appeal to potential investors. Using this method of funding, businesses eliminate the application and vetting processes. However, this method doesn’t guarantee success. It depends on how well you market your campaign and how many people invest in your cause.

Types of Alternative Lending Available

The alternative lending space is innovative, with new types of business loans and other financing forms regularly being introduced. This makes it a diverse space with many types of loans available. Some of the most common alternative loans for small businesses include:

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 up to a fixed amount from the funds, only paying interest on the amount you borrow.

Short-term Loans

These are loans scheduled to be paid back in a year or less. Most banks don’t offer short-term loans. But they are common among alternative lenders. Short-term loans are helpful when your business needs working capital or has to cover a one-time cost quickly.

Instalment Loans

These loans provide a lump sum of money to a borrower. The loan is then repaid to the lender regularly until the principal plus interest is paid off.

Instalment loans from alternative lenders have a fixed payment amount, meaning the interest rate doesn’t fluctuate during the life of the loan. The loans can finance the purchase of real estate, vehicles and any equipment the business needs.

Merchant Cash Advances

A merchant cash advance offers a business cash upfront in exchange for its future credit card sales. The advance is a quick lump sum of money, sometimes within a day, based on the business’s expected daily credit card receipts. Once the advance is issued, the borrower repays it through a percentage of the business’s daily credit card revenue.

Microloans

These are low-value loans, typically worth less than $50,000 or less. Alternative lenders devised these small loans because they are not available in banks. The loans are ideal for small businesses that don’t need more than $50,000 to open their doors or buy new equipment. These loans are also short-term, with some repayment periods lasting just a few months.

Invoice Factoring

This type of financing is when the business sells its outstanding accounts receivable to a third party (called the “Factor”) at a slight discount. The business can expect up to 90% of the value of its invoices to be paid upfront less the factoring fee. The factor may then also be responsible for collecting the payments. The 10% is called retention and released back to the business upon full payment by the customer[s], less any additional cost if applicable.

Bridge Loans

This is also a short-term loan backed by an asset rather than a credit score. 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 the closing costs. The new property would be the collateral for the bridge loan. These loans are short-term, often taking less than a year to repay.

Equipment Financing

Equipment financing is a loan used to purchase equipment for your business. It differs from other loans, which can be used for more abstract purposes like working capital or payroll. Equipment financing relies on the equipment as collateral, enabling lower rates and more application approvals because it is tied to the equipment rather than your personal credit or annual revenue.

Closing Remarks

The uptake of alternative financing among businesses is higher because of the adaptable repayment structures, flexibility in using funds, and high approval rates. However, you should consider the cost of the financing and the lender’s reputation and understand the terms and conditions before applying for alternative financing.

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