Small Business Guide to Alternative Lending

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 small business owners rely on bank loans or loans from the U.S. Small Business Administration (SBA).

Sometimes, though, small business owners can't qualify for these loans or need something shorter-term or more flexible. In these cases, alternative lenders offer ways to access the capital you need to grow your small 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. It also presents some of the major players in the space to help you find the right lender for your business. If you're looking for more detailed information on business loans, see our reviews and picks for the best loan and financing options.

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Alternative lending industry overview

Alternative lending is the process of turning to nontraditional lenders to invest in your company. According to Morgan Stanley, alternative lending streamlines the process for borrowers who may be underserved by traditional lending institutions. It was born out of peer-to-peer (P2P) unsecured loans, but with the rise of technology and the expansion of online lending opportunities, alternative lending's definition has evolved. Besides P2P unsecured loans, alternative lending sources now include crowdsourcing and marketplace lending.

The growth of alternative lending is projected to continue. According to a recent study from Oracle, over 40% of consumers feel that non-banks can offer more than a traditional bank. Small and midsize businesses, in particular, are experiencing a funding gap – leading them to search for nontraditional sources of money. A survey from Richmond's Federal Reserve Bank found that banks have an approval rate of approximately 58% from small business applications. In comparison, alternative lenders have a 71% approval rate for small businesses.  

Did you know? When it comes to small business funding, alternative lenders are more willing than their bank counterparts to approve a loan. Sure, you'll pay more in interest, but if the benefits of accessing capital outweigh the costs, it's a viable option.

What is alternative lending?

Alternative lending is any lending that occurs outside of a conventional financial institution. Alternative loans tend to be more flexible than conventional loans, and often have a faster application turnaround. Many types of alternative loans are available, so there is likely an alternative loan out there that suits your small business's circumstances.

While most banks and conventional lenders could take weeks to approve or deny a loan application, many alternative lenders can deliver funding in a few days. The loan application process for alternative loans also tends to be simpler, requiring only a credit score, tax returns and bank statements rather than a detailed pro forma or business plan.

In addition, alternative lenders are more likely to offer loans in smaller amounts than banks, which often include minimum lending terms that are too high for a small business. Alternative lenders 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?

Organizations that offer alternative small business loans are called alternative lenders. "Alternative lender" is an umbrella term for several alternative lending models, including 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. They 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 offer low-value loans that many conventional financial institutions won't consider.

Marketplace lenders

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

Crowdfunding platforms are especially popular for businesses in the prototype or startup stage. A crowdfunding platform gives borrowers a place to raise small amounts of money from a large number of individuals. Generally, the borrower sets a goal and markets their campaign to appeal to potential investors. The benefit of crowdfunding is that it eliminates the application process. However, success is not guaranteed; it comes down to how well you market your campaign and how many people invest in your cause.

Bottom line: Variety is the name of the game when it comes to alternative lenders. From marketplace lenders to direct ones, you have many options when looking for funding outside of a bank.

What types of alternative lending are available?

The alternative lending space is innovative; it regularly introduces new types of small business loans and other forms of financing. That makes it a diverse space with many types of loans available. Here's a look at some of the most common alternative loans for small businesses.

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.

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 offering from alternative lenders. Short-term loans are useful when your business needs working capital or has to quickly cover a one-time cost.

Installment loans

Installment loans provide a lump sum of money to a borrower, which they repay to the lender at regular intervals until the principal plus interest is paid off. Many installment loans from alternative lenders have a fixed payment amount, meaning the interest rate will not fluctuate during the life of the loan. Installment loans are commonly used to finance the purchase of real estate, vehicles and the equipment a business needs to operate.

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 pays it back through a percentage of their business's daily credit card revenue.

Microloans

Microloans, as the name suggests, are low-value loans, typically $50,000 or less. Alternative lenders devised these small loans because conventional lenders like banks typically don't consider them at all. For many small business owners, $50,000 is more than enough to open their doors or acquire new equipment. Microloans can also be incredibly short-term, with some repayment periods lasting just a few months.

Invoice factoring

Invoice factoring is a type of financing in which a business sells its outstanding accounts receivable to a third party (referred to as the "factor") at a slight discount. Typically, a business can expect about 90% of the value of its accounts receivable upfront. The factor is then responsible for collecting the payments. The 10% the factor saves on the discounted purchase of the business's accounts receivable represents its potential profit.

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.

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.

Tip: Before you apply for alternative funding, think about what you need the cash for. If it's to bankroll an expensive piece of equipment, a long-term loan or equipment financing may make the most sense. If you need to deal with a cash flow issue or purchase more inventory, a short-term loan is better.

The best alternative lenders and business loans of 2021

Here's an overview of the lenders we think are best for a variety of loan needs.

Noble Funding: Best for customer service

Noble Funding is an alternative lender that puts customer service first. In our review of Noble Funding, we found that it provides borrowers a variety of loan types, including short-term bridge loans and long-term business loans. We like that Noble Funding is willing to work with all borrowers and will continue to service the loan long after the money is in your bank account. Noble Funding doesn't charge upfront fees and will work with you even if your credit is challenged. It doesn't hurt that Noble Funding has been in business since 2005 and has a strong reputation in the market. 

Fora Financial: Best for short-term loans 

Fora Financial is an online lender that provides business owners with short-term loans that are fast to fund and don't have extra fees attached to them. When reviewing Fora Financial, we found that it offers a quick, easy online application and fast funding. That's important for business owners who need cash yesterday. Fora Financial also doesn't require any collateral and little in the way of paperwork. Not to mention this alternative lender doesn't tack on any additional fees. You pay off the loan principal and interest, and that's it. Fora Financial lets you take out loans ranging from $5,000 to $500,000, even though you'll have to pay it back within 15 months. 

Rapid Finance: Best for fast funding 

Rapid Finance is an alternative lender that provides its own loans, as well as a network of lenders, to get you the best loan product in the shortest time possible. Our research proves this. When reviewing Rapid Finance, we found that funding can arrive in your bank account in just a few hours. That's impressive, and key for business owners looking for fast funding. With this online lender, you can borrow anywhere from $5,000 to $10 million through a variety of loan products, including term loans, lines of credit, bridge loans, SBA loans and invoice factoring. 

Biz2Credit: Best marketplace lender

Biz2Credit is a marketplace lender bringing business borrowers and lenders together since 2007. Biz2Credit operates a robust lending marketplace and has arranged more than $2 billion in small business funding since its inception. In our full review of Biz2Credit, we found this alternative lender can accurately match small businesses with sources of capital that meet their unique needs. That really stood out to us, as it can't be said of all marketplaces. Some will sell you a one-size-fits-all loan that may not work for your enterprise. Biz2Credit offers term loans of up to $250,000, working capital financing of up to $2 million, and commercial real estate loans up to $6 million.

SBG Funding: Best for flexible terms 

SBG Funding is an online lender that provides small businesses with a variety of loan products and flexible terms. We found through our comprehensive review of SBG Funding that you can borrow up to $5 million and set repayment terms of as short as six months or as long as five years. We like that SBG Funding gives you a choice in terms and the frequency by which you pay back your loan. You can make payments biweekly and monthly. We also like that SBG Funding is willing to work with borrowers who have less-than-stellar credit scores. The lender says it approves 85% of term loan applicants, which is a testament to its flexibility. You can get a decision in 24 hours and funding within 12 to 48 hours. If you decide to pay off your loan early, you won't get hit with any prepayment fees.  

When is alternative lending a good idea for your business?

Alternative lending is a good option for your small business when conventional lenders either don't offer the financing you need or won't approve you for a loan. It's telling that alternative lending took off following the 2008 financial crisis, when banks were hesitant to lend to virtually anyone; alternative lenders fill the gaps left by conventional financial institutions.

Alternative lending is also a good option for your business if you have an immediate need for capital, especially in low amounts. Whether that's working capital to keep a seasonal business afloat in the offseason or financing for an equipment purchase, alternative lenders can provide fast funding and a short repayment term when banks will not.

While alternative lending offers key advantages for small business loans, there are some drawbacks. To minimize risk and ensure you can repay any loan you accept, you need to know the advantages and disadvantages of alternative lending options before partnering with a lender.

What are the advantages of alternative lending options?

Alternative lenders offer some major advantages over bank loans and other conventional financing options. Here's where alternative lenders outshine banks and credit unions:

• Simple application process: The requirements of an alternative loan application tend to be far less rigorous than those of traditional bank loans. Sometimes alternative lenders simply require access to your digital bank statements to return a verdict on your application.
  
  
• Fast turnaround: In addition to their simplicity, alternative lenders tend to be much faster than banks or credit unions, n terms of both approval and funding delivery. While conventional lenders might need weeks or months to make a determination and extend the capital, alternative lenders can often get small business funding in a matter of days.
  
  
• Flexible loans: Alternative lenders, particularly direct private lenders, have more free rein in how they package loans and financing options. This has allowed alternative lenders to create unique financial products such as invoice factoring and microloans.

What are the disadvantages of alternative lending options?

Banks and credit unions naturally have their own advantages over alternative lenders. Traditional bank loans tend to beat alternative lending options on the following issues.

• Higher interest rates: The less-strict requirements, shorter terms and unconventional nature of alternative loans often translates to higher interest rates than conventional lenders charge. In some cases, this is due to a business's annual revenue and credit score; in others, it has to do with the type of financing a business requires.
  
  
• Short-term loans: While short-term loans can be useful to businesses in some cases, alternative lenders often set short repayment terms even on high-value loans. This means you could end up making higher installment payments to an alternative lender for the same amount of money you could borrow from a bank. 

Alternative lending fills the gaps in business financing

When bank lending isn't possible or desirable, alternative business lending options are worth considering. Whether your annual revenue or personal credit score isn't up to the bank's standards or you just need an amount of money that conventional lenders won't offer, alternative lenders fill in the gaps with a variety of funding options.

Before you choose to partner with an alternative lender, carefully review the terms of the loan. Your ability to repay the loan on time is key to your small business's continued success. When you need funding that the banks won't provide, alternative lenders can help, but always borrow responsibly.

Alternative lending FAQs

What is the cost of alternative lending?

Review the loan terms with the alternative lending provider. Depending on the alternative lending source, you may or may not be subject to an annual percentage rate (APR). Some providers may charge a monthly fee for the loan instead, which is beneficial for those who plan on quick repayment.

If, however, the lender charges an APR that seems low, confirm the fees associated with the loan. For example, the lender may charge an organization fee. An organization fee represents the expense of processing your loan and may cost upward of 3% of the loan amount. Other lenders may charge a set dollar amount for closing costs. At the time of the loan, ask for a breakdown of the total loan costs to understand what you'll be paying in full to borrow the money.

Is alternative lending better than traditional lending?

Alternative lending isn't necessarily better than traditional lending, but it offers distinct advantages. Primarily, alternative lending provides the opportunity to harness funding for small and midsize businesses that may not qualify for traditional loans. Also, alternative lending provides more flexibility, including faster processing and shorter payment terms.

Alternative lenders are also versatile in the amounts that they can provide businesses. In some cases, businesses borrow a moderate amount from an alternative lender in addition to a standard bank loan. Another benefit of alternative lending is the industry relies on risk assessments beyond a credit score to approve loans. 

When did alternative lending begin?

According to Funding Circle, the first alternative lenders entered the marketplace around 2005. Prosper and LendingClub, both specializing in P2P loans, are credited with launching the alternative lending trend. Alternative lending companies were launched to aid small and midsize businesses due to banks' preference for funding corporations, which they consider less of a financial risk. 

Can I get an alternative loan with bad credit?

Yes, some lenders provide lending options to those with bad credit. Instead of looking at a credit score, these lenders will consider qualifications such as minimum annual revenue. The alternative lender also reviews the applicant's experience. For instance, the lender may request that applicants have operated a business for at least a year.

Adam Uzialko contributed to the writing and research in this article.