Running a small business is a challenging endeavor, often fraught with hurdles that test the resilience and adaptability of an entrepreneur. Unlike large corporations, small businesses typically operate with limited resources; financial constraints and a smaller workforce mean that owners often wear multiple hats, from handling customer service to managing finances so being able to secure adequate funding to sustain and grow their operations is vital.
While traditional bank loans are often the go-to source for business financing, the stringent credit requirements and lengthy approval processes can be a deterrent for many. This is where alternative financing comes into play, offering a variety of solutions that are often more flexible and accessible than traditional funding methods. In this blog, we will explore the various alternative financing options available for small businesses and discuss why they are becoming increasingly popular choices.
1. Why Consider Alternative Financing?
Before diving into the different types of alternative financing, it’s crucial to understand why they might be such a good option for small businesses. Traditional banks often have strict lending criteria, which can be difficult for newer businesses or those with fluctuating revenues to meet. Moreover, the process can be time-consuming, taking weeks or even months to get an approval, which may come too late if the financing need is urgent. Alternative financing, on the other hand, typically offers a faster, more streamlined application and approval process, making it an attractive option for businesses that need quick access to funds or those that might not qualify for traditional loans.
2. Types of Alternative Financing
Crowdfunding:
This involves raising small amounts of money from a large number of people, typically via online platforms. Crowdfunding is not only a way to raise capital but also a great method to validate a product or service in the market. Platforms like Kickstarter and Indiegogo allow entrepreneurs to launch their ideas while gaining a base of supporters who are interested in their success but do typically charge fees as a percentage of the funds raised. Additionally, costs related to rewards, shipping, and marketing can add up, reducing the overall funding available to the project.
Not all projects funded through crowdfunding succeed, and failure can damage the reputation of those involved. Moreover, backers generally have no recourse to recover their funds if the project fails after funding is released and the pressure to meet backers’ expectations on deliverables and timelines can be intense. Sharing an idea before it is fully developed can expose creators to the risk of copycats who might steal the idea and bring it to market more quickly.
Peer-to-Peer (P2P) Lending
P2P platforms connect borrowers directly with individual lenders, bypassing traditional financial institutions. Sites like LendingClub and Prosper facilitate these transactions, offering both personal and business loans. The rates can often be competitive, and the requirements more relaxed than those of banks. If a borrower defaults, the ability of lenders to recover their funds is limited. Unlike banks, P2P platforms typically do not have the same level of security or guarantees, making recovery efforts more challenging.
Merchant Cash Advances (MCA)
This option provides businesses with a lump sum of capital in exchange for a portion of future sales, typically credit card transactions. It’s particularly useful for B2C businesses with high credit card sales volumes but less-than-perfect credit ratings. The repayment is a percentage of the businesses’ daily credit card income, taken directly from the processor that clears and settles the credit card payment.
Online Business Loans
Many online lenders offer various loan products tailored to small businesses, often with less stringent requirements and quicker turnaround times than traditional banks. Companies like OnDeck, Kabbage, and Funding Circle provide short-term loans and lines of credit based on the applicant’s business performance rather than just credit scores. Loans amounts may only go up to $250,000 and still require the business to have been in operation for at least a year and the owner to have a credit score somewhere in the 600’s and a proven minimal annual revenue amount.
Both MCA’s and Online Loans provide a business with quick access to capital, with no collateral and easier approval criteria than a traditional bank loan or line of credit. On the negative side, they are much more expensive than traditional financing and repayments can be taken automatically from funds received in the business bank account which can lead to cash flow problems if those funds were needed for other expenses such as rent or payroll on that day.
“Loan stacking” is a common occurrence and happens when a business has taken out multiple merchant cash advances before paying off the first one because they need additional funds, often to make the repayments. Once in this position, it gets very difficult to secure additional financing to exit the situation. Defaulting on a merchant cash advance or online loan can have devastating consequences for your business. The funder can quickly drain your accounts, disrupt operations, and pursue legal action against company and personal assets.
Invoice Financing
Also known as factoring or account receivable funding, this option allows businesses to sell their outstanding invoices to a third party at a discount in exchange for immediate cash. This is a useful solution for businesses that sell to other businesses on credit terms as they no longer have to wait 30, 60 or even 90 days to get paid.
They now have the cash flow to manage day-to-day operations and an ongoing working capital line of credit moving forward. Many factoring companies do not have a time in business, minimum revenue or credit score requirement as they look at the quality of the end customer rather the business and its owner and can offer facility limits as much as several million dollars when appropriate. Fun fact, this financing mechanism is believed to date back as far as the Roman times, and helped fund the Mayflowers voyage to the America’s.
3. Benefits of Alternative Financing
Accessibility
Perhaps the most significant advantage of alternative financing is its accessibility. These options often have less stringent qualification requirements, making it easier for small businesses that might not have been in business very long or an extensive credit history or collateral to pledge.
Flexibility
Many alternative financing options provide more flexible terms, such as repayment plans tied to business income, which can be particularly beneficial for businesses with seasonal fluctuations in revenues.
Speed
Time is money, especially in business. Traditional loans can take months to process, and then result in a turn down, whereas alternative financing methods like online loans can provide funds in as little as a few days or even hours. This speed can make all the difference for a business needing access to capital quickly to make a purchase or critical payment.
Technology-Driven Solutions
At the heart of alternative lending is the use of cutting-edge technology. Many alternative lending platforms provide user-friendly online interfaces that allow borrowers to apply for loans, upload necessary documents, and manage their accounts easily from their computers or mobile devices. This tech-driven approach not only makes the process more convenient but also improves the accuracy and security of the lending process.
Support and Networking Opportunities
Platforms such as crowdfunding not only provide financial support but also build a community around your business. This can be invaluable for marketing and networking purposes, creating a base of customers who are emotionally and financially invested in your success.
4. Conclusion
Alternative financing offers small businesses a range of options to meet their specific financial needs. With benefits such as flexibility, accessibility, and speed, it’s no wonder that more and more business owners are turning to these innovative, easily available solutions. Whether it’s through crowdfunding, P2P lending, merchant cash advances, online loans, or invoice factoring these alternative solutions are helping small businesses grow and thrive in a competitive market. The world of business financing is ever changing, offering more opportunities and solutions for entrepreneurs everywhere.