Alternative funding options for small businesses
In part one of this series, we looked at the different reasons for getting a small business loan and determined the right time to apply for loans based on what you want to do with the funds and your personal and business credit history.
In part two, we talked about the different types of loans that a small business can apply for from traditional lenders, specifically a bank or credit union. In part three, we discussed how to apply for small business funding and why banks often say no to small business loan requests.
Which brings us to part 4, the final article in this series. Here we look at what your options are if you didn’t qualify for loan from a big bank and answers your questions about alternative funding – what it is, the benefits and risks, types of alternative funding offers and where to find trustworthy alternative funding sources.
What is alternative funding?
Also known as “alternative lenders,” these funding sources provide working capital and other forms of financing for small and medium-sized businesses whose owners need to access funds quickly and/or don’t qualify for more traditional loans from banks or credit unions.
Many alternative funders conduct their businesses primarily online. Rather than requiring massive amounts of paperwork, in-person meetings and detailed business plans, alternative funders rely on targeted algorithms and the current financial status of a business to determine whether to offer funding. It’s a simpler and far more streamlined process.
Benefits of alternative funding
People without a strong personal credit rating often turn to alternative lenders when they realize that they don’t qualify for a small business loan – particularly one with good rates – without a credit score of at least 700.
Time is also an issue. Many small business owners work around the clock to run their businesses. They struggle to find the time (usually about 25 hours) to complete the paperwork needed for bank loans and work through the loan application process. Plus, even if approved, applicants often wait a month or more for the funds to actually be available for use.
All that effort might be acceptable if the end result was a loan. But small businesses typically are not a big bank’s preferred customer. Some banks do not lend to businesses within particular industries (for example, restaurants) or those below revenue thresholds of $2 million. Traditional funding sources simply see small businesses as a huge risk, and also point out that servicing a loan to a small business takes as much effort and time as more profitable and less risky loans to big businesses.
Community banks and credit unions often have less restrictive guidelines, but still rely heavily on personal credit scores to determine whether a loan is approved.
Alternative funding was created in response to the difficulties that small businesses have experienced with the traditional loan process, and the opportunities to quickly assess funding applications enabled by data analysis and other technology that supports smarter decision making.
Risks of alternative funding
There are two issues to be aware of when you are reviewing alternative funding options – costs/fees and scams. Neither of these risks are specific to the alternative funding business.
If you don’t have an excellent credit score, you will pay more in fees for a loan. Financial institutions assign a quality score to a loan based on a borrower's credit history, collateral and likelihood of repayment of the principal and interest. Credit scores indicate a pattern, and one that banks feel is likely to repeat – if you habitually pay back your debits, chances are you will continue to do so. If you’ve struggled to repay in the past, banks manage that heightened risk with higher fees, interest and collateral requirements. Or they simply reject the loan.
Alternative lenders take a different approach, but still need to mitigate the risks of working with businesses that may not be able to repay funding. Higher fees are one way to do this, and automatic payments from a merchant account are another frequently used tactic. But you logically can’t expect preferred terms without a nearly perfect credit history.
You also want to make sure you’re working with a trustworthy lender. Some of the ways to do this is check the lender’s business address, and ensure business is actually being conducted from that physical address. Also check online reviews and Better Business Bureau scores. Beware of offers that sound too good to be true and offers with significantly lower rates than you have seen from other sources.
As with any other subject you are researching, you’re likely to suddenly see a flood of ads and emails from companies offering you amazing deals on funding. Use your common sense and business savvy.
You may also choose to work with a partner such as One Park Financial to simplify the funding process. One Park Financial is not a funder, the company instead helps you understand your options, pre-qualifies you for funding and then connects you with the right members of its network of funders.
Types of alternative funding
Merchant cash advances enable smaller businesses to access funding quickly. And since MCAs are not loans - they are an advance against a business’s future income - no collateral is needed. The funder provides a lump sum advance on the merchant’s future revenues. The advance is then repaid from a set percentage of the merchant’s actual revenues. For example, if the set percentage is 10%, and the day’s revenues total $5000, then the repayment amount for that day is $500. On another day, when revenues are $1,500, the repayment amount would be $150. Repayments are automatically withdrawn until the advance and any associated fees and interest is paid back.
Typically, merchant cash advances were available to small businesses such as stores or restaurants that were paid primarily by credit or debit card. Funders were paid back directly from payment card receipts. MCAs can now be paid back by remitting the agreed upon percentage from a business bank account through ACH (Automated Clearing House) withdrawals. You no longer need to be a “merchant” to get a merchant cash advance.
Accounts Receivable Financing, also known as Invoice Financing/Factoring provides expedited access to uncollected funds owed to your business. You get an advance on the money due, the lender later collects the amount, plus fees and interest. Depending on the agreement, the funder will collect the money directly from the company that owes the money (e.g.: your customer) or the small business owner is responsible for collecting on the invoice and paying back the advance along with fees and interest.
Equipment loans provide funding up to 100% of the value of business equipment owned by a small business, such as computers, vehicles or machinery. The equipment itself is the collateral for the loan, making this an option that may met the needs of business owners who have substantial equipment assets but will low or no credit ratings.
Requirements vary according to the type of funding, the amount requested, and the funder.
How to get funding for your small business
One easy way to get started is by getting pre-approved by One Park Financial, which then gives you access to a funding expert who can discuss your business needs and options to determine what funding types best meet your needs.
One Park Financial works to help owners of small and mid-sized businesses access the funding that meets their needs. Established in 2010 and founded by entrepreneurs, One Park Financial understands the challenges associated with small business loans and their need for working capital. Visit oneparkfinancial.com or call 855.218.8819 and connect with a funding expert to discover the options that make sense for you and your business.