Securing funds to either start or grow business was once every entrepreneur’s worst nightmare. In the past, big banks and credit unions often rejected loan applications, leaving business owners with the only option of borrowing from friends and family or borrowing against receivables.
A lot has, of course, changed mainly because business owners today have more options than before. Alternative lenders and institutional investors have made it easier for entrepreneurs to access funds and grow.
For a small business owner, it pays to understand how institutional lenders and alternative lenders differ and the best options available to get funds.
Small Business Funding Options
Alternative Lenders
Alternative lending took off during the 2008 financial crisis when big banks backed out of small business funding. At that time, online lenders stepped in to fill the vacuum and assist small businesses. They created web-based lending platforms that facilitated a faster loan application process and provided the much-needed respite to small businesses.
Today, alternative lenders are the new normal for small businesses looking for funds to meet their financing needs. Some of the well-known alternative lenders include Kabbage, OnDeck and CAN Capital.
There are four main types of alternative lending options available to small businesses. These are:
- A line of credit that provides access to a set amount of cash that’s mostly used to meet short-term financing needs.
- A term loan that allows business owners to borrow and repay the loan amount in about four or five years.
- Invoice factoring that helps businesses deal with unpaid invoices.
- Merchant cash advances that help businesses get an advance on future credit card or debit card sales.
Pros and Cons of Alternative Lending
Alternative lending is a good option when you are looking for funds to address an urgent business need. To give an example, if there is a plumbing issue that needs to be fixed immediately, you can use alternative lending options to secure funds in no time.
Another big advantage of alternative sources of financing for small business is simplicity. Unlike big banks, alternative lenders require fewer documents to process loan requests. That’s because for the alternative lenders, the main focus is whether you have the cash flow to repay the loan.
Alternative lenders also offer longer-term loans to invest in your growth. For example, if you want to recruit more workers or open a new store, you can opt for alternative lending options.
For all the benefits associated with alternative lending options, it’s important for businesses to know that the interest rates are extremely high. Most alternative lenders offer business loans with double-digit, sometimes even triple-digit, rates. For a small business owner, such steep rates are not always the best option.
Institutional Lenders
Institutional lenders refer to hedge funds, family funds, insurance companies and other non-bank institutions. These lenders have slowly but steadily emerged as important players in the small business credit marketplace. Some of the well-known institutional lenders include StreetShares, Funding Circle and Kickfurther.
An increasing number of small businesses are opting for institutional lending options because approval rates are high. Institutional lenders are, in fact, surpassing alternative lenders, including merchant cash advance companies and other non-bank finance companies.
In July last year, institutional lenders approved 61.7 percent of small business loans, up from 61.4 percent in June.
Pros and Cons of Institutional Lending
Because institutional lenders invest heavily in technology, they act promptly and approve loans faster than alternative lenders and big banks.
“These pools of money have never been available for small businesses,” Biz2Credit CEO and co-founder Rohit Arora tells Time.com.
For new entrepreneurs, institutional lending is a feasible option because the interest rates are considerably low. That’s because institutional lenders usually have access to a comprehensive profile of businesses that approach them for loans.
Moreover, institutional lenders don’t ask for any specific collateral to approve loans. They mostly require a personal guarantee and may place a lien on your business assets.
On the flip side however, institutional lenders place some very specific requirements to qualify for loan approvals. Further, these loans have typical terms of 1-5 years or even a shorter span. This means they are not ideal for businesses looking for big investments.
How to Seek Small Business Loans from Alternative and Institutional Lenders
To qualify for a loan or small business line of credit, it’s always advisable to know the right way to go about it.
While it is true that your chances of getting approved by an institutional or alternative lender are greater than big banks, it’s important to make note of a few things to ensure you qualify.
To begin with, you should know that unlike traditional lenders, alternative and institutional lenders depend on technology to determine whether or not you can repay the loan amount. They use sophisticated software tools and data metrics, including social media interactions to assess businesses.
If you have just started out, you probably won’t qualify for a big loan. Conversely, if your business is up and running and you can show a good track record of revenue performance, you will find it easier to secure funds.
What’s worth noting is that you need a good business plan in place to increase your chances of qualifying for a loan. It’s also advisable to know which lender is your best option before you approach them. For example, Kickfurther is ideal for small businesses looking for inventory financing. There are similar lenders who specialize in real estate business, purchase order financing and other kinds of small business loans.
It’s important to maintain a good credit score because most alternative and institutional lenders carry out credit checks to ascertain a customer’s credit worthiness.
Another good option for small businesses is to consider collaborative lending opportunities. Banks like JP Morgan Chase are partnering with alternative lenders to offer loans customized to the needs of business owners. In certain instances, such options would make more business sense.
Armed with enough information and insight, you can easily secure funds without borrowing from your IRA or approaching big banks and community banks.
Loans Photo via Shutterstock
This article, "Alternative and Institutional Small Business Funding Options" was first published on Small Business Trends
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