Beyond the banks: A primer on alternative business loans & financing

Wed | October 2023

As a small business owner, you might find yourself in a challenging position as you navigate the current financial landscape. There was a time when entrepreneurs could visit a traditional bank when seeking capital and have an excellent chance at approval, but funders are no longer handing out credit to just anyone with a business idea or small businesses in general. In March 2023, the big banks only approved 13.8% of all small business loan applications, leaving many entrepreneurs scrambling to find alternatives.

The reasons for this shift are complicated but involve inflation, interest rates, and even the ongoing fallout of the 2008 financial crisis. Traditional funders took a significant hit in 2008; many needed a bailout for survival. When First Republic Bank, Signature Bank, and Silicon Valley Bank failed in 2023, it sent shockwaves through the industry and reopened those wounds from 2008.

Moreover, big banks don't always offer the flexibility small businesses need, making gaining approval and finding suitable interest rates challenging. Alternative business loans are a valuable option for businesses that either fail to meet the stringent criteria of traditional bank loans or want to avoid the complicated processes involved. Learning about alternative funding methods is a step in the right direction for businesses needing working capital to launch or grow.

Defining alternative business funding

Alternative business loans are any funding type outside a traditional bank. Some alternative funders operate only using a peer-to-peer model or through a marketplace looking to connect potential funders with small businesses.

This type of funding is typically faster than going through a bank and more accessible for small businesses because poor credit or lack of business history doesn't necessarily disqualify you. There's also less paperwork and, in many cases, an automated online process.

Alternative business funding is worth considering as you seek capital for your growing company. There are various funding types to learn about, which could influence your decision.

Diverse types of alternative business finance

You'll encounter a few financing types as you seek alternate business lenders. Learning about the various alternative business loans available can help you make the right funding decision. Once you know your options, you can examine how these funders operate in the market and what makes the most sense for your unique business case.

Some standard alternate funding products include:

The flexibility of short-term loans

Short-term loans are a form of specialized business funding with a predetermined repayment period, typically nine months to one year. Funders provide you with capital, which you'll repay with interest before the repayment period ends. Your payments go toward clearing the debt before reducing the principal amount borrowed, and your interest rate depends on your credit history and the funder.

This funding is best for businesses that need a short-term influx of cash to support temporary business needs. A solid credit rating is often a requirement because this type of funding is risky for all parties.

Unlocking capital with invoice factoring

With an invoice factoring agreement, you'll sell your outstanding invoices to a third party at a discount. This funder sends you a percentage of the money your clients owe upfront and is responsible for collecting the entire amount from them. After collecting this money from your customers, the funder will send you the rest of the balance minus the fees you agreed upon beforehand.

This type of funding works well if you know you have money coming from a client but can't wait for it to arrive because of short-term funding needs. It could also be worth considering if you have a challenging client taking too long to pay, as the funder could have collections resources available.

Benefits of invoice financing

Invoice financing involves borrowing money from a funder using any unpaid invoices you have as collateral. In this scenario, the funder provides you with a portion of the cash from your unpaid invoices as a loan or line of credit, and you'll repay the money plus fees and interest once you collect it from your customers or clients.

Unlike invoice factoring, you're still responsible for collecting your accounts receivable with an invoice financing agreement. However, the rates are typically lower because you provide collateral and do the collection work. Invoice financing is better for maintaining relationships with customers, too, rather than having a third party collect their outstanding invoices.

Understanding lines of credit

A business line of credit is a form of revolving funding that allows you to borrow money up to a specific limit whenever you wish. You don't have to reapply whenever you need money, as the account is there to withdraw from when you need cash for business expenses. Your funder collects payment through interest with this funding type, but it only applies when you have an outstanding balance on your account. You can repay your line of credit at any speed you wish, and you'll negotiate your interest rate with the funder.

The main issue with a line of credit is that you'll need an excellent credit score to qualify. These funding arrangements are typically for established businesses with regular funding needs or companies looking to keep emergency funds on hand.

Growth through revenue-based financing

Revenue-based financing, also known as a merchant cash advance, is a type of business funding where a funder gives you money upfront and, in return, receives a percentage of your company's daily credit card sales or future revenues up to a predetermined amount. The amount depends on what you qualify for, but it will include the principal plus the cost of the capital, which will vary from business to business.

This form of financing doesn't have a repayment term because it depends on your company's performance. The more money your company makes, the faster you repay your funder. Because of this structure, this revenue-based financing is not considered a "loan."

Small businesses looking to partner with alternative business funders and avoid loan debt might consider revenue-based financing an alternative. These funders are betting on your future sales, so they'll also want to see you succeed and return for more.

The pros and cons of borrowing from acquaintances

If you have a parent, sibling, friend, or even spouse with significant capital willing to help you, you could seek private business funding through them.

One famous instance of this type of funding comes from 1962, when Ross Perot, who would later become a presidential candidate, had an idea for a computer company but needed money. Rather than going to a bank for funding, Perot borrowed $1,000 from his wife and grew his startup, Electronic Data Systems, into an industry giant, later selling to HP for $13.9 billion.

This option is only suitable for some, but it can save you both time and money in the long term, as interest and repayment terms are easier to negotiate and change.

How alternative business financiers operate?

With traditional business funding from a big bank, you'll go through a multi-step process following essential small business loan requirements that could take a significant amount of time. You'll begin by gathering financial documents before meeting with a funding officer to fill out applications and pay an application fee. You'll then wait weeks for approval and need notary services to finalize the agreement.

Alternative financing is far more straightforward. You can often apply online or by phone and be pre-qualified in minutes. You can then review your offer and receive your funding anywhere from a few hours to a few days.

Your funder will still need some documentation, as you must prove you can repay the money, and you'll have to agree to the repayment terms, costs of capital, and fees. However, the qualification requirements are typically less stringent than through a traditional funder, as you can have a lower credit score, a shorter financial history, and less time in business.

Potential drawbacks of choosing alternative funding

Despite the positives of this borrowing method, there are also some drawbacks to keep in mind. For instance, your costs of capital could be significant, especially if you have a limited credit history. You might also have to deal with short repayment periods, depending on the funding type, the funder, and your business, so spreading the financing over multiple years while you grow your company might not be possible. It's also worth noting that alternative business funders price to risk. This is usually not "cheap money."

By choosing a funding type that suits your business model and borrowing only what you can afford to pay back, however, you can get the most out of your alternative funding arrangement and grow your business without putting a strain on your finances.

Quick access to capital with One Park Financial

Growing your small business comes with a considerable price tag, and it can take time for new companies to meet the qualification standards required by big banks. Fortunately, financial solutions are available to small business owners looking to achieve growth.

At One Park Financial, we can help connect small businesses to the funding they need. If your company has been operational for at least three months and generates a minimum monthly revenue of $7,500, you might qualify for the working capital you need to help your business thrive.

Are you ready to take your company to the next level? Complete our quick pre-qualification form to begin your journey with One Park Financial today.

Disclaimer: The content of this post has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. Consult with your tax, legal, and accounting advisor before engaging in any transaction.