Alternative lending presents an alternative to traditional methods of financing your business. But when is it more suitable than conventional lending?
Discover what alternative lending entails, explore its various types, and evaluate its advantages and disadvantages compared to traditional borrowing. Additionally, understand the qualifications and application process for alternative financing.
What Is Alternative Lending?
Alternative lending encompasses consumer and business financing provided by nontraditional loan providers, distinct from banks or credit unions.
The concept originated in the early 2000s with the rise of peer-to-peer (P2P) lending, where individuals and groups utilized the Internet to lend directly to consumer borrowers. The 2008 recession further popularized alternative lending as a mainstream option.
Today, alternative lending primarily involves digital platforms that connect borrowers (both consumers and businesses) with lenders, often referred to as marketplace lending. While alternative lending also includes crowdfunding, this guide will primarily focus on marketplace lending.
Who Uses Alternative Lending?
Alternative lenders often cater to consumers and business owners who are underserved by traditional financial institutions, including those with low credit scores who may not qualify for conventional loans. According to the Federal Reserve Banks’ Small Business Credit Survey, 35% of businesses with lower credit scores sought financing from online lenders, while 23% applied with nonbank finance companies.
Nevertheless, alternative lending providers may also serve borrowers who could potentially qualify for traditional financing. However, some of these borrowers opt for alternative lending due to its perceived speed and convenience compared to traditional channels.
Related: High-Risk Business Loans: Know Your Options and Get Low Rates
How Does the Alternative Lending Process Work?
Alternative lending typically operates through online platforms that facilitate connections between borrowers and investors. These platforms leverage digital technology to streamline the loan application process.
Prospective borrowers seeking alternative credit usually start by filling out an online discovery form to determine if they prequalify for a loan or other forms of financing. This form collects essential financial information from the applicant to conduct an initial assessment of their creditworthiness. The data entered is automatically reviewed by a software program, often providing a preliminary decision within minutes. However, some applications may require further manual review by a human specialist.
If applicants pass the initial prequalification stage, they are invited to proceed with the full application process. This typically involves working closely with a designated loan officer and submitting additional qualifying documentation. Upon approval, funds are typically disbursed electronically within hours or days.
What Are the Different Types of Alternative Lending Models?
Today’s alternative lending market encompasses various types of lenders:
- Marketplace Lenders: These platforms utilize technology to process loan applications, screen applicants, and connect qualified borrowers with potential lenders. Marketplace lenders aggregate loans from investors and electronically deliver them to borrowers, earning commissions and fees for facilitating the transaction.
- Direct Private Lenders: These lenders finance loans using their own capital rather than relying on bank deposits or investor funds. This gives them flexibility in setting loan terms and qualifications. Direct private lenders may offer smaller loan amounts compared to traditional lenders.
- Crowdfunding Platforms: Crowdfunding occurs on digital platforms where borrowers seek funding by appealing to a large number of investors, each contributing small amounts. This method allows borrowers to raise capital for various purposes, leveraging the collective financial support of multiple individuals.
While both marketplace lending and direct private lending are often categorized under peer-to-peer (P2P) lending, true P2P lending involves individuals lending directly to borrowers. Marketplace lending, on the other hand, facilitates loans from both institutional investors and individuals through digital platforms.
What Types of Financing Do Alternative Lenders Offer Businesses?
Marketplace alternative lenders can offer a wide range of financial products to businesses. Depending on the lender, business financing options may include:
- Term loans: Funds must be repaid over a specific period (the term of the loan) at a fixed or variable interest rate on a predetermined repayment schedule
- Short-term loans: Term loans with a short window for repayment, often less than a year
- Microloans: Term loans for low amounts, such as $50,000 or less, often with short-term repayment schedules
- Bridge loans: Short-term loans used to cover cash-flow needs while longer-term financing is being arranged
- Commercial loans: Longer-term business loans typically used to pay for significant capital expenditures, such as real estate or equipment investments, or to cover operational costs
- Working capital loans: Short-term loans used to finance daily business operations rather than purchases of long-term assets or investments
- Small Business Administration (SBA) loans: Term loans backed by the SBA, reducing the risk to the lender and enabling lower interest rates for borrowers
- Accounts receivable financing: Cash advance based on receivables owed to borrowers by their customers
- Merchant cash advances: Cash advance lent on the strength of sales projections, to be repaid from a percentage of future sales
- Equipment financing: Loan used to purchase or lease equipment, with the equipment serving as collateral
- Business lines of credit: Similar to a credit card but differing in that it can be used to write checks; may be borrowed against up to a set limit, with funds typically becoming available for spending again after they’re repaid (known as a revolving line of credit)
Some lenders will offer all of these products. Others may specialize in certain products, including others not listed here.
How Do Alternative Business Loan Lenders Differ from Conventional Lending?
Alternative lending companies differ from conventional lenders in several key aspects:
Operational Model:
Alternative lenders primarily operate online, whereas conventional lenders typically have physical branch locations.
Application Processing:
Alternative lenders use digital technology to process applications quickly, often within hours or days, whereas conventional lenders rely on manual review processes that can be more complex and time-consuming.
Risk Appetite:
Alternative lenders are often willing to extend credit to higher-risk borrowers, albeit with higher interest rates and less favorable terms, whereas conventional lenders have stricter qualifying criteria.
Documentation Requirements:
Alternative lenders may require less documentation from applicants, simplifying the application process compared to conventional lenders.
Funding Speed:
Approved funds from alternative lenders can be transferred electronically within days or even hours, whereas conventional lenders may take weeks or months to complete the application process and disburse funds.
Mike Dell, client success manager at Wall Street Funding, a merchant cash advance provider, emphasizes the contrast: “A traditional lender’s process is typically much longer than ours.” He notes that many merchants find the extensive paperwork and collateral requirements of conventional lenders lead to significant “time erosion.”
While funds from conventional lenders may be less costly with lower interest rates, Dell points out that time is crucial for small business owners who cannot afford to wait weeks or months for approval. Alternative lenders streamline the approval process with fewer requirements but assume greater risk, balancing this with shorter repayment terms and higher rates.
Regarding alternative lending, Dell states, “We’re a bridge of sorts – a merchant is able to come to us [and] in a very timely fashion, we’re able to review the very few necessary documents, determine an amount of funding that they qualify for and get them funded. It doesn’t even matter the size of the deal…it could be funded in 2 days or even less in some cases.”
What Are the Advantages of Alternative Lenders?
Alternative lenders offer several advantages that can appeal to business borrowers:
Convenience and Speed:
Digital application processes, reduced paperwork, and expedited processing make alternative loans more convenient and faster to obtain compared to conventional loans.
Flexibility in Financing:
Alternative lenders often provide a broader range of financing products tailored to meet the diverse needs of various borrowers.
Ease of Qualification:
Alternative loans can be easier to qualify for than traditional bank loans, accommodating borrowers who may have difficulty meeting the strict criteria of conventional lenders.
Quick Access to Funds:
Funds from alternative lenders can be made available swiftly, allowing business owners to capitalize on opportunities promptly.
Mike Dell emphasizes the strategic advantage for business owners: “It’s important for business owners to understand that they can deploy this money quickly to seize opportunities that might not be available otherwise or not yet available.” He suggests scenarios where businesses can benefit, such as purchasing bulk merchandise to increase profits even after factoring in the cost of capital.
Dell concludes, “We provide an easy, fast way to access capital,” highlighting how alternative lending can circumvent the time-intensive processes often associated with conventional lenders.
These benefits make alternative lending an attractive option for business owners seeking quick access to financing or facing challenges in obtaining traditional bank loans.
What Are the Disadvantages of Alternative Lenders?
While alternative lending offers several advantages over conventional options, there are tradeoffs to consider:
Potentially Higher Costs:
Alternative loans often come with higher interest rates or less favorable terms compared to traditional bank loans. However, this isn’t always the case, especially with alternative lenders offering SBA loans, which maintain standard terms regardless of the lender.
Shorter Loan Terms:
Loans from alternative lenders may have shorter repayment periods than those from traditional banks, which can affect cash flow management and repayment schedules.
Impact on Cash Flow:
Alternative lending products that use accounts receivable or future sales as collateral can temporarily reduce profits and cash flow until the advances are repaid.
Mike Dell advises business owners against using alternative funding without clear benefits. He suggests considering the following questions to determine if alternative lending is advantageous:
- Do you need to cover payroll while waiting for accounts receivable?
- Do you require immediate capital to secure a project?
- Are you facing a short-term operational challenge?
- Is there an opportunity, like an auction or discounted sale, where acquiring equipment at a lower cost would benefit your business?
Before choosing a financing option, carefully evaluate the advantages and disadvantages of alternative lending to ensure it aligns with your business goals and financial needs.
When Should I Try an Alternative Lender Instead of a Conventional Lender?
There are several situations where opting for an alternative financing product might be suitable for your small business:
- You face challenges qualifying for conventional loan products due to factors like limited time in business, a low credit score, or insufficient revenue.
- You require immediate access to funding and cannot afford to wait for the processing time of a conventional loan.
- Your business model and sales projections indicate a strong capability to repay a short-term loan or advance.
- You urgently need financing for an equipment purchase.
Conversely, if you qualify for a bank loan or can afford to wait for financing, exploring conventional options may be more appropriate.
Alternatively, Dell suggests, “Perhaps you qualify for traditional lending but cannot wait… You can address your needs with our capital and subsequently repay us when you receive the traditional funding. There’s no restriction against doing so.”
Ultimately, when contemplating whether to finance with an alternative lender, business owners should ask themselves: “Can I seize an opportunity at a favorable cost that might otherwise disappear?”
How Do I Qualify for Alternative Business Lending?
Different alternative nonbank lenders may assess your application based on various criteria for approval. Typically, lenders consider the following factors:
- Personal or business credit score
- Monthly or annual revenue
- Time in business
- Cash flow
Specific requirements can vary depending on the type of lending product. For instance, for accounts receivable financing, lenders may request documentation of outstanding invoices, while merchant cash advances may require proof of recent revenue levels to support sales projections.
Apart from personal credit, Dell emphasizes the importance of reviewing recent bank statements to evaluate revenue trends and payment history, and conducting background checks to identify any legal or financial issues.
For larger loans, additional documentation such as balance sheets, profit and loss statements, and accounts receivable reports may be necessary.
Conventional lenders often impose stricter criteria for larger loan amounts or lower interest rates. A strong credit rating and robust revenue history can improve your chances of securing higher amounts and more favorable terms.
Before applying for business loans from conventional or nonbank lenders, it’s advisable to monitor your credit score and take steps to strengthen your business credit profile.
How Do I Apply for Alternative Lending?
The process of applying for alternative lending typically involves several steps:
- Completing an online form with initial information like revenue and years in business to prequalify.
- Upon meeting prequalifying criteria, receiving one or more loan options and being asked to submit qualifying documents such as financial statements or tax returns.
- Upon approval of your application, receiving documents from the funder to finalize your lending agreement.
- After finalizing the agreement, receiving your funds, usually via electronic transfer.
Each lender and loan product may have variations in these steps, with some offering more streamlined application processes than others.
How Do I Find Alternative Lenders for Small Business Financing?
There are many lenders offering alternative financing for small businesses. In fact, iBusinessLender provides reviews of some of today’s most popular alternative lending providers.
See how lenders compare on popular review sites too, such as:
Keep in mind, we have partnerships with many industry funders, so you can quickly compare multiple financing offers on our secure platform.
Find Out Whether You Qualify for Alternative Business Lending
Alternative lending offers a viable solution for businesses unable to qualify for traditional bank loans or in urgent need of financing. If this describes your situation, exploring business loans from nonbank lenders could prove beneficial.
iBusinessLender collaborates with lenders across the country, facilitating swift access to various financing options such as SBA loans, business lines of credit, accounts receivable financing, and merchant cash advances.
To discover which forms of alternative lending you qualify for, take a few minutes to complete our no-obligation online application. Our software matches your prequalifying criteria with our extensive network of lenders, ensuring you find the right provider for your needs.
