Commercial banks have long been the go-to source for business owners who need an infusion of cash. But they may not be an option for everyone, especially if you need money fast or don’t meet their underwriting standards.
Fortunately, there are a lot of alternative sources out there, some of which have only emerged over the past several years. The catch: Some offer much more favorable terms than others. That’s why it’s important to understand how these unconventional lenders operate before making a decision.
1. Peer-to-Peer Lending
When it comes to business financing, one of the newer kids on the block is peer-to-peer lending. Sites like Funding Circle and Lending Club act as an intermediary between investors (who supply the funds) and borrowers.
One of the upsides is quick access to capital. Some sites promise loan decisions in as little as 24 hours. So it’s an appealing option if you need some extra cash fast.
As with traditional lenders, your credit score plays a big part in getting a favorable rate. Funding Circle rates can be as low as 4.99% per year, although some sites can go as high as 40% for those with less-than-stellar credit. Often, they’ll tack on a loan origination fee as well.
Most peer-to-peer sites cater to borrowers with credit scores north of 600 – and sometimes higher – so you may have to pursue other options if your credit history has major blemishes.
Another way to get cash in a hurry: selling your accounts receivable to a financial institution, or factor. Companies often use factors to help manage cash flow and slow-paying customers. The factor advances a portion of the accounts receivable – typically 75% to 80% of an invoice – and holds the remainder as a reserve. The higher the quality of the accounts, the more you’ll be able to borrow.
Let’s say you’re an auto-parts maker and agree to sell a $100,000 invoice owed to you by RevUp Auto Supply. The factor may decide to discount the invoice by 4%, keeping the $4,000 as its fee. It advances $75,000 to your business and keeps the remaining $21,000 in reserve. Once RevUp pays the invoice in full, the factor forwards that $21,000 to you.
The glaring downside to factors is their high cost. That said, they’re an appealing option if you operate in an industry where there’s a long lag time in collecting on receivables.
3. SBA Microloans
The U.S. Small Business Administration offers a number of loan programs designed to help entrepreneurs launch and grow their businesses. One of the easiest to access is the Microloan program, which offers loans up to $50,000 for small businesses and qualified childcare centers. Business owners can use these microloans, made available through nonprofit community-based organizations, to increase their working capital as well as buy inventory, supplies, and machinery. Often, these lenders provide more than funding – they also offer consultative services designed to help your business succeed. In fact, some borrowers have to undergo training before their application is even considered.
According to the SBA, interest rates are generally between 8% and 13%. To find a microlender in your area, contact your SBA district office.
Small business owners have long turned to family and friends when other lending sources seemed out of reach. With the arrival of crowdfunding websites in recent years, drawing on your personal connections is perhaps easier than ever.
Among the more popular crowdfunding sites are Kickstarter and Indiegogo. You provide information about your funding needs and solicit people you know to make pledges.
To be sure, some businesses are a better fit for this type of social lending than others. Kickstarter, for example, specializes in helping creative professionals with their projects. Conversely, many of Indiegogo’s users are technology firms trying to get a new product off the ground.
Some of these sites work on an “all or nothing” basis – if you don’t hit your fundraising target, you don’t get any of the pledged money. But the bigger your network, and the more creative advertising you do, the better your chances of making it work.
5. Private Lenders
In the wake of the financial crisis nearly a decade ago, so-called private credit firms have emerged as major competitors to commercial banks. Thanks to double-digit annual growth, the private credit industry is on track to reach roughly $1 trillion in assets under management by the year 2020, according to a recent report by the Alternative Credit Council, or ACC.
Unlike some of the other sources mentioned here, these firms tend to specialize in bigger loans, usually in the $25 million to $100 million range. The ACC touts more flexible terms and quick loan approvals as a couple of the key reasons that this form of lending has grown in popularity among small and medium-sized businesses.
There are some drawbacks, however. The borrowing costs are often higher than more traditional sources, and it’s not uncommon for lenders to charge prepayment penalties when you try to repay the loan early.
6. Customer Lenders
A little over a decade ago, some farmers began using community-supported agricultural loans, or CSAs, to finance their operations. Customers would provide cash before the planting season and receive produce at discounted prices when the harvest arrived.
Soon, that model spread to the retail industry, with local food markets borrowing from their shoppers. For example, in exchange for cash, customers at a specialty grocer in Boston received a set discount on food items throughout the year. It not only made sense financially but helped sustain a local business that customers felt was important to the community.
Unfortunately, this may not be a viable option for every business. But for organizations that have a strong connection with the people they serve, it’s a clever, outside-the-box solution to a financial shortfall.
7. Home-Equity Loans
For some borrowers who have trouble qualifying for a business loan, the obvious alternative is to get a personal loan. One of the more common ways to do that is by borrowing against the collateral in your home and injecting the money into your company.
Because these are secured loans, you can take out a line of credit at remarkably low rates if you have a good credit score and sufficient equity in your home. But there are some serious risks, too. Should you default on the loan, you’re putting your home in jeopardy. That’s a proposition some business owners aren’t willing to stomach.
8. Rollover for Business Startups (ROBS)
Rollover for Business Startups (ROBS) has become another viable alternative for those looking to raise funds for a business. When a ROBS transaction is implemented correctly, it provides entrepreneurs with a way to invest their retirement savings into a new business venture without incurring taxes, early withdrawal penalties, or loan costs.
However, executing a ROBS can be extremely complicated, which is why it's essential to work with a competent provider that has experience with these transactions. While there are plenty of ROBS providers to choose from, most offer a similar product with similar fees and support. In addition to researching potential ROBS partners, it's important to consider how tapping into your retirement assets will affect your long-term financial plans.
The Bottom Line
When traditional business loans aren’t an option, it might be time to look at an alternative lending source that can supply the capital you need. Just make sure you know what you’re getting into before you sign on the dotted line.