Bank loans are known as the primary route to starting a new company. Over the last few decades, however, several new fundraising routes have been increasingly growing in popularity.
Acquiring financing for a small business can often be difficult. When you apply with a large bank, there’s no guarantee that your loan will be approved, especially since most banks require your business to have a good foundation. This might include at least a two year record with great credit. Reports state that in March 2019, only 27.3% of small business loan requests were approved by the big banks, while the smaller banks approved 49.3% of the applications.
Here’s the kicker: 57.3% were approved by alternative lenders.
As most of the alternative funding options are available online, one doesn’t even need to go to a bank to obtain them. With the internet making it easier to choose an alternative financing option, more and more small businesses are turning towards it.
If you have a less-than-ideal credit score and not too many years in the business, alternative funding makes it easier for you to raise funds for your new enterprise. Some may choose alternative business financing after being turned down by traditional banks or because they don’t meet the eligibility criteria for a bank loan.
In many cases, however, alternative funding options are better for bank loans for a number of reasons. At 7 Figures Funding, our financial consultants promise to help you find the right funding option for your small business needs. With that in mind, here’s our guide to what’s available.
Alternative Financing Options for Small Businesses
There are several alternative financing options that exist for entrepreneurs today. Some of them are as follows:
The most public form of alternative funding, crowdfunding typically occurs through an online platform where several investors (typically regular people) invest small amounts in a company. It makes use of networks of people through channels such as social media to bring investors and entrepreneurs together. This expands the circle of investors beyond the traditional circle of fund-givers during the early stages of a business. Crowdfunding allows entrepreneurs to raise millions of dollars with the help of anyone who has the ability to invest. If you have a business idea, all you have to do is submit it to a platform like Kickstarter or IndieGogo.
Grants can be difficult to obtain, but if you think you’re eligible and meet the criteria, it’s a worthwhile avenue to explore. Grants are usually funded by the government, but certain NGOs and private businesses provide grants as well. Unlike a loan, you don’t have to pay back a grant. They are usually given or gifted so by an entity, such as a trust, foundation, or corporation. The application process for a grant is pretty long. Plus, grants are awarded for a specific purpose, such as research or development.
3. Venture Capitalists
Venture capitalists are those who invest money in exchange for equity in the business. They receive their returns after the business goes public or gets acquired by a larger parent company. Venture capitalists typically invest money in many different companies, expecting and hoping for a small percentage of them to offer a massive return. As such, venture capitalists primarily look at companies that have “venture scale” potential – that is the potential to return $100m+ in the future, like tech companies. That’s why venture capitalists are very exclusive.
4. Angel Investors
People often get confused between angel investors and venture capitalists. The main difference between the two is scale: angel investors are typically wealthy personal investors looking to invest at the seed stage. Angel investors usually provide you with flexible business terms and also guide you and lend you valuable advice since they belong to the same industry. Angel investors look for an equity stake in a company, so they’re looking for a long-term exit.
5. Small Business Administration (SBA) Loans
SBA loans are when your loan is partially funded by the government while being associated with legit financial institutions. The guarantee provided by the SBA is what makes it easier for banks to trust small businesses with the loan. SBA loans help develop solid relationships between the borrower and the lender, and they also make it easier for you to get a bank loan in the future if you do well paying it back.
Are you qualified for an SBA loan? Find out with 7 Figures Funding.
6. Merchant Cash Advance
In a merchant cash advance, the lender goes through the business’ cash flow to ensure that it’s positive and steady. You can secure this type of funding through future credit card transactions, making it a wise alternative when compared to business loans or other traditional funding options. The lender, therefore, receives a set percentage of the company’s credit card sales. It becomes especially useful for those businesses that don’t have the collateral or credit ratings to get a traditional bank loan but have a reasonable early cash flow. Although merchant cash advances don’t have a fixed interest rate, they can often be quite expensive.
7. Purchase Order and Trade Finance
One of the fastest and most flexible financing options is purchase order and trade financing. For small businesses, sales or production isn’t usually a tough nut to crack. What’s challenging is finding the funds to gather the necessary raw materials or pre-sold merchandise. Therefore, by going for purchase order financing, financers, producers, and distributors can fulfill the big orders and thereby gain more profits. This will save them from selling equity or getting their debts multiplied. Not only will their market share increase, but they will also be able to make timely deliveries.
8. Invoice Factoring
For those selling B2B services or products, invoice factoring is a fantastic option. With invoice factoring, clients or customers first receive an invoice, then the copies are sent to the lender as well. Once the lender receives the invoice, he/she pays a percentage of the invoice value to the company. When the clients pay for the complete invoice, the lender pays up the remaining invoice value post deducting whatever fees is applicable. Businesses that suffer from unpaid invoices and issues in cash flow timings can opt for invoice factoring.
Related: Startup Funding Options
Pros and Cons of Alternative Financing
Much like exploring institutional funding options, alternative financing also comes with its own pros and cons. It’s best to explore them thoroughly beforehand before opting for one.
- Easier access: For millennials and small business owners, alternative funding really serves as a boon because it gives them access to financing much more easily. It is often seen as being fairer and more balanced with regard to making loan decisions. Alternative funding makes use of non-typical forms of determining credit worthiness so that the lender can get a more comprehensive idea of the borrower’s footprint, and something that goes beyond just credit history (which especially hurts younger founders).
- Lower interest rates: Compared to traditional financial institutions, alternative lenders can provide borrowers with lower interest rates since they have a comprehensive understanding of the borrower’s financial history. This helps the applicant in managing risks, as the lender has a fair idea as to how long it will take the borrower to repay the loan.
- Faster approval rate: Reports state that the approval rate with alternative lenders is over 50%. Only institutional lenders come close to beating that percentage.
- Inadequate regulations: Alternative financing is not regulated in several jurisdictions. Therefore, the risk of fraud losses can be higher for lenders if strict procedures aren’t followed with due diligence. But if you use a financial advisory service, you can eliminate risk by communicating with trusted financial advisors.
- Higher loss risk: As far as potential returns on investments are concerned, the risk is much higher in alternative financing. This is because the approval rate of these loans is much higher even though the banks usually consider these lenders as being more incapable of paying back on time. Therefore, the lenders stand a risk of losing either some or all of their capital.
In short, there are far more benefits than downsides when it comes to securing alternative funding. In order to maximize the benefits, use business funding specialists to help you get the funding that’s right for you.
Start your 7 Figures Funding Entrepreneur Education here.
Small businesses often find it tough to obtain funds since most traditional banks are reluctant to loan out money to startups or non-established businesses. They also have strict requirements that not all small businesses can meet. Alternative financing serves as a great way out in such situations. Not only do they have easier credit requirements and flexible terms, but their application process is much faster, allowing founders to quickly move back to focusing on their business.
If you’re looking to raise some funds to grow your small business, it’s definitely worthwhile to consider some of the alternative methods available today. Get started with 7 Figures Funding to find out which option best suits your business needs.