Although the biggest hit from the Great Recession seems to have passed, small business owners are still finding it difficult to acquire the capital needed to grow. Data obtained from the National Federation of Independent Business shows that only 15.7% of small business owners have a loan and only 33.7% have a line of credit. That is considerably smaller than their larger (less needy) counterparts. According to the NFIB, 56.8% of larger companies have a loan and 65.4% have a line of credit. This is mainly because small businesses are seen as a higher risk to lenders than big businesses.
Most often, larger business “don’t need funding” and can use the cash they have on hand, however may prefer getting a loan or line of credit to preserve that cash. They can afford to pay back whatever they borrow. Whereas smaller businesses that are fairly new, don’t have a track record (i.e. no sales or significant revenue), thus have a higher rate of defaulting. Lending to small business is understandably a very big gamble for many traditional banks and lenders. That’s were alternative lending fills the void. Alternative lenders lend to small businesses that traditional banks and lending sources would completely overlook.
Popular Alternative Lending Options
There are three popular alternative lending options that small business owners can consider if they don’t qualify for traditional bank financing. They are:
Crowdfunding & Peer to Peer Lending – According to a recent infographic created by Craig Newmark, Cracking the Crowdfunding Code, crowdfunding and peer-to-peer lending have exploded amongst small businesses that cannot obtain traditional bank financing. According to the infographic, small business owners raised about $5.1 Billion worldwide through crowdfunding and peer-to-peer lending isn’t that far behind. Peer-to-peer lending companies like LendingClub.com have seen consistent growth in the number of applicants applying for small business loans. According the Finance and Economics Discussion Series, Peer to Peer Lending to Small Businesses, over the period of 2007 to 2012, 3.5 percent of all funded loans were small business loans. During the same period, small business loans increased from $750,000 in 2007 to $22 million in 2012. The average business loan obtained through LendingClub.com was about $15,000.
Accounts Receivables Financing/Factoring – This is an option for a high risk small business that has already begun billing its clients but is waiting to be paid on a 30, 60, or 90 day basis. Higher risk small businesses typically will not qualify for traditional bank financing. It’s also a pretty expensive funding option according to this article written by the staff at Las Cruces Sun-News in New Mexico. The articles states receivables financing can have a 36% APR rate on 30 day receivables. That’s pretty high compared to more traditional financing options. The article also states the importance of understanding that this type of financing is a source “interim financing”, meaning it’s should only be used until the business’ revenues get to a place where it can take advantage of less costly borrowing options.
Merchant Cash Advances – This type of financing is also an expensive option for high risk small businesses. Approved funding amounts are largely based on your business’ daily credit card sales or bank deposits. The money usually has to be repaid on a daily or weekly basis. Although this is a viable funding option, you have to be really careful with borrowing this type of funding. Debiting your bank account daily to repay the advance could get you in trouble if your business doesn’t have a high volume of daily credit card sales or deposits. Merchant Cash Advances are another example of interim financing that should only be utilized until the business’ revenue increases and it can take advantage of less costly borrowing options.
Microloan Lenders – Microloans have become a huge source of capital for small business owners who have less than perfect credit. According to the recent report, Business Microloans for U.S. Subprime Borrowers, business owners who benefited the most from microloans were those that were minorities and had less than perfect credit. The report found that the average microloan issued by Accion Texas to small business owners between 2010 and 2012 enabled them to increase their sales, revenue, and workforce substantially. In addition, small business owners were also able to sustain their business due to the microloan. The average microloan size was about $15,000.
One thing you should keep in mind is that alternative lending can be expensive, especially when you are factoring. It’s always important to seek expert help when you consider applying for small business financing. Good experts will be able to pinpoint the most appropriate funding option for you based on your unique situation. It’s wise to never jump into applying for certain lending program if you don’t fully understand the terms and conditions. Consulting with an expert could save you a ton of money. Try contacting your local Community Development Agencies to get more information on alternative lending. A good example of a Community Development Agency would be the Detroit Economic Growth Corporation. Doing a simple Google search for community development agencies in your area will lead you in the right direction.