- Small businesses that don't qualify for bank loans may find an obtainable option in alternative loans.
- Alternative loans are typically easier to apply for, with less stringent requirements to qualify.
- Crowdfunding, microloans and SBA loans are popular types of alternative loans.
- This article is for new small business owners who need information on alternatives to traditional bank loans.
Funding a small business is never easy. For many small businesses, getting a loan from a bank is near impossible. If you don't have a rich uncle or a ton of cash stashed somewhere, an alternative form of financing may be the answer.
Editor's note: Need financing for your business? Fill out the below questionnaire to have our vendor partners contact you with free information.
Why is it difficult for small businesses to get loans from banks?
Capital is difficult for small businesses to access for several reasons. It's not that banks are against lending to small businesses – they want to – but traditional financial institutions have an outdated, labor-intensive lending process and regulations that are unfavorable to local shops and small organizations. The difficulty of accessing capital is exacerbated because many small businesses applying for loans are new, and banks typically want to see at least a five-year profile of a healthy business (for instance, five years of tax data) before extending an offer.
Key takeaway: Banks prefer to lend to organizations that have been in business for at least five years, so startups and new businesses often don't qualify for traditional loans.
What is alternative financing?
Alternative financing is any method through which business owners can acquire capital without the assistance of traditional banks. Generally, if a funding option is based entirely online, it is an alternative financing method. By this definition, options such as crowdfunding, online loan providers and cryptocurrency qualify as alternative financing.
Why might small businesses seek alternative financing?
There are several reasons why small business owners such as yourself might turn to business loan alternatives. Here are three of the most common:
- Lower credit requirements. Traditional banks are almost certain to decline loans to borrowers with credit scores below a certain threshold that, though different for each loan provider, is often between 600 and 650. [Read related article: How to Build Business Credit]
- Easier qualification. Not all small business owners meet the additional requirements to apply and be approved for traditional loans. In these cases, business loan alternatives are helpful.
- Faster approval. Traditional bank loans can take weeks to be approved, whereas some business loan alternatives give you access to funding in as little as one week.
Key takeaway: Available almost exclusively online, alternative financing options are often easier and faster to apply and be approved for than traditional loans.
[Read Related: How to negotiate a business loan]
What are the types of alternative loans?
There are three main alternative forms of financing available to small businesses: crowdfunding, microloans and SBA loans.
Crowdfunding involves raising funds from a large number of people. If you've ever donated to a Kickstarter campaign or heard stories of a new business that raised hundreds of thousands of dollars on similar platforms in just weeks, then you've seen the power of crowdfunding as a business loan alternative.
Crowdfunds can be considered donations, loans or investments. Typically, crowdfunding works by "backers" contributing a fixed amount of cash to the business, idea, or project, for which they may receive a reward. Equity crowdfunding provides donors with securities or shares of the company in exchange for an investment.
Microloans (or microfinancing) are small loans given to entrepreneurs who have little to no collateral. Microloans sometimes have restrictions on how you can spend the money, but they typically cover operational costs and working capital or equipment, furniture, and supplies. One example of a small business microfinancier is Kabbage, which offers microloans of $2,000 to $250,000. Another example is SBA microloans administered by nonprofit organizations – but microloans are not the only business loan alternatives the Small Business Administration offers.
[Also Read: How SBA loans differ from conventional loans]
As mentioned above, the SBA has its own small business microloan program. Instead of lending directly to businesses, however, the SBA distributes the funds to nonprofit, community-based organizations that decide which businesses get the loans. Other SBA loan programs are administered by banks and other lenders. These include general small business loans – known as the 7(a) Loan Program – real estate and equipment loans, and disaster loans.
Small business lending experts often view SBA 7(a) loans as the best funding option – even better than traditional bank loans – given their low rates, long terms and low monthly payments. You can use them toward working capital purchases, debt consolidation, and commercial real estate purchases or mortgage refinancing. The SBA also runs a 504 loan program, through which you can obtain loans for expansion or modernization projects. [Read related article: A Guide to Choosing the Right Small Business Loan]
How can small businesses prepare to apply for alternative lending options?
Applying for financing entails much more than just filling out an application. To increase your chances of getting financing, small business owners should do their homework and have a strategy.
Here are five tips to help you prepare your business for financing success:
- Know how much you need to borrow upfront. When you apply for business loan alternatives, you'll likely find that many different loan amounts are available. Don't commit to borrowing more than what you need – sometimes, you'll receive penalties for early repayment or for not using your whole loan.
- Write a business plan with financial projections. While not all alternative financing providers will demand to see your business plan, enough funding sources have this stipulation that you should prepare your plan now. [Read related article: The Do's and Don'ts of Writing a Great Business Plan]
- Do market research and know the conditions of your industry. Lenders may be more likely to approve borrowers in growing industries. As such, if you can prove that your company's sector or market primes your business to expand and succeed, present your argument firmly somewhere in your application.
- Know your credit score. Often, a credit score below a certain number is an immediate disqualifier for loan applications – even if your company is primed for rapid growth and you're working on repaying your loans.
- Meet with a small business expert and attend training provided through the SBA. As with any important small business decision, you shouldn't go this one alone. Consult experts and seek training on how to apply successfully for the funding your company needs to thrive.
As a small business owner, you should also establish a strong online presence and pay attention to how your company looks online, because lenders will be reviewing this information too. Online review sites such as Yelp, Angie's List and TripAdvisor help paint a picture of your operations and serve as an indicator of your overall business health. Social connections and customer relationships on social media can also play a role in a lender's decision to offer financing.
Key takeaway: Before your apply for an alternative loan, it's important to know how much you need to borrow and be prepared to prove that you will be able to repay it.
Sara Angeles contributed to the writing and research in this article.