Starting a new business can be a thrilling venture, but it often comes with financial challenges that can derail plans before they get off the ground. A key issue many entrepreneurs face is securing the funding needed to launch and sustain their business. While traditional bank loans are a common go-to, new businesses may not always meet the strict lending criteria imposed by banks.
This is where alternative financing options come into play.
This article will explore various types of alternative loans available for new businesses, helping you make an informed decision about the best funding source for your needs.
What Is Alternative Financing?
Alternative financing refers to any loan or funding that comes from non-bank lenders. This can include online lenders, fintech companies, and private investors. There are many different types of business loans, so entrepreneurs who don’t qualify for traditional loans from banks, credit unions, or government-backed institutions like the Small Business Administration (SBA) often turn to alternative financing for a solution.
Alternative financing tends to be more flexible in terms of requirements and often provides options for high-risk businesses, companies with low credit scores, or businesses needing smaller loan amounts. This type of funding is particularly useful for startups, minority-owned businesses, or firms in industries that banks may view as risky.
Key Benefits of Alternative Financing
- Flexibility: These loans typically have easier application processes and quicker approvals. Alternative lenders are often more willing to accommodate urgent business needs and offer more lenient qualification criteria.
- Low Credit Requirements: Many alternative lenders cater specifically to businesses with low or poor credit, making it easier for these firms to secure funding.
- No Collateral Needed: In many cases, alternative loans don’t require collateral, which is a major hurdle for many startups seeking traditional loans.
Top Alternative Funding Options for New Businesses
Now that you understand the basics of alternative financing, let’s explore some of the most popular options available to entrepreneurs today.
1. Revenue-Based Financing (RBF)
Revenue-Based Financing allows businesses to receive capital in exchange for a percentage of future revenues. Unlike traditional loans with fixed monthly payments, RBF repayments fluctuate based on a business’s revenue, making it more manageable during periods of low income.
Benefits:
- Flexible repayment terms based on actual revenue.
- No need for collateral or equity.
- Quick approval process.
Drawbacks:
- Higher overall cost due to interest rates.
- Not ideal for businesses without consistent revenue streams.
Example: A small software company with inconsistent monthly income due to subscription renewals might choose RBF. During months when revenue is low, the company would pay less, ensuring they don’t strain their cash flow.
2. Merchant Cash Advances (MCA)
A Merchant Cash Advance (MCA) gives businesses a lump sum of money in exchange for a portion of their future credit card or debit card sales. This option is particularly suited for businesses that generate a significant amount of revenue through card transactions, such as retail or restaurant businesses.
Benefits:
- Fast funding, often within a day or two.
- Approval even with poor credit.
Drawbacks:
- Daily or weekly repayments, which can be stressful for new businesses.
- High internal fees compared to traditional loans.
Example: A restaurant with seasonal peaks might use an MCA to manage cash flow during the off-season. The loan would be repaid daily from card transactions when business picks up again.
3. Working Capital Term Loans
Working capital term loans are short-term loans designed to help businesses cover operational expenses, such as payroll, rent, or inventory purchases. These loans are typically repaid within a year and are a good fit for immediate, short-term financial needs.
Benefits:
- Fast access to funds.
- Fixed repayment schedules make budgeting easier.
Drawbacks:
- Higher interest rates than traditional loans.
- Short repayment cycles, which may be challenging for businesses with fluctuating cash flows.
Example: A retail business needing extra inventory before a major holiday might take out a working capital loan, repaying it after the sales season ends.
4. Crowdfunding
Crowdfunding allows businesses to raise money from the public by pitching their idea on platforms like Kickstarter or Indiegogo. Backers typically provide small investments in exchange for rewards, such as early access to a product, without the expectation of repayment.
Benefits:
- No repayment required, as funds are essentially donations.
- Great for testing a product idea before fully launching it.
Drawbacks:
- No guarantee of reaching funding goals.
- Time-consuming to manage a campaign and gain visibility.
Example: A tech startup might use crowdfunding to raise money for its new gadget by offering early-bird pricing to backers. If the campaign is successful, the startup gains both funding and a base of loyal customers.
5. Business Credit Cards
Business credit cards can be a quick and flexible financing option, offering higher spending limits than personal cards and rewards geared toward business expenses. They can help with everyday purchases and build business credit over time.
Benefits:
- Fast access to capital.
- Rewards and perks such as cash-back on business-related expenses.
Drawbacks:
- High interest rates if not repaid in full each month.
- Some issuers require a personal guarantee, which means the business owner’s personal credit is at risk.
Example: A freelance graphic designer might use a business credit card to purchase high-end software, taking advantage of rewards and repaying the balance over time to avoid interest charges.
Important Considerations When Choosing Alternative Financing
When evaluating alternative funding options, it’s crucial to do thorough research and consider factors like:
- Interest Rates: Alternative loans often come with higher interest rates than traditional bank loans, which can add to the overall cost.
- Repayment Terms: Look for flexible repayment schedules that align with your business’s cash flow.
- Hidden Fees: Be cautious of additional fees that can inflate the total cost of the loan.
Is Alternative Financing Right for You?
Alternative financing can be a great solution if your business doesn’t meet traditional lending criteria or needs fast access to capital. However, it’s essential to weigh the pros and cons, including higher costs and potentially shorter repayment cycles, to ensure that the loan fits your business’s long-term financial health.
Securing your funding shouldn’t be difficult but be diligant
The growing landscape of alternative financing provides entrepreneurs with more options than ever before. By understanding the different type of business of loans available and carefully considering your business’s specific needs, you can secure the funding necessary to grow your company without getting bogged down by rigid traditional lending requirements. Always take the time to evaluate all your options and read the fine print before committing to any loan.