Why small businesses are turning to alternative forms of funding
Alternative lending has been raising eyebrows in the finance industry lately as a rising underdog for sources of working capital for small businesses.
What was thought to be another fad-funding trend has proven over the past ten years that this new grubstake is here to help small businesses and here to stay.
According to a 2017 study by Forbes, out of 29.6 million businesses in the U.S., all but 19,000 are small. Small businesses make up a major percentage of the economy and yet have always had a hard time getting the extra working capital they need to grow. In the early 2000s, banks dominated the lending scene, doling out loans to any merchant, even if it overleveraged them because the banks were so bloated with funders and investors. When the recession hit in 2008, many business owners were badly hurt or entirely shut down from the banks’ irresponsibility. Alternative lending emerged as a way to provide much-needed funding to companies that didn’t qualify for strictly regulated bank loans, and the industry continues to grow as it is fresher and leaner than big banks.
Bank loans and SBA loans require a credit score of 700 or higher, ample collateral to offer, and strong revenue flow. Funding companies will accept credit scores as low as 520, as long as the business proves to be in good health, and deals are typically unsecured. In an age where everything is calculated with algorithms and AI, it’s rare to find a process where the merchant is evaluated through a phone interview, site visit, and the health of the industry in addition to the typical credit checks and bank statements.
Extra working capital is necessary for growth. Growth is necessary for the economy. Therefore, alternative lending is necessary. Business owners use a boost in working capital to expand, renovate, upgrade equipment, bridge payroll gaps, provide employee training, boost marketing efforts and for any other expense that needs upfront financing but will pay off later.
It is also common for business owners to turn to alternative funding when they need cash immediately. Thanks to the internet, wire transfers and DocuSign, getting the money to a business in need is quick, easy and can be done in 72 hours or less, a crucial time frame when a pizzeria’s oven breaks down or a manufacturer’s burner decides to quit.
A business might seek a bank loan because the rates are low, but the truth is, most companies don’t qualify. Then there’s venture capital funding, but that requires equity, which most founders don’t want to part with. Online lenders see business and people, not algorithms and credit scores, a perk afforded because the new industry is full of startups that perform everything in-house and can tailor their financing plans to fit a business’s needs. By offering short-term plans up to 15 months, companies also use alternative lending as a source of bridge funding until the long waiting process for their bank loan to kick in is over.
Small businesses especially, but all sizes of businesses, have taken to alternative lending as a source of funding when all other options shut them out. Regulations are continuously being put in place to establish the industry, protecting both the merchants and the funders. Banks are still a popular choice of loan for business owners, but their cumbersome regulations, slow processing and long application processes just can’t compete with this new wave of alternative lending willing to work with businesses that were previously barred from achieving growth.