Alternatives to getting a small business loan at a bank

Two female entrepreneurs stand by the sink in their shop, collaborating and looking at a phone.

Two female entrepreneurs stand by the sink in their shop, collaborating and looking at a phone.

If you want to start or expand a business, one of the most popular ways to get funding is to borrow money from a bank. Traditional business loans from a bank are popular since there are many options, and they’re typically reasonably priced.

But if you struggle to qualify for a traditional loan or want to look at other options, try one of these alternatives.

Grants

Grants are a great way to start or grow a business if you can qualify for them. They are cash awards that you don’t have to repay. Depending on the terms, you might have restrictions on how you can use the money or be free to spend it however your business wishes.

There are many places to look for grants. Many local or state organizations and federal agencies offer grant programs that you can apply to. There are also privately-run grant programs funded by businesses or non-profit organizations.

Eligibility for these grants will vary. The federal government typically doesn’t provide grants to help you start or grow your business. Instead, it offers grants to non-profits, and state and community organizations. In turn, these organizations provide assistance to small businesses.

While it does offer some grants to small businesses, like the  Small Business Innovation Research (SBIR) and the Small Business Technology Transfer (STTR) programs, direct grants are typically funded by non-federal agencies. Many non-federal grants are aimed at helping underserved groups that have historically lacked access to business financing. This includes:

Special purpose credit programs

Special purpose credit programs (SPCPs) are unique loans authorized by the Equal Credit Opportunity Act to help for-profit businesses offer loans that benefit economically disadvantaged groups.

These programs let lenders use less-traditional or unique lending standards to make approving loans to traditionally underserved populations easier. Applicants need to meet specific criteria to qualify for these loans.

Outside of their different underwriting process, these loans function like other business loans. You get the funds and need to pay back the money you borrow, plus interest.

Microloans

Microloans are loans for relatively small amounts, usually no more than $50,000. Microloans are available from a variety of sources, including nonprofit organizations.

For example, the Small Business Administration microloan program offers loans of up to $50,000 through intermediary community-based nonprofits. The average loan is $13,000, which is much lower than the typical business loan amounts.

Crowdfunding

Crowdfunding is a way to raise money from everyday people rather than a traditional lender. There are four primary types of crowdfunding:

Donation

This asks people to donate money to your cause. There’s no expectation that you’ll repay the donors or offer them anything in return.

Debt

You get money from contributors and promise to repay them in the future. Typically, these crowdfunding campaigns outline the repayment timeline and offer interest, giving the funders a chance to earn a return on their investment.

Reward

This lets funders give your business money and receive something in return. Kickstarter is the best-known example of this type of crowdfunding. For example, you might offer a sticker, digital content or another award for funds. Effectively, this lets you sell products before you’ve produced them, raising funds that you then use to make and deliver the product.

Equity

Popular for startup businesses, this form of crowdfunding sells a share of the ownership in the business in exchange for funds. This means investors may have a say in how you run your business.

Peer-to-peer lending (P2P)

Peer-to-peer lending involves borrowing money from other people rather than traditional lenders like banks and credit unions. Usually, borrowers and lenders work through an intermediary or marketplace website where borrowers can apply for loans and people can invest their money into those loans.

The benefit of peer-to-peer lenders is that they offer easier qualifications and may offer better rates if you have strong credit. The online application also makes the process quick.

The drawback is that rates and fees can be much higher for peer-to-peer loans if you have bad credit. They may also charge higher fees.

Alternative lenders

Most businesses rely on traditional lenders like banks or credit unions, but there are also alternative lenders, which are usually web-based businesses, private lenders, or peer-to-peer lending sites.

Online lenders can be great to work with thanks to their easy application process and quick loan funding. They may also offer easy qualifications. But online lenders often have lower loan maximums and may charge very expensive rates for applicants who need a bad credit business loan.

On top of more typical term loans, alternative lenders offer other types of business financing, like lines of credit, invoice-based loans, and merchant cash advances.

Business lines of credit

A business line of credit is a flexible source of funds for your company. When you’re approved for a line of credit, the lender will set a credit limit that you can draw from.

You’re free to draw funds from the line of credit up to that set limit. You only pay interest on your outstanding balance, and you’re free to leave the balance at $0 if you don’t need funds at the moment.

This makes a line of credit very useful for covering unexpected, short-term expenses. The drawback of lines of credit is that they often have variable, high interest rates. If you carry a balance, you could win up paying a lot in interest.

Invoice financing

If your company finds itself waiting on customers to pay the invoices you submit, you may turn to invoice financing to get cash quickly.

With invoice financing, you use the money you’re due based on the invoices you’ve submitted as collateral to get a loan. The lender will give you cash upfront with a set repayment plan and interest rate. As you get paid for those invoices, you can repay the debt.

Invoice factoring

Invoice factoring is much like invoice financing. It uses the invoices you’ve submitted as a way to help your business get a loan.

What makes it different is that the factoring company actually buys your invoices from you. When your customer pays the invoice, the money goes directly to the factoring company rather than you. The factoring company buys your invoices for between 70% and 90% of their face value, giving it room to make a profit.

Merchant cash advances

Merchant cash advances (MCAs) are an option for companies that make a lot of sales through debit and credit card purchases. With an MCA, the lender gives you a lump sum of cash. You then repay that loan through a percentage of your future card-based sales.

For example, a lender might give you $10,000 with a 1.15 factor rate and demand 10% of your sales until the loan is paid back. That means until you’ve paid back $11,500, you’ll have to give up 10% of your revenue either daily or weekly.

They’re useful for companies because they don’t require great credit and can be a quick source of funding. But there is little regulation regarding MCAs, and the rates that MCA companies charge can be quite high.

Plus, it’s easy to get trapped in a cycle where you use an MCA to help with cash flow issues, only to find that the MCA makes those issues worse by taking a large percentage of your revenue.

Bottom line

If you want to get a business loan, banks and credit unions aren’t the only sources of funding. It’s important to consider all of your options to find the right source of funding for you and your business. If you’re eligible for a loan, consider looking into grants or special purpose credit programs, and remember that other loans, like microloans, might better fit your needs.

Frequently asked questions

  • Most lenders will deny you a small business loan if you have very bad credit or a recent bankruptcy. You also can’t use a small business loan to fund illegal activities or specific activities, such as gambling or multi-sales distribution.

  • Lenders will typically consider your business and personal financial situation and credit. This is especially true if the business is very young. Lenders want to see solid revenue, positive cash flow, and good business and personal credit scores.

  • If you’re having trouble qualifying for a business loan, there are a few options. One is to wait and work on improving your financial situation or credit score. You might also turn to an alternative, such as a grant program or alternative lender. Just be sure to calculate the full cost of the loan because the rates or fees will likely be high.

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