In recent years, many small business owners have had an exceedingly difficult time getting funding for their business through small business loans from a bank. Although some business owners have better luck at community banks than they have at larger national banks.
Many small businesses are feeling completely shut out because of bad credit, not having assets to use for collateral, or for simply not seeking loans large enough for a bank to be interested. With so many banks closing their doors on small businesses, online lending and alternative funding options have become increasingly popular.
Companies such as Green Capital, Kabbage, and OnDeck have succeeded by removing many of the biggest barriers small business owners face at the bank. Many of the funding options they offer don’t require collateral and are attainable even with a damaged credit score.
And instead of spending hours laboring over complicated paperwork, then waiting for weeks to find out if they’ve been approved or not, online lenders and alternative funding providers use simple applications that can be completed an hour or less and applicants will be approved or denied within a matter of days, or in some cases, as soon as 24 hours.
If you’ve been considering alternative funding for your business, but aren’t sure which type of funding would be right for you, here are a few of the most common types of alternative funding and what they are best used for:
1/ Merchant Cash Advance
Best For: Businesses who get a lot of credit and debit card sales.
What Can You Use It For: Virtually any business-related expense.
How it Works: With a merchant cash advance, a third-party (in this case, the alternative funding provider) purchases a certain amount of your future credit and debit card sales. The third-party then collects a percentage of your daily credit and debit card sales until the amount of the advance has been repaid with interest.
Advantages: Merchant cash advances have a unique benefit of being somewhat flexible with repayment. If business is slow, a smaller percentage can be collected and a higher percentage can be collected on busier days.
This type of funding doesn’t require collateral and can be an option for business owners with bad credit. If you typically have a lot of customers who pay by credit or debit card, your cash advance could be repaid very quickly.
Disadvantages: Since merchant cash advances are not technically considered loans, they aren’t bound by usury laws and therefore the fees associated with them can be higher than they would be if you got a loan from a bank in the same amount.
2/ Accounts Receivable Financing
Best For: Businesses who give their customers over 30 days to pay invoices.
What You Can Use It For: Virtually any business-related expense.
How it Works: If your business needs money and you can’t wait 30, 60, or 90 days for your customers to pay their bills, a third party can purchase your outstanding invoices at a discount. Instead of paying you, your customers pay the third-party. Once the invoices have been paid, the third-party then pays you back the difference between the value of the invoices and the amount they paid you for them, minus a fee.
Advantages: Accounts receivable financing can be a fast and easy way to free up some working capital. Instead of spending your time and energy on collecting from customers, you can focus on helping your business grow in other ways. This is also an option for business owners with bad credit or aren’t able to put up collateral.
Disadvantages: Like merchant cash advances, accounts receivable financing is not technically a loan and therefore can have higher interest rates than a bank loan would have. Although the business owner’s credit score is less of a factor with this type of funding, the credit scores and payment histories of your customers do matter.
If you have customers who have bad credit or often take an excessively long time to pay their bills, the funding provider can charge you higher interest rates or even prohibit you from doing business with them until the advance has been repaid because of their history. If one of your customers fails to pay the funding company, you could be the one stuck footing their bill.
3/ Working Capital Financing/Loans
Best For: Businesses who have a temporary need money for to handle day-to-day expenses, seasonal businesses who typically go through slow times during off-seasons.
What You Can Use It For: Basic, short-term expenses that come along with running a business.
How it Works: The money a business uses to cover things like paying employees, marketing, and buying more inventory is called working capital. But sometimes businesses find their working capital is tied up in things like unsold inventory or outstanding invoices and need extra money to cover other expenses. Working capital loans and financing gives businesses money to use for those expenses.
Advantages: Your business will be able to survive and continue growing even if you’re going through a slow business period or seasonal slump and can get you over temporary financial hurdles.
Disadvantages: Since working capital loans are meant to cover ordinary, day-to-day expenses that come along with running a business, they generally isn’t used for making large, long-term investments like property or particularly expensive pieces of equipment.
4/ Equipment Financing
Best For: Any business who needs equipment.
What You Can Use It For: In this situation, the word “equipment” encompasses a huge variety of things: vehicles, computers, copy machines, tools, heavy construction equipment, desks, chairs, kitchen equipment, and more.
How it Works: Equipment financing is one of the most commonly used types of financing for businesses. Instead of paying the full price for equipment all at once, you make monthly payments for the equipment, plus interest. It’s a secured type of financing, with the equipment itself serving as collateral so you won’t be required to put up anything extra.
Advantages: Virtually all types of businesses can benefit from equipment financing. It’s a way for businesses to get the equipment they need and improve their productivity but while avoiding the financial shock of paying for it all upfront. This can be particularly advantageous for businesses who need things like heavy equipment or expensive tools.
Disadvantages: Unlike most other types of alternative funding, which can be used for a wide variety of business expenses, equipment financing is meant to be used exclusively for equipment.
5/ Unsecured Loans and Funding
Best For: Businesses who have good credit.
What You Can Use It For: Practically any business-related expense.
How it Works: Loans and funding come in two basic types — secured and unsecured. Secured funding and loans require an asset like property or vehicles to be used for collateral. Unsecured loans and funding are not secured with collateral. You can use them for all the same sorts of business expenses you could use a secured loan for.
Advantages: If you aren’t able to repay your loan, you won’t have to worry about losing an important asset to the bank.
Disadvantages: Since unsecured loans don’t have the security of being backed by collateral, they can be harder to get, especially if your credit score isn’t perfect. Also, since the lender is taking a greater risk by not having collateral backing the loan, they often have higher interest rates than a secured loan for the same amount would.
6/ Micro Loans
Best For: Small businesses who don’t need large loans.
What You Can Use It For: Micro loans can be used for most business expenses, except for paying down existing debt or buying real estate.
How it Works: The name pretty much says it all! Micro loans are a type of business loans that are for smaller amounts of money than most bank loans are, typically $35,000 or less. They can be used for many business-related expenses like payroll, equipment, or inventory.
Advantages: Micro loans can be extremely helpful for small businesses who simply don’t need large loans and don’t have the stellar credit scores banks look for. Many alternative lenders offer micro loans and don’t have the strict requirements that banks and other establishments might not be able to qualify for bank loans.
Disadvantages: Although micro loans can be easier to obtain through alternative lenders, if you’re trying to get an SBA-backed micro loan, you still have to apply through a lender or other approved organization, which can be difficult to do if you don’t have the best credit score.