If you’ve run a quick Google search anytime recently for “small business loans,” the results you found likely didn’t come from Bank of America, Wells Fargo, or any of the traditional corporate banking giants that may have initially come to mind. Instead, you probably encountered brands like Kabbage, LendingTree, and Funding Circle—all top names in the growing alternative lending market that have quickly taken over the small business financing space.
But what exactly is alternative lending? Are these brands trustworthy and legitimate? And what can they offer you that your local community bank can’t? To answer all of these questions and more, let’s walk through the top five things about alternative lending that you as a small business owner need to know before you begin your search for a business loan.
1. More options for less than stellar credit
For years, a business owner’s personal credit score has been the single deciding factor dictating the traditional bank lender’s approval process. Particularly since the 2008 financial crisis, when traditional banks tightened up already stringent small business lending standards, owners without a nearly perfect credit history didn’t stand a chance of being approved for a small business loan.
Thanks to more complex digital algorithms that can weigh a wider array of financial information, alternative lenders are far less dependent on the credit score to determine a borrower’s business loan eligibility. While credit history is still important, factors like time in business, cash flow, annual revenue, and even future financial forecasts also impact a business owner’s eligibility.
Small business owners with below-average credit scores may have more limited borrowing options or pay slightly higher interest rates with alternative lenders than they otherwise would—but thanks to the new underwriting methods of the alternative lending market, they are more likely to have some options available.
2. A loan product for every need
Stepping beyond the limited offerings of traditional banks, alternative lenders have introduced a wide range of business loan products to meet the varying needs of borrowers. Taking into consideration your use of funds and your desired repayment timeline, a knowledgeable loan broker can help guide you to the right loan product at the right price.
For seasonal business owners facing unpredictable cash flows, short-term loans offer capital to purchase inventory before the busy season, while merchant cash advances allow for a flexible repayment structure proportioned to the business’s daily credit card sales. For business owners unable to put up collateral, self-collateralizing equipment, or invoice financing can make necessary capital available without the need for a personal guarantee. With every new hurdle presented by business borrowers, the alternative lending marketplace has been quick to innovate accompanying solutions.
3. Variety in pricing structures
When working with an alternative lender, it’s important to note that pricing structures between alternative loan products aren’t as standardized as they are in the traditional lending market. Different lenders and different products may state interest rates in different ways, meaning that a direct comparison of two different percentages may not give you a full picture of the difference in cost between the two loans.
For example, instead of the typical monthly repayment schedule of a traditional term loan, short term loans through alternative lenders often have a daily or weekly amortization period (i.e. the frequency that interest compounds and that loan repayments are due). As a result of that more frequently compounding interest, a 20 percent interest rate (sometimes called a factor rate) on a short-term loan can often result in costs more in line with what would be a 35-40 percent interest rate on a traditional term loan.
To make sure you’re comparing apples to apples, always ask the lender for the loan’s annual percentage rate (APR), or calculate it for yourself using an online APR calculator. Regardless of any loan’s specific terms, evaluating the APR will give you a clear, standardized picture of your true cost of borrowing.
4. Fast and easy application processes
Compared to the extensive paperwork and weeks- or months-long underwriting processes involved when applying for a traditional bank loan, online alternative lenders have streamlined the application process to make it much faster and easier.
With many alternative lenders, business owners can apply for a business loan online in less than an hour and be notified with approval within one business day. This is a major relief for businesses needing quick access to capital in order to manage daily expenses or take advantage of new business opportunities!
5. Less regulation requires more education
Unlike traditional banks which are still beholding to FDIC regulations, the alternative lending industry is still almost entirely self-regulated. In some ways, this is a benefit to borrowers, as less regulation allows for more innovation in loan products and terms. And for the most part, the desire for legitimacy has led most alternative lenders to protect consumer best interest with their practices.
That said, lack of federal regulation does mean that borrowers have to be smart and do their research when choosing lenders and shopping for loan products. Investigate the lender’s reputation and make sure they are a legitimate business before working with them and shop around with multiple lenders in order to compare pricing. If you’re uncertain, work with a quality loan broker to make sure you’re getting a good deal.
Obviously, there are pros and cons for small business owners seeking a loan through an alternative lender instead of with a traditional bank. Processes will be faster, but rates will be slightly higher. Lack of regulation requires more vigilance from borrowers, but it also offers more freedom of choice. As long as small business owners are doing their homework and fully understanding the terms of loan agreements before signing the dotted line, there is little to lose and much to be gained for entrepreneurs who choose to consider alternative lending as part of their small business loan search.
Meredith Wood is the editor-in-chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. She is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as Yahoo!, Fox Business, Amex OPEN, AllBusiness, and many more.