July 24, 2020 By SmartBiz Team

In the past, small business owners had one option for a loan – their local bank. Today, there are hundreds of online alternative lenders that facilitate fast loans for small business owners. Here are advantages and disadvantages of working with an alternative lender or a traditional bank.

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What is alternative lending?

Alternative lending is the process of providing business loans outside of traditional routes. Alternative lenders can provide more flexible loan options, giving more people the chance to qualify for a business loan.

Types of alternative lending products

New technology platforms, alternative lenders, and online marketplaces each aim to make capital more accessible. Following these technological advancements, online lending began to grow as a source of funding for small businesses. In 2017, for example, 24% of firms applied for funding directly from online lenders. As they became more popular, three financing products emerged:

Merchant Cash Advances

A merchant cash advance (MCA) can be a quick fix for small business owners. MCAs can be a fit for those who need short-term financial assistance or have been denied a traditional bank loan because of poor credit scores or weak business financials. However, cash advance loans can cost you a bundle. Before you consider applying for one, make sure you do your research. The SmartBiz Blog has in-depth articles on this option:

Peer-to-Peer Lending

Peer-to-peer lending came onto the scene when the Great Recession of 2008 and 2009 made it nearly impossible for small businesses to get bank loans. Recognizing a need, online marketplaces were founded that connect businesses with individuals who have money to lend. However, buyer beware. Review the reasons outlined below to reconsider this funding option: 4 Reasons Small Businesses Should Avoid Peer-to-Peer Lending.

Online Marketplaces

Marketplaces offer lots of educational content to educate borrowers on funding options that they’re eligible for. They can’t extend direct financing, so small business owners might find themselves applying for a costly loan product.

Alternative lender advantages

These are the major benefits:

  • Simpler qualification process: Non-bank lenders can use different information than a bank requires to assess creditworthiness. Some see this process as easier, fairer, and more balanced.
  • Funding options: It’s a fact: major banks tend not to bother with loans they consider too small. That’s because they do the same amount of work to fund these loans and don’t make as much as they do off of larger loans. The right non-bank lender has funding options tailor made for small businesses.
  • Quicker approvals: You don’t need a long, drawn-out approval process as a startup founder. As an entrepreneur, you must get going quickly, so choosing an alternative lender is ideal.

Alternative lender disadvantages

Consider these disadvantages before you start working with an alternative lender.

  • More expensive: Because alternative lending is used by small business without an extensive background, they represent a greater risk. As a result, non-bank-lenders can charge higher interest rates or a shorter term, leading to large payments that can cut into your cash flow.
  • Smaller loan amounts: Alternative lending platforms lessen their risk by offering smaller loan amounts. Most range from $1,000 – $50,000, with the most common loan in 2017 averaging $13,000. However, if you have a good credit rating, loan amounts can be higher.
  • Shorter terms: Lenders mitigate risk by shortening the repayment period. This means small businesses may end up having access to funds for a shorter period of time, which can impact their cash flow once the loan expires. If you have a strong credit rating, you may be able to negotiate longer terms leading to shorter payments.
  • More frequent payments: While traditional bank loans typically require monthly payments, some alternative lending solutions require daily or weekly repayments.
  • You may only be able to get a large loan: Some non-bank lenders may be unwilling to sign off on
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  • Non-bank lenders may go out of business: Because they are relatively new, there’s a chance lender you work with could go out of business. How would that affect your business operations? When deciding to work with a non-bank lender, look at them the way you might evaluate any other business before you decide to trust them and transact with them. Investigate if they’ve been in business for at least a few years. Determine if they are well-funded and have the support staff available to answer questions and guide you through the application process. Another great way to get a pulse on an alternative lender is to read reviews from real customers. Google reviews, TrustPilot, and ConsumerReports are good sources of information.
  • You may not get any discount if you repay your loan early: Ask about repayment penalties or fees. You might be planning to pay off your loan early and you don’t want to be penalized.
  • Some non-bank lenders may charge hidden fees: It’s vital for a small business borrower to read the fine print. Also important is to have good customer service so you can get clear answers to any questions. Some alternative lenders may add disbursement fees, origination fees, repayment fees, and more. It’s recommended to work with your bookkeeper or accountant to determine the loan amount and cost that’s right for your unique business.

What is a bank loan?

A small business bank loan is when a bank offers to lend money to a business for a certain time period. The borrower pays a certain amount of interest for the life of the loan.

Advantages of a bank loan

  • Low interest rates: In general, bank loans have the lowest cost interest rates than alternative lenders.
  • Flexibility: When you receive a bank loan, you won’t have stipulations about how you can spend the money. Whether you need capital to purchase new equipment, enter a new market, or carry out a new marketing plan, you can use funds from a bank loan.
  • Maintain control: You don’t have to give up any equity to get a loan from a bank.
  • Interest is tax deductible: The interest on business bank loans is tax-deductible. In addition, especially with fixed-rate loans, in which the interest rate does not change during the course of a loan, loan servicing payments remain the same throughout the life of the loan. This makes it easy for businesses to budget for payments. Even if the loan is an adjustable-rate loan, business owners can use a spreadsheet to compute future payments if rates go up or down. For more detailed information about deducting interest on business loans and other information on business deductions, see IRS Publication 535.

Disadvantages of a Bank Loan

  • Requires profitability: While venture capitalists and angel investors usually take risks to invest in companies that haven’t yet become profitable, banks won’t take that risk. To be eligible, your company must be consistently profitable, which disqualifies the majority of startups.
  • Complicated: Obtaining a bank loan can be time consuming if you don’t have your financials in order.
  • Speed: The process with a bank can be slow. It often takes several months to qualify and obtain capital from a bank. Compared to other financing options, bank loans serve as one of the most difficult to obtain.
  • Collateral: Regardless of profitability, time in business, or how good your credit score happens to be, banks will need some form of collateral. Banks need to protect themselves in the case that you can’t make your payments. More information from SmartBiz University here: Reviewing Collateral Requirements.

Funding options through SmartBiz Loans

SmartBiz Loans is not a bank or an alternative lender. SmartBiz is the leading online bank network for SBA loans and assists small businesses to apply for these loans through its network of preferred SBA lending banks. Approval rates are increased by matching small businesses with the bank most likely to say “yes” to their loan. SmartBiz offers the “gold standard” in small business lending, SBA loans. Bank term loans and more financing options are also available. Learn more on the SmartBiz Loans website:

SmartBiz has an online application through an easy-to-use dashboard. Additionally, small business financial experts are on hand to answer any questions and offer assistance. If you’re ready to apply, start an application and discover if you’re prequalified in about 5 minutes.

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