5 Alternative Lending Solutions for Small Business Financing

When the Bank Says ‘No,’ Alternative Financing May Be the Answer

Even a reasonably healthy business may run short of cash from time to time, or have an unexpected opportunity come up that causes it to need a loan.

In both scenarios, traditional lenders are faced with regulatory constraints and other limitations preventing them from acting quickly enough to be helpful.

Enter ‘alternative financing.’ This is financing provided by a party other than a bank or credit union. Pursuing alternative lending options offers viable solutions, particularly for borrowers seeking small business financing.

Alternative Financing on the Rise

Alternative financing has become increasingly prevalent over the last decade. The market size was estimated at $3.82 billion in 2024, and is projected to grow at 25.4% CAGR over the next five years.

Growth here has been driven significantly by technological advancements. New technologies have seen fintech companies entering the market, offering more innovative digital lending solutions. Alternative lenders have also used AI and big data to create streamlined application processes that are able to make real-time lending decisions, unlike the stringent processes in traditional banks. This efficiency allows them to cater far better to customer needs.

Why Would a Bank Decline a Loan?

Conservatism is in a bank’s DNA. Bank regulatory requirements are necessary because they lend from depositors’ funds. In addition, it’s undeniable that banks have an outsized effect on the national economy. Hence, the creation of the Dodd-Frank rules following the 2008 financial crisis.

There is also the dominant industry business model of pursuing long-standing relationships with borrowers to whom a bank can cross-sell other services. This aligns nicely with their conservatism. For banks, the financial and operational condition of a borrower’s business is key. Quick and tailored funding of a liquidity-challenged or struggling business is naturally difficult for banks to accomplish.

In light of their limited risk appetite, some banks have started partnering with alternative lending companies. For those seeking small business financing who are unable to meet bank loan criteria, the banks can now refer them to alternative lending solutions. Small businesses can thus pursue more tailored funding opportunities, outside of traditional lending.

What About Selling Equity?

You may have considered selling equity in your small business to meet cash needs. This will require you to first consider various securities law issues. Beyond these issues, the fundamental problem with selling equity is that many business owners want to maintain control of their companies.

Furthermore, while typically more expensive than traditional bank financing, alternative lending solutions are almost always cheaper than equity. This is especially true at the lower end of the middle market. Here, institutional or private equity investors have little appetite for minority investments.

Why Are Alternative Lenders More Nimble?

Alternative lenders are able to move more quickly and enter into smaller and creative loan structures. This is in part because their regulatory load is oftentimes lighter than a bank’s.

Unlike banks, alternative lenders do not lend from depositors’ funds. Rather, they lend from the funds of investors, such as hedge funds, family offices, and accredited investors, and from bank lines of credit. Some alternative lenders grew out of large but cyclical businesses (e.g., shipping) that generated a lot of cash.

Business Financing At What Cost?

Alternative lenders charge higher interest rates and fees than traditional lenders. They also tend to insist on other terms that are ‘harder’ than those of traditional lenders. This has earned them the moniker ‘hard money lender.’

A hard money lender may ask for a security interest in collateral with a value comfortably exceeding the loan amount, irrespective of the financial and operational health of the borrower. An equity ‘kicker’ is also commonly negotiated.

Alternative lenders undoubtedly charge a premium for providing quick response, creative financing solutions, and additional liquidity for non-standard situations. However, it can be worth it for small businesses when they need to quickly access capital.

5 Alternative Financing Solutions

1. Hard Money Loans

Alternative lending firms often provide short-term financing with a very rapid turnaround, with some loans ranging up to $350,000. In exchange, the firm asks for titles to and possessions of valuable personal property such as jewelry, cars, or boats. Different lenders will lend upon different assets, or upon the overall assets of an unencumbered business. These assets are stored by the firm and returned upon repayment.

These loans are not only for borrowers who don’t have access to bank loans. In some cases, the borrower may have an immediate cash need that forces them to turn to an alternative lending firm, while waiting for their bank loan to close. The lender is later paid back with proceeds from the bank loan the borrower eventually receives.

The borrower may also be a seasonal business that doesn’t receive steady capital all year round. They may pledge their winter equipment to get start-up capital for their spring business.

2. Online Loans

There are a variety of internet-based lending platforms for online loans. Some specialize in short-term capital needs for small companies that are unserved or underserved by banks. Such loans are often made on an unsecured basis. Other platforms, commonly referred to as ‘marketplace lenders’ (or ‘peer-to-peer lenders,’ though that term can be a bit of a misnomer), offer term loans that can substitute for bank loans.

A good example is a marketplace lender like Funding Circle, which facilitates small businesses by helping owners get access to the finance they need. The lending process here is oftentimes more transparent than a bank’s process. This alternative financing option can also be more economically friendly than others.

3. Cash Advances

Sometimes, merchants that regularly do business with a company will provide cash advances. The borrower typically receives cash from the merchant in exchange for a promised percentage of future sales. For example, the merchant could provide a loan in exchange for a set percentage of the borrower’s daily credit card receipts.

These loans are short-term, usually less than a year, and of small scale. With this type of alternative lending, the average amount borrowed is usually under $100,000.

It’s important to note that some experts do warn against merchant cash advances (MCAs). MCA providers can set strict repayment terms that can impede a company’s chances of overcoming financial distress.

4. Factoring

A ‘factor’ provides cash to the business in exchange for ownership of the company’s accounts receivable. Accounts receivable may be the only assets a borrower has that are not subject to another lender’s lien. Factors focus on the soundness of the borrower’s customers and not of the borrower. This allows them to offer credit to companies to which traditional lenders will not lend.

Factors are extremely agile. They provide quick approval of a factoring arrangement, and also bring efficiency and discipline to the collection process.

In taking control of accounts receivable, the factor becomes intimately involved with the borrower. A rapidly growing company may benefit here, since it may lack the managerial processes to manage its burgeoning invoices. A struggling company may also benefit, as it may lack the bandwidth to collect efficiently.

Of course, borrowers should note that giving up control of collection to the factor may affect the company’s relationship with its customers.

5. IP Financing

An emerging type of alternative financing is financing secured by intellectual property. Intellectual property (e.g., trademark, trade name, patents) may contain substantial value that may not be fully understood by its owner.

Valuation of these types of assets can require specialized knowledge. Additionally, start-ups and small businesses may struggle to demonstrate that their intellectual property has a value separate and apart from the company’s general goodwill.

Final Considerations

Understanding your options in traditional and alternative financing enhances your chances of a positive outcome. Small business owners must remember to consult their attorneys, accountants, and other advisors before approaching a potential financing source. They should also review the relevant data and package it appropriately for presentation in an organized fashion.

Having a seasoned advisor can make the financing process much less daunting for borrowers who lack the time or resources to explore all alternative financing options. An advisor can present the information in a concise manner and in language that lenders understand.

They can also inform you on which segment of the financing market to target based on industry preferences, risk appetite, size of the deal, etc. Careful targeting will help foster competition and urgency among lenders. This will in turn help you get the deal done faster and on more advantageous terms .

We think you’ll also like:

1. When Is it Appropriate to Take on a High Interest Rate Debt Loan?
2. Managing Your Relationship With Your Business Lender in Times of Crisis
3. Merchant Cash Advances & Your Business – Just Say No

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Business Borrowing Basics / What Kind of Loan?
2. Alternative Structures- PO Financing, Factoring & MCA
3. Basic Concepts Applicable to All Borrowers & Lenders

This article was originally published in June 2018 and updated on November 27, 2022. This article was most recently updated by the Financial Poise Editors.]

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