At the peak of the Great recession many small business owners worried that they had no lending options at all. How things change. Today not only are traditional lenders ready to provide financing, but so too are a wide variety of nontraditional sources.
But all those choices don't necessarily make borrowing easier. To make the smartest choice for your company you'll need to invest some time in assessing the pros and cons of each option before signing on the dotted line.
“Before taking out a loan, the small business owner should thoroughly understand why they need the money and what their options are in terms of getting that financing,” says Steve Milan, a partner with Fuse Financial Partners in Charlotte, NC. “There are a great many sources of alternative financing, but the terms can be very confusing and may ultimately be quite expensive.”
Who's Lending to Whom, and Why?
As more investors enter the lending market in pursuit of higher returns, alternative lending sources are increasing rapidly. Here are a few of the much-talked-about options that you may want to explore:
- Microloans: Small Business Administration Loans ranging up to $50,000.
- Crowdfunding: Through online platforms, business can raise money for the development and/or launch of new products and services.
- Peer-to-Peer lending: Pairs investors with business owners in need of capital.
- Merchant Cash Advances: Advances funds based on future debit and credit card receivables.
- Factoring: Loans made on outstanding invoices.
- Asset-based lending: Loans based on assets such as inventory or accounts receivables.
For the most part, alternative lenders make loans based either on assets or cash flow, Milan says. The major advantages of alternative financing is that it makes available funds for businesses that don’t have the track record, assets, or cash flow to qualify for a traditional bank loan. The major disadvantages are the fees and interest rates.
“There’s financing available for small business owners who need it,” Milan says. "The trick is that such financing is confusing and expensive. The terms can be difficult to figure out because of the combination of interest rates and fees.”
When evaluating financing options, take a hard look at the interest rate and make sure you have a full understanding of all fees. Think about how much the loan will cost you in total so you can decide whether it's a wise move. Also keep in mind that the time from when you apply for a loan to when you receive the money can vary by type of loan source and the individual lender.
Milan notes that rates and fees vary widely. Peer-to-peer lending rates, for example, run from 5.9 percent to 36 percent annually. Asset-based loans tend to end up in the low teens once you combine the interest rate and fees.
"It makes sense for small business owners to consider alternative lending anytime they need financing but a traditional bank loan is not the best option," Milan concludes. “The first step is to consider why the financing is needed and then conduct a profitability and cash analysis. Once the small business owner knows what types of financing are available, then it’s time to compare costs and terms and decide which route to pursue.”
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