Turning a small business owner’s vision into a success sometimes requires outside financing. How can business owners know what the best place is for them to get financing for their business? Small business loans can come from traditional brick-and-mortar locations, like banks and credit unions, or from alternative lenders, including private companies and online lenders.
Knowing which type of lender is best for your business funding can be overwhelming, but it doesn’t have to be. In this article, we look at the differences between traditional lenders and alternative lenders for small business financing and talk about a few of the pros and cons of each so you can make the best decision for your business.
Traditional lenders, including banks, credit unions, and other financial institutions, work with large corporations, small businesses, and individuals, offering many different types of financing depending on the business plan and cash flow requirements. Because of their size and various areas of focus, traditional lenders usually have stock-standard financial product offerings when it comes to business loans and financing.
Some of the types of small business loans that may be available at a traditional lender include the following:
Business term loan
A business term loan is a traditional type of bank loan where a lump sum of money is borrowed and repaid over a fixed number of payments. A term loan can be used for working capital, a large purchase, or any number of financing needs. The interest rate on term loans can either be fixed to stay the same throughout the entire term or variable, fluctuating depending on the market rate and terms of the loan. Some term loans require a down payment, which may depend on the creditworthiness of the borrower. For small businesses with less-than-ideal credit history, they may still be able to take out a secured term loan, where a personal guarantee or collateral is required. Term loans are available through traditional lenders and alternative lenders.
Business line of credit
A line of credit is a flexible loan where a borrower is approved for a maximum loan amount. A small business can then borrow funds against its line of credit as needed. A business line of credit can be used for large purchases, working capital, or other cash flow issues, including seasonal gaps. This type of revolving credit only requires that borrowers make payments and pay interest on the amount of funds that they have withdrawn. When the balance is paid off, the money may be withdrawn again.
Equipment financing is a business loan used to purchase equipment necessary for operations, like restaurant equipment, vehicles, or office equipment. Small businesses can borrow up to 100% of the cost of equipment and then the equipment becomes the collateral on the loan. Interest rates are fixed on equipment loans, and repayment terms depend on the lender and the total cost of the purchase.
Commercial Real Estate (CRE) Loans
Commercial Real Estate loans are a type of financing used for purchasing or expanding a business location, like a home mortgage. The real estate purchased is used as collateral on these loans. CRE loans usually have long terms up to 30 years and can have a fixed or variable interest rate like a term loan. They require a significant down payment and good creditworthiness from the borrower. CRE loans can come from a traditional or alternative lender.
Pros and cons of traditional lenders
There are some benefits to using a traditional lender. Many entrepreneurs find comfort in borrowing from a bank that they already have a business checking account with or have used in the past. It can be easy to keep track of your money when all your accounts are with one institution. Traditional lenders also often offer lower interest rates and fees to their customers compared to other sources of financing, although these rates and fees are usually reserved for a select group of clients such as those included in a “Private Client” or “Rewards” program that the traditional lender is offering.
There are also some disadvantages to taking out a small business loan with a bank or credit union. Working with a traditional lender is a time-consuming choice. The wait between the loan application and the funding of the loan can be up to two months. Getting a loan with a traditional lender also comes with stricter approval requirements, so small businesses or startups with less-than-ideal credit scores or low annual revenues may not qualify. And traditional lenders generally have more paperwork requirements and will require much more information for underwriting than, say, an online lender.
FAQs About Traditional Lenders
How do you find a traditional lender?
Many people use the lender where they currently have business credit cards or bank accounts. Some borrowers ask trusted partners and friends for recommendations. A simple internet search for lenders will also produce a list of traditional lenders.
Do traditional lenders offer SBA loans?
Yes. It depends on the institution, but in general banks and credit unions are more likely to offer this kind of loan. Loans backed by the U.S. Small Business Administration are issued by banks and lenders that have been authorized by the SBA. Small business owners should look for a lender that is an SBA preferred lender.
Is a good personal credit score required for business owners that want to borrow?
There is no magic number when it comes to qualifying for a loan. However, at a traditional lender the requirements for personal credit score are much more stringent than at other lenders. Depending on the financial institution and the type of loan, a high personal credit score may help lower the rate of the loan. In general, a FICO score above 680 is required for business owners to be considered for a loan at a traditional lending institution like a bank or credit union.
Does it matter which traditional lender you choose?
It can. Small business owners may be able to find better interest rates by checking around. Also, some types of loans are not available at all banks, so ask about loan type and rates before starting the application process. And if you have an existing relationship with a lender, this can work to your advantage if you use the total value of your existing relationship with the bank to negotiate on terms and pricing.
Who is the best traditional lender?
The answer to this is really personal preference based on your business needs, and the loans and rates available. However, at Biz2Credit we work with many traditional lending companies that have a long, successful history of working well with small businesses. You can learn more about the banks and traditional lenders we support by visiting our technology platform website at biz2x.com.
As the name implies, alternative lenders are another option that many business owners consider when they are seeking financing. Often, a lender is considered an alternative lender when their primary focus is on specialty lending instead of all the other kinds of products that a bank or other traditional financial institution might provide.
There are all kinds of alternative lenders out there, each with their own specialty. Alternative lenders can work with small businesses, new businesses, and individuals seeking personal loans. Unlike with banks, no two alternative lenders are exactly alike. They can offer many of the same financing options as traditional banks like term loans, business lines of credit, CRE loans, and equipment financing, or they can provide credit options that you won’t find with your more traditional institutions.
Some of the other funding options that are offered at alternative lenders include the following:
SBA loan programs are partially guaranteed by the U.S. Small Business Association but financed by a traditional or alternative lender. The loans are low risk, so lenders can offer lower interest rates and more flexible terms. Borrowers repay SBA loans by making monthly payments to the lender, not the Small Business Association. Most SBA loans are still made by traditional lenders, but there are some specialists in the alternative lending industry who do offer them as well.
There are several different SBA loan options, depending on the business needs. A few types of common SBA loans include:
- SBA 7(a) – loans up to $5 million for working capital, equipment, refinancing, and real estate
- SBA Microloans – up to $50,000 for business purposes
- SBA Express loan – up to $350,000 for working capital
- SBA 504 – up to $5 million for major fixes assets, available through Certified Development Companies (CDCs)
Merchant cash advance
A merchant cash advance is a type of financing that is not a loan and is paid back with daily credit card sales. They are a quick solution to working capital needs because a merchant cash advance is funded fast. Since the financing is guaranteed with future sales, this type of financing has high approval rates and generally doesn’t require high FICO scores to qualify. They are a great option for business owners experiencing a temporary shortage of cash flow, or that need to take advantage of a growth opportunity without waiting for the long delays involved in bank financing.
Invoice financing and invoice factoring
Invoice financing or factoring are short-term financing transactions for businesses going through cash flow fluctuations. These loans are paid back with receivables, or customer invoices for products or services that have already been sold. With invoice factoring, the financing company will collect the balance of customer invoices on behalf of the small business. A large percentage of each collected invoice will go towards paying off the loan, and the remainder goes back to the borrower. Invoice financing works the same way except the business collects on their unpaid invoices themselves and then makes payments to the lender.
Pros and cons of alternative lenders
There are many advantages to securing business financing with an alternative lender, including saving time. Online lenders and private companies can fund loans much faster than traditional banks. The time from application until the loan is fully funded can be as quick as 1-3 days. Alternative lenders are also easier to work with because they offer an online application process. Required documents, like bank statements and tax returns, can quickly be uploaded from the borrower’s home or office.
Small business leaders who have bad credit or are just getting started may prefer working with alternative lenders because of their higher approval rates. Online lenders and private companies offer flexible eligibility requirements to borrowers, so they are able to finance more small businesses, startups, and companies with less than perfect credit history. Getting that approval can often be the difference between success and failure in a small business, which is why so many business owners turn to alternative lenders in the first place.
Just like with any loan, there are also some disadvantages to borrowing from an alternative lender. Some loans that are financed by an alternative lender will have higher interest rates and origination fees than may be advertised at a traditional lender. This is mostly due to the flexible approval rates, speed of turnaround and simple underwriting process that alternative lenders can provide. Another aspect of alternative lenders is that they tend to have fewer resources for customer service and relationships with their clients than a traditional lender.
FAQs About Alternative Lenders
How do you find an alternative lender?
Alternative lenders can easily be found online, along with reviews about their reliability, rates, and services. You’ll want to select a lender that has a great reputation and offers more than one type of financing.
Can you get a line of credit at an alternative lender?
Absolutely. Business lines of credit are a very popular choice for small businesses because of the freedom they offer. Many borrowers need the peace of mind that a credit line offers, but only want to make payment on funds they’ve already borrowed. Alternative lenders can approve revolving credit limits and fund cash fast.
However, you should be careful about picking the proper option when it comes to financing for your business. Many alternative lenders do not actually provide a line of credit and instead provide a series of instalment loans with mandatory withdrawals against the so-called credit line and high maintenance costs if there is no borrowing.
Can you get equipment financing or real estate loans at an alternative lender?
Yes. Alternative lenders can approve equipment financing for up to 100% of the cost of the new equipment. They offer a fast alternative to big banks and more flexible application requirements. Just be aware that this kind of financing is generally a secured loan, requiring repossession of the collateral in the event of non-payment.
Can a non-profit organization qualify for a loan?
Yes. Non-profits can get approved for more than one type of loan. Lenders can work with nonprofit organizations to find the right type of loan and repayment terms for any business model.
Does it matter which alternative lender you choose?
Yes. There are many different alternative lenders advertising quick and easy loans. However, it is important to find the right lender that specializes in small business lending. Alternative lenders can offer different types of financing, funding times, and have varying fees, so be sure to find the best fit for your small business.
Who is the best alternative lender?
Of course, if you ask us, Biz2Credit would be our top pick for helping you acquire funding. We are a long-standing funding provider that offers many types of loans and financing for a diverse group of borrowers. When you apply with us, we match you with reliable funding opportunities quickly and with minimal paperwork. We’ve helped hundreds of thousands of small businesses secure capital with financing products including term loans, invoice financing, merchant cash advances, SBA loans, and more. Our goal is to support small businesses with their needs and goals, independent of traditional lending roadblocks that so many business owners face through no fault of their own.