Small Business Owners’ Guide to Private Lending

Today, where market competition is fierce and consumer demands are evolving rapidly, many businesses feel the need to rely on external funding. Earlier, businesses mainly used to rely on banks for financing their various business needs. Now, with private lenders offering a wide range of financial products at compelling terms, there has been a shift in the mindset of business owners.

Owners may require small business loans for multiple reasons. But traditional banks and credit unions follow strict underwriting rules. As a result, this leaves many entrepreneurs and small business owners searching for alternative funding.

Private lenders fill this space for business owners. They offer faster funding decisions, flexible eligibility requirements, and more liquidity. However, the interest rates and loan terms offered by private lenders require careful evaluation.

In this article, we will shed light on what is private lending, what are its multiple types, benefits, and how it differs from traditional bank lending.

What is Private Lending?

Private lending refers to all those forms of lending where a non-banking institution is involved. Businesses usually consider private lending as a substitute for banks, but it may come with its own set of benefits and risks that we have discussed in this article. Private lenders set their own terms and conditions for repayment, prepayment, foreclosures, and more. Other factors, such as interest rates and annual percentage rates (APR) may also differ vastly from what banking institutions offer.

Many times, private lenders design their financial products to attract businesses that do not prefer to take loans from traditional banks because of reasons like existing debts, limited credit history, and longer approval process. To fulfill the requirements of such businesses, the eligibility criteria of private lenders is not that strict.

Types of Private Lenders

1. Private Financial Institutions

These are non-banking institutions or companies that have created several loan products for business owners. Private financial institutions often offer lower eligibility criteria to businesses and faster decisions. The requirements for any collateral or downpayment vary in each product. Also, private financial institutions may serve as a marketplace and help you secure funds through third-party lenders.

2. Private Individuals

These are high-net-worth individuals turned into investors. These offer loans to small businesses after carefully analyzing their business model and profitability. Private individuals may offer higher scope of negotiation to business owners if their revenue generation potential is high.

3. Direct Lending Companies

These refer to private financial institutions that offer direct loans to businesses without any intermediaries. To finance small businesses, direct lending companies often use their own funds. As these companies remove any intermediaries, business owners may be able to secure lower APR.

4. Hard Money Lenders

Instead of having a broad eligibility criterion including credit score, income stability and debt-to-income (DTI) ratio, hard money lenders make decisions considering the overall value of the property or asset. These private lenders mostly offer asset-based loans, often for fix-and-flip properties or commercial real estate.

5. Private Equity Funds and Hedge Funds

These funds are pooled investment vehicles that raise funds from several private lenders and institutions and offer loans to small-to-mid sized businesses. While private equity funds usually invest in long-term loans, offering funds for purposes like business expansion and mergers & acquisitions, hedge funds focus on short-term loans for purposes like store renovation, managing working capital, doing payroll, and more.

6. Peer-to-Peer (P2P) Lending Platforms

These are entire lending platforms that help small businesses connect with individual lenders or private lending companies. Borrowers can compare specifications like interest rate, APR, loan tenure, maximum loan amount, decision time, etc. on these platforms to make a well-informed decision. In exchange for acting as an intermediary and loan processing, P2P lending platforms often charge a small commission from both lenders and borrowers.

Benefits of Private Lending

Business owners may opt for private lending over banking institutions because of various benefits:

1. Faster Decisions

Just like traditional banks, private lenders evaluate borrower profiles over several parameters. However, in comparison, the decision making in private lending firms is faster, ensuring quick access to funds to businesses for time-sensitive investments.

2. Easier Qualification Criteria

Traditional banks often have strict eligibility criteria, which new businesses with just few months in operations may not be able to meet. When this happens, those businesses often turn to private lending that accept lower business age, decent credit scores, and even limited financial documents.

3. Higher Loan Amounts

Private lenders may approve higher loan amounts to businesses in comparison to banking institutions. Those extra funds help businesses in better achieving their goals and with cash flow management problems. Certain lenders may approve higher loan-to-value (LTV) for borrowers, requiring only minimum downpayment.

4. Multiple Loan Options

Today, private lenders offer a wide range of financial products and small business loans for small businesses. These range from term loans and business line of credit to equipment financing, commercial vehicle loans, and more. Business owners get the option to choose from asset-based loans, revolving loans, installment loans, and even revolving line of credit.

Some types of loan products that private lenders offer are: Term loans for long-term business funding Short-term loans or working capital loans for urgent business needs Equipment financing for purchasing tools and machinery Business line of credit for flexible borrowing of funds Commercial real estate loans for property purchases

5. Flexible Repayment Options

With the emergence of private lenders, there now exist loan options with varying repayment terms for small businesses. Business owners can opt for the repayment tenure they prefer. This may range from a few years to a decade, depending on your lender and loan product.

6. Highly Suitable for Asset-Based Lending

Private lenders offer competitive asset based loan rates for businesses interested in secured loans. When it comes to real estate loans, like for fix-and-flip properties, hard money lenders are one of the most preferred lending options available today.

Private Lending vs Traditional Banks

Private lending and traditional banks vary in several ways. From the eligibility criteria to decision making, a lot of factors change when small businesses decide to borrow money from private lenders instead of traditional banks.

Private Lending vs SBA Loans

The U.S. Small Business Administration also offers several loan programs in collaboration with certified Community Development Financial Institutions (CDFI). In these programs, SBA only guarantees the loan, while the CDFI provides the funds. Because of lower eligibility criteria, several small business owners consider SBA loan programs as an alternative to traditional bank loans.

However, for small business loans, both traditional banks and SBA loans have tedious application process. On the other hand, private lenders simplify loan approval through digital systems. This creates faster funding opportunities for small businesses and nonprofit organizations.

Risks and Red Flags to Watch for When Dealing with Private Lenders

When seeking business loans from private lenders, certain warning signs require attention. This awareness protects business owners from costly outcomes in the future.

Here are some risks associated with private business lenders:

• Unclear written agreements: Professional lenders always provide documented repayment terms and loan amounts. However, lack of proper documentation signals concern.

• Hidden fees in loan contract: Private lenders should offer full transparency around origination fee and service charges. Because vague explanations suggest risk.

• Pressure to accept loan offers quickly: Reliable lenders allow business owners to have their review time. Because rushed decisions often benefit the lender more than borrowers.

• Missing registration or business presence: Federal Deposit Insurance Corporation (FDIC) registration does not apply to all private lenders. However, legitimate business operations and verifiable offices matter for business lending.

• Inconsistent communication: When applying for business loans, seeking clear answers show professionalism. And evasive responses suggest caution for business owners when borrowing.

Thus, spotting these red flags early protects business funding efforts and long-term stability.

Final Thoughts

Private lenders play a vital role in the business lending space in the U.S. Startups, nonprofits, and expanding companies now can access broader funding options other than just traditional bank loans and SBA loans.

There are various alternative funding options available for small business owners. These loan options offer speed with better flexible terms. However, asking clear questions reveals loan products that match business needs. Also, having transparency supports healthy cash flow and long-term success.

So, if you’re ready to secure smarter business funding options, prepare your business plan, review credit score, and approach private lenders with confidence.