Many small businesses find financing very difficult. The average approval percentage is only 30%. This is where alternative loans appear. As a direct response to this great need, alternative online lenders such as Lending Club, OnDeck, Funding Circle have emerged . What they do is use large data and algorithms to reduce the long process of a loan from 2-3 months to 3-4 days.
Although it seems simple, borrowers are left with questions:
- How does the online loan process work? What is an algorithm? What is that “big data”?
- Are all alternative loans the same?
- Does an alternative loan make sense to my business?
In the following article we will answer the three most common questions about alternative loans.
Alternative loans: questions and answers
Question 1: What are alternative loans online?
Instead of asking for a large amount of financial information and a lot of documents, alternative lenders use technology. They obtain financial information from large data sources. These sources are commercial credit agencies, QuickBooks, and social networks (Yelp, Facebook). The potential borrower only has to complete a one page application form, and provide the account statements for the last 3 months. With this information, online lenders will be able to estimate the cash flow of a business. And before securing a loan, they are based on the volume and frequency of the account statements.
Question 2: What types of alternative loans are there and which one is best for my business?
There are many alternative capital products on the market: Ferdies Financial, for example, offers 8 products. Not all loan products are the same: they will depend on the type of company and the use of capital.
Option 1: Short term loan
The short-term loan is usually designed for small business owners who have an immediate demand for cash, and therefore need fast financing. The terms of these loans vary between 3 to 18 months, with minimum interest rates of 18% and maximum of 50% or more.
Advantages: fast cash deposit, with a relatively simple application process. Disadvantages: high interest rates and daily automatic payments.
Short-term lenders tend to be more flexible with borrowers who do not have optimal credit. For many emerging businesses or owners with FICO scores below 640, these loans may work. However, these loans have a long-term prohibitive cost.
Option 2: Intermediate term loans
Intermediate loans are intended for established companies, with at least 2 years in operation and with positive cash flow. These loans are used for medium to long-term investments in the business (for example, purchase of equipment, or expansion of the premises). The terms of these loans vary between 6 months to 5 years. Payments are made bimonthly and interest rates are between 8 and 25%.
Alternative lenders process these loans faster than traditional banks. They lend up to $ 500,000, and there are no penalties for repaying the credit early. Intermediate loans are an excellent alternative for established companies that want to expand. Normally the credit quality standards for these loans are similar to those of a bank loan. So if a potential borrower has time (2-3 months), it is advisable to check first with a bank.
Option 3: Credit Line
Credit lines are similar to a credit card. It is a credit available to business owners. It is used to pay daily or monthly capital requirements at work. The big difference with a credit card is in the structure of the money back. Once the cash is withdrawn from the credit account, the principal and interest payments are automatically returned, daily and for a predetermined period of time. Twice a month you must pay interest of 5%, and APRs of 30% or more.
While APRs are high, these open lines of credit are very accessible to business owners. Even if your credit history is not optimal. What counts is the frequency and size of transactions in a company’s bank account. Another benefit is the high credit balance available to business owners ($ 100,000). This is different compared to traditional lines of credit and credit cards.
Option 4: Market cash advances
Market cash advances (“MCAs”) are the most flexible option. But it is also the most expensive financing alternative in the market. MCAs are not loans. They are cash advances that are returned with what is received on credit cards in a company. The MCA provider keeps a percentage of sales charged with debit or credit cards, until the amount agreed at the beginning is paid in full.
There are restrictions on the use of earnings without requiring a personal guarantee. A key advantage is the simplicity of the application process and the return of the money, which is paid on the fly. This is ideal for seasonal business.
MCAs can be a good source of capital for short-term investments and with the possibility of large profits. But a very expensive and risky option. APRs exceed 50%. In addition, there is a possibility that business owners will be left with negative income.
Other asset-based alternatives
There are many alternative ways of accessing capital, usually using collateral some type of goods. These types of loans vary in their structure and payment schedule, but are a reasonable alternative for a business. Especially for those with limited cash flow or a credit history that is not optimal.
Question 3: Is an alternative source of capital a good idea for my business?
Disadvantages of a traditional bank loan
Major banks are increasingly reluctant to make loans under $ 150,000. This is due to the high costs of associated services and the low collateral value of small businesses. On the other hand, small business owners find the process of a traditional loan difficult. They need high credit standards, and there is a lot of paperwork. In addition you have to wait a long time to receive the money, up to 2 and 3 months. A lender from a traditional bank wants potential candidates with a capital need of at least $ 150,000. The ideal candidate must also have a personal credit score of at least 680.
This is where alternative lenders appear.
This is where alternative lenders arise, with a valuable proposal that can mitigate these inconveniences. Alternative lenders use a formula-based approach to pre-qualify loans in just a few minutes. During the approval process, paperwork is reduced. In addition, cash flow is considered more than the personal credit score of the business owner.
But the most worrying thing about these alternative loan options is the high percentage of interest per year, which ranges from 8% to 60% or more. With these prices, these types of loans can be prohibitive for small businesses. Especially if we compare them with GFA loans, which are priced between 6 and 8%. Therefore, alternative financing does not work for everyone.
However, alternative financing does work for many of these companies. In fact, unbanked lenders lent $ 9 billion in 2015 (source: Liberum). The reality is that there are many drawbacks in the traditional process of a loan, and that is why this is an attractive option.
In Ferdies Financial, we find many businesses that have capital limitations. Many times their cash is already invested in the business, which prevents them from investing in the growth and maintenance of the company. And what is worse, most of these small businesses use their credit cards or informal lenders with high interest rates. Much higher than alternative capital options. We also see many companies with a solid cash flow, but whose owners have low credit scores. This is due to several reasons, such as having sold a property during a mortgage crisis. Or we find solid companies that need capital immediately to buy a large inventory order to meet their high demand. The examples are innumerable and the nature of the needs varies. In summary, the extra amount spent with an alternative loan compensates for what is being lost by not obtaining it.
So before you reject alternative ways of financing for your small business because they seem very expensive, consider everything your small business can get in return, without the traditional obstacles and inconveniences.
Do you want to know more about alternative loans? Read on 6 Data on alternative loans.