Turning a small business owner’s vision into a success sometimes requires outside financing. 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. 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.
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. Some of the types of small business loans that may be available 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of revolving credit only requires that borrowers make payments and pay interest on the amount of funds that they have withdrawn. When the balance is paid off, the money may be withdrawn again.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. Traditional lenders also can offer lower interest rates and fees to their customers than other sources of financing (which can be a huge advantage for small businesses).
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.
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. Loans backed by the U.S. Small Business Administration are available at both traditional lenders and alternative lenders. 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. Depending on the financial institution and the type of loan, a high personal credit score may help lower the rate of the loan. But for some lenders and some loans, the business owner’s personal credit score may not even be considered during the application process.
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.
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, we recommend that you check out Bank of America (BoA) and Chase Bank. Both BoA and Chase have a long, successful history of working well with small businesses.
Types of small business financing
Alternative lenders work with small businesses, new businesses, and individuals seeking personal loans. They offer many of the same financing options as traditional banks like term loans, business lines of credit, CRE loans, and equipment financing. 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.
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 loan that 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 loan is guaranteed with future sales, this type of financing has high approval rates. They are a great option for business owners experiencing a temporary shortage of cash flow because merchant cash advances are short-term.
Invoice financing and invoice factoring
Invoice financing or factoring are short-term loans 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 for their 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.
Just like with any loan, there are disadvantages to borrowing from an alternative lender. Some loans that are financed by an alternative lender will have higher interest rates and origination fees. This is mostly due to the flexible approval rates and simple underwriting process they can provide.
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.
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.
Can a nonprofit organization qualify for a loan?
Yes. Nonprofits 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?
Biz2Credit is our top pick for helping you acquire funding. They are a reputable online lender that offers many types of loans for a diverse group of borrowers, and they can match you with reliable funding opportunities with speed and efficiency. They are a great choice for any working capital loan including term loans, invoice financing, merchant cash advances, SBA loans, equipment financing, and more. At Biz2Credit, they focus on the small business needs and goals, not just the creditworthiness of the borrower.