If you’ve been doing any research on non-bank financing for your micro business, chances are you are holding two pretty contradictory feelings regarding alternative lenders. On one hand, they are providing a valuable service. Banks aren’t lending and it’s leaving a lot of small business owners out in the cold, and this even includes those businesses that are performing well with a solid sales history and other great credentials. But, on the hand, the Internet is filled with numerous horror stories of excessive interest rates, unclear terms, and outrageous fees. While there are many honest companies out there, speaking to some of these alternative lenders may just make your skin crawl.
It’s thus no surprise that there is a lot of content online about non-bank financing. There’s an army of alternative lenders and their associates trying to convince you that their product is the best solution for your business. But in this sea of content, very few articles offer advice on how you should decide on a specific product as well as how you can weed out the good lenders from the bad.
That said, my goal with this post is threefold:
- To help you clarify what your financing needs are.
- To help you decide what kind of alternative finance service is the most appropriate for your business
- To give you some clues that you can use to find a reputable alternative lender or loan advisor who you can trust
Three Popular Sources of Non-Bank Financing
Before I get to some of the steps that you can take in order to find a good non-bank lender, here is a brief rundown of the most talked about forms of alternative lending. Though there are literally dozens of different alternative financing products on the market, with new ones constantly being created, the most enticing products to small business owners will be some kind of off-shoot of the following three models:
1. Business Cash Advances
A business cash advance (also known as a merchant cash advance) is a form of alternative financing based on either future credit card sales or future revenues. In this set up, the cash advance provider “purchases” some of a business’ future sales at a discount. Cash advances aren’t cheap. Typical fees can be the equivalent of 30% to 50% annual percentage rate (APR), with rates up to 100 % not uncommon. In exchange, the business receives a predetermined amount of instant cash which can be used as working capital. The cash advance company then collects a set daily percentage of the business’ sales until the full amount funded has been paid off.
One big benefit to this kind of financing is that since repayment is based on a percentage of sales, there is no set time to repay the amount owed, and the owner of a seasonal business does not have to worry about making payments during periods of slow or no sales. Cash advance companies usually require that a company be in operation between 3 and 6 months, and may also require a minimum sales volume, but factors, such as the business’ credit profile, are not as important.
Another benefit is the speed at which a cash advance company can approve and fund a business. Usually, the whole process from the start of an application to the receipt of funds can take anywhere from 1 to 7 days.
Today, there are many different flavors of the business cash advance model where borrowers can make set daily payments or have a percentage of their total deposits automatically withdrawn from their online banking accounts on a daily basis. These services often come with very short repayment cycles (3 to 9 months) and a hefty price tag (a 50%-200% APR), yet the business owners who use them are attracted to the convenience and speed these lenders offer and look no further.
But as the options have increased, many of these cash advance companies have become more aggressive in profiling their borrowers. Kabbage, for example, which provides working capital advances to online business owners, connects to a potential borrower’s online business accounts, such as Paypal, eBay, and QuickBooks, and even looks at the business’ social media activity before approving a cash advance. Other lenders are known to also send mystery shoppers to check out the business first hand. Much of this due to the fact that a lot of these lenders are now backed by hedge funds seeking to get in on all the action surrounding alternative financing and maximize their return on investment.
2. Micro Loans
Micro lending has been gaining traction over the past few years as an affordable and practical alternative to a traditional business bank loan. Like the business cash advance, micro lending comes in several forms. Some business owners are aware of micro lending from the popular SBA Microloan Program. These are short-term business loans that typically go through a bank or a commercial lender. While the rates and payment terms can be reasonable, the downside is that the approval process can often take several weeks, and it is not always so easy to qualify.
Another popular form of micro lending is peer-to-peer lending via sites, such as Lending Club and Prosper.com. In this model, private investors collectively fund a borrower’s request, with loans ranging from a few hundred dollars to $25,000. When it comes to peer-to-peer lending, only borrowers with good credit need apply. Those who can access this form of microlending will enjoy good interest rates on unsecured financing and avoid all the processing requirements and fees associated with traditional business loans.
A third and growing segment of microlending, is from private lenders who offer working capital microloans. Unlike bank loans, with this type of microlending there is no down payment or collateral requirements. At Sunovis Financial, for example, which specializes in connecting small business owners to affordable SBA and microloans, a business’ cash flow and its ability to repay are most important factors they consider. There are many benefits to this form of business finance, including the fact that it can be significantly cheaper than the other alternatives out there. Moreover, microloans are not cash advances, though many business owners mistakenly think they are, and that distinction is important. Unlike other forms of alternative finance, a microloan that is successfully paid off can create a positive entry on your credit profile that will make it easier for your business to qualify for financing again in the future.
3. Factoring or Financing Accounts Receivables
This form of alternative financing has been around for over a century and has enjoyed a strong revival over the last few years. If your business deals with customer invoicing, then you may be able to leverage your outstanding customer Accounts Receivables (AR) in exchange for an instant influx of cash.
You should be aware, however, that there is a difference between AR factoring and AR financing. With AR factoring, your business would receive 70-90% of the total value of the outstanding receivable up front, the rate is generally dependent on the age of the account. The factor company would then assume responsibility for collecting the outstanding invoice. Upon full receipt of the payment from the customer, the factor company will return the remaining balance, minus a small processing fee. With AR financing, your business would use its outstanding invoices as collateral for financing, but you would still be responsible for collecting payment from your customers.
Now, as I mentioned above, there are other popular forms of alternative lending, such as equipment leasing and inventory financing. But, the three forms above draw the most attention primarily because they offer business owners the chance to receive quick, unsecured financing.
How Do You Decide What Type of Alternative Financing to Use?
So, now that you have a taste of the options, how do you go about deciding which type of financing is the best for your business? To get you thinking in the right direction, consider the following questions:
- How does your business operate? What do your profit margins look like? How smooth is your cash flow?
- What do you intend to use the money for? To cover a cash shortfall? To purchase inventory? To make renovations? Etc.
- How quickly do you need the money?
- How important is it that your lender reports your activity to the credit bureaus?
- What does your business look like to the lender? How long have you been in business? What is your sales and profits history? What is your credit profile? What industry do you operate in?
If your business has only been around for a few months, and/or you need access to on-the-spot short-term financing, then a small cash advance could make sense for your business. If you are dealing with a lot of outstanding customer invoices and you want to smooth out your cash flow, then invoice factoring may be a good option to consider especially if you also want to pass off your collections. For business owners who have been in business for at least 1 to 2 years, the best option in many cases may be micro lending. Since it offers a fast, yet much more affordable solution, and it helps to build a business’ credit.
How Do You Find Alternative Lenders Who You Can Trust?
One thing that you should keep in mind about alternative lenders is that these companies are not subject to the same regulations that guide banks, and as I mentioned above, many of them are backed by hedge funds that are demanding high returns. Ad to this mix a population of small business owners who are desperate for financing, and you’ve got the perfect recipe for an industry prone to predatory lenders and other opportunists.
So how can you weed out the legitimate businesses from the scammers? Here are five tips:
1. Take a good look at their website. You need to pay attention to how the company represents itself online, and I’m not talking about how flashy or professional-looking it’s website looks or how many followers they’ve got on their social media accounts. There are other, more subtle clues to watch out for. For starters, are their any real people represented? Do they have pictures of themselves and their team and/or the full names, locations, and pictures of satisfied customers? If all you see are stock photos and testimonials from “Jim H” then do yourself a favor and look somewhere else.
2. Find out what their customers are saying. Do you know any business that has received financing from this company? If you belong to any business communities, ask if anyone has been a customer and what the experience was like. If you don’t know of anyone, then look for customer reviews online. You could also ask the lender for references of previous customers. Just make sure you actually speak to them.
3. Speak to the lender directly. Don’t be shy about asking questions. Not only do you want details on the financing terms and conditions, such as what the requirements are, how much they fund, and how the money will be paid back, but you also want to pay attention to how the person answers your questions. If you sense that this person is running out of patience or is offering vague or off-target answers, then it’s a pretty good sign that you should be looking elsewhere.
4. Be clear about the costs. One thing that you should do particularly in a situation where the payment cycle is less than a year is to insist that the alternative lender provide a projected APR for your loan. Many lenders are quite adept at hiding the real cost of their financing, so even if they answer you, you should still make it a point to read the fine print of their terms and conditions.
5. Bottom line… trust your gut. Above all, pay attention to the overall feeling you have about this particular lender. If alarms are going off that something seems wrong, then don’t just proceed because you think you don’t have any other choice. In pretty much every situation there are good, responsible options. You just have to make the effort to find them and maybe be willing to have some flexibility.
In short, navigating the sea of alternative lenders can be overwhelming if you don’t exactly know what you are looking for and where to go in order to get it. But armed with a sense of direction and the right knowledge you’ll find the right solution for your business.
This post was brought to you by Sunovis Financial. They help small business owners of 1 year or more find the most suitable and affordable loans in the market. Though, they specialize in SBA and microloans for small business, via their hand-picked network of small creditors, they they also offer equipment lease financing and accounts receivables factoring. If you are interested in applying for a micro business loan or want to find out more about microlending, contact us at: 855 243-7191 or via email info(at)sunovisfinancial(dot)com.