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Top 3 Alternative Lending Sources for Small Businesses in 2016

deBanked-56114226207137Since 2008, banks have made it even more stringent for merchants to qualify for small business loans. As such, there are very few sources for small businesses to turn to for quick working capital without having to jump through major hoops to qualify. Quite frankly, banks perform rigorous financial review (profit & loss sheet, detailed business plan, 2 years of tax returns, business owner’s blood type, first-born child’s dental records and food allergies…okay maybe not the last three) that would turn off and/or disqualify businesses that are both viable and income-producing.

But, guess what, it’s 2016, baby! Henry Fernandez doesn’t need to wait on a bank loan to grow his Italian ice shop neither does Janice Kennedy when she wants to put a new wing on her Irish pub or Leon Baptiste when he needs equipment for a new construction job. In fact, no proprietor has to wait on a bank loan anymore to grow, expand or, even, start his/her own business.

Here are the 3 top alternative funding sources for any business in 2016.

  1. VENTURE CAPITALISTS

Seeking funds from venture capitalists is a good source for growing businesses in the new millennium. You’ve all seen ABC’s Shark Tank, right? Where a bunch of millionaire and billionaire business tycoons listen to pitches made by aspiring and current entrepreneurs then decide if they’d like to get in bed with the guy selling the latest toilet tissue dispenser or the world’s first self-tying sneaker.

Here’s the catch: venture capitalists are looking for ownership stake in the business and they seek to deploy hundreds of thousands or millions of dollars, not small investments, because they are seeking multiple times return on that capital. Thus, venture capitalists focus heavily on the size of the market: if they don’t believe the market is large enough, they won’t invest.

Additionally, securing financing from venture capitalists is kind of like dating; the VC needs time to warm up to you. So, VCs want to get to know you – the founder. They want to watch you execute and make progress before committing to invest in your idea, invention or company.

  1. MERCHANT CASH ADVANCE LENDERS

The merchant cash advance industry has become popular in the past decade as it is known for underwriting high-risk loans – loans that banks wouldn’t touch with a ten-foot pole.

Companies like On Deck Capital and Merchant Cash & Capital in New York or Global Business Lending in Ft. Lauderdale, Florida qualify businesses without a credit check. Instead, they use more common-sense guidelines to ensure that the business they lend to is financially healthy enough to pay back a short-term loan.

They must prove things like having a monthly bank balance of $6,000, having been in business for 3 months and not be in an open bankruptcy.

The funds that these companies provide are technically not loans; the correct term is a merchant cash advance, which is a short-term advance of funds against a business’s future receivables. According to Entrepreneur.com, this 15-year-old industry is “booming, mainly because bank lending criteria have become so tight since the Great Recession that very few small businesses are able to qualify for bank loans.”

Businesses like restaurants, retail shops, contractors and service companies generally find these funds helpful because most times they need lump sums to purchase supplies, equipment or to expand their space. They can qualify for $2,000 to $3 million.

 

  1. CROWDFUNDING WEBSITES

Crowdfunding has also grown in popularity due to the very reason that merchant cash advance firms did — a lack of lending appetite from the major banks.

Crowdfunding uses a website and email campaign to persuade individuals to each give a business a small donation — $10, $50, $100, maybe more — within a fixed term. It has all become possible in recent years thanks to a proliferation of websites that allow nonprofits, artists, musicians and businesses to raise money. There are more than 600 crowdfunding platforms around the world with fundraising reaching billions of dollars annually, according to the research firm Massolution. The most common are Kickstarter, Indiegogo and The Lending Club.

If you are going to use a crowdfunding platform, you must have an engaging story to tell so that audiences can almost immediately attach value to your product or service. A business owner initially sources individuals from within his/her own network of friends, sending out correspondence through their email’s address book. The key is to gain interest from friends of friends or strangers, so that your network doesn’t exhaust quickly.

Here’s the tricky part: a business can raise thousands at the end of such a campaign, but most times can only keep the money they raised if their total funding goal is met. Also, be careful, a business risks getting sued if it promises customers products or perks in return for donations, and then fails to deliver.

 

TiffaniTop 3 Alternative Lending Sources for Small Businesses in 2016
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The Pains and Perks of Business Lending

The world of banking has changed dramatically, if not radically, in the years since September 2008 when Lehman Brothers went bust. The mortgage crisis ensued and then WHAMMO … banks decided to make borrowing from them a HUGE PAIN. Here is an in depth infographic explaining the differences between traditional and alternative business lending.

 

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TiffaniThe Pains and Perks of Business Lending
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Why Banks Are No Longer Lending to Small Businesses?

Remember the days when you’d need funding to start or grow your business, and you’d get in your car and head down to the bank on the corner?

You knew your banker personally, perhaps even had kids in the same class at school, or would often see them at your favorite local restaurant. This personal relationship helped fuel a strong financial relationship; you knew exactly where to go to get the loan you needed.

But, the days of driving to your local bank for a business loan are long gone. Not only are community banks getting eaten up by the big banks, but bank lending to small businesses is at an abysmal rate. If you’re a small business owner, and you walk into a bank, you’ve got around an 80% chance of getting denied. Yep. That’s right.

Instead of sitting here, drowning in these depressing statistics, let’s take a look at why this drop in small business bank lending is happening.

See Also: 10 Things the Bank Will Ask When You Need a Business Loan

unsecured-loan

Why lending to small businesses is declining

When small business lending took a hit during the recession, most thought it was purely a victim of the economic downturn and would eventually inch its way back up.

However, that hasn’t been the case. The total dollar volume of bank loans to SMBs has declined by 20% since the start of the recession. And, it just continues to trend down. Here is why:

  1. Increased regulation. Post-recession, banks have had to tighten up their standards and be extra-cautious about the risk in their portfolios. Remember, they are making these loans with my money, your money, and your neighbor’s money. Hence the reason they have to be so cautious. Unfortunately, small businesses are inherently riskier than their larger counterparts, which makes banks think twice before extending them credit.
  2. Downturn in community banking. Small businesses have historically had more success finding a loan at a community bank than a big bank. In fact, community banks have 3 times the approval rates on small business loans than the big banks. But, our number of community banks have been declining since the 1980’s, inadvertently hurting America’s job creators. With fewer community banks, there is less opportunity for business owners to find a loan at a traditional banking institution.
  3. Less profit on smaller loans. More often than not, small business owners are looking for smaller loan amounts. In fact, our average loan size at Fundera is $40,000. Other data shows that about 80% of small businesses want loans that are less than $500,000. But, it doesn’t make financial sense for banks to provide these smaller loans. Why? It costs banks just as much to underwrite a $1 million dollar loan as it does a $100,000 loan. Therefore, they can make way more money focusing on larger loans. At the end of the day, banks are businesses too.

When you stop and look at the reasons banks have cut their lending to small businesses, it makes sense. But, it is still frustrating that business owners are having to face so much rejection. That being said, small business owners need to learn to approach their loan search differently. It’s no longer about expecting the banks to give you credit; it’s about being aware of multiple ways to fund your business and preparing to try a few different sources.

 

Beyond bank loans: Explore alternative lending

But, what are other sources of funding outside the bank? 

Meet “alternative” lending. Online lenders have started emerging over the years to help fund borrowers that can’t find capital at the bank, and given the decline in bank lending to small businesses, the alternative lending industry is booming. 

Alternative lenders are simply any non-bank lender. These lenders can most often be found online, as they don’t have physical storefronts like the banks. They include well-known companies like Lending Club and OnDeck, as well as hundreds of lesser-known companies. These alternative lenders are offering traditional term loans, invoice financing, short term loans, and more.

So, as you can see, there is hope. As these online lenders mature and their underwriting algorithms get smarter, online lending could very well become the “norm” and end up being able to compete with banks on price. 

Next month we will explore this new, “alternative” lending industry—what it is, the pros and cons, and what it could mean when your business needs financing.

By: Meredith Wood

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