Many small businesses struggle to get the funding they need to launch and grow. According to the Wall Street Journal, loans from financial institutions to small businesses decreased 38% over eight years. Only 13% of small business loans from big banks were approved in November 2023.
Comparatively, approval rates at non-traditional lenders, also known as alternative lenders, reached 30% in November 2023. Alternative credit is emerging as a strong option for small business owners who can’t get approval from banks and other traditional lending institutions. Here’s what you need to know about the benefits and risks associated with alternative lenders.
What is alternative credit?
Alternative credit, also known as alternative lending or fintech lending, refers to any lending that takes place outside of traditional financial institutions. This includes peer-to-peer lending platforms, term loans, equipment loans, and other tech-based lending platforms.
“In general, alternative lenders operate online, using technology to underwrite, price and issue different types of business loans,” wrote NerdWallet. “While traditional lenders tend to rely on a manual review system to evaluate loan applications, alternative business lenders often use digital data sources — such as bank accounts, merchant accounts or accounting software — to analyze your finances and determine your creditworthiness.”
Many of these alternative lenders use alternative credit data, such as rent payments, employment history, mobile phone payments, or certain bank account information, to approve loan applications. This can make alternative credit appealing to entrepreneurs who are often shut out of traditional financing options.
[Read more: 6 Popular Financing Options for Your Startup]
The benefits of alternative lending
The Consumer Financial Protection Bureau (CFBP) estimates that 45 million Americans have either no credit history or a credit history that is too thin to generate a credit score. This dynamic disproportionately affects Black, Hispanic, and low-income consumers.
Having no credit history makes it more difficult to get a credit card, qualify for a loan, and even rent a storefront. Any entrepreneur trying to get a business loan will struggle without either personal credit history or business credit history; most banks require two years of transaction data to approve a business loan.
Alternative lending can be a good option for small businesses that can’t qualify for traditional bank loans, including startups and businesses with bad credit
Randa Kriss and Olivia Chen, NerdWallet
Alternative lenders alleviate this problem by using alternative credit data to assess someone’s creditworthiness. Alternative credit data often paints a more complete picture of the applicant’s entire payment history, including on-time payments. This information allows alternative lenders to provide startup or expansion funding to consumers.
How does alternative lending work?
Alternative lenders are more flexible than traditional ones and are often more willing to work with small businesses or new ventures.
“Alternative lending is usually a faster, more accessible financing option than traditional lending. Unlike banks, which usually require you to submit a detailed business plan and slew of financial documents, all of which can take months to compile, alternative lenders typically only need your credit score and most recent tax returns and bank statements,” wrote Funding Circle.
However, alternative lenders provide small loans with higher interest rates, which may not be a good long-term funding option as your business matures.
“Alternative lending can be a good option for small businesses that can’t qualify for traditional bank loans, including startups and businesses with bad credit,” wrote NerdWallet. “If you can qualify for a bank or SBA loan, however, those options will likely be the most affordable funding for your business.”
As you explore your options, be aware that alternative lending is less regulated than traditional lending. It’s important to do your research to make sure you are aware of fees, the repayment cycle, and the terms of the alternative credit. Know the true cost of your loan and obligations associated with repayment to avoid any surprises that could put your business at risk.
[Read more: Startups Turn to Venture Debt to Turbocharge Growth]
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