The alternative financing market is expected to grow by nearly 10% to exceed $1.4 trillion this year, driven by small businesses increasingly opting for flexible funding options over traditional banks. To help understand if you should hop on the fast funding bandwagon, we’ve compared popular alternative and traditional business funding options to determine the type of financing that’s best for your business.
Traditional Financing
What is traditional financing?
Traditional financing usually refers to funding for your business through a bank. Beyond bank loans, other sources include:
Non-bank traditional lending options
Small Business Administration (SBA) loans
Loans issued by a government agency; these include SBA 7(a), popular for working capital, and Microloan programs, popular for small startups and small businesses.
Credit unions
Loans from a member-owned financial cooperative that provides banking services. These can be more favorable for borrowers (lower rates) than traditional banks, but may have fewer branches, require membership, and lack sophisticated tech.
Pros and Cons of Traditional Financing
The stability and predictability of traditional financing appeal to many businesses. Yet, not all ventures qualify, particularly when you are starting out.
Pros
- Lower interest rates
- Predictable repayments
- Long-term relationships with lenders
- Convenience: Ability to have all of your financial services needs, including checking and savings accounts and business credit cards, under one roof
- Stability
Cons
- Lengthy application and loan approval process, due to being risk-averse
- Strict eligibility criteria: Those with a sub-700 FICO score often turned down; may need to be in business for two years or more
- Collateral often required
- Slower funding times: Even if approved for a bank loan, it could take several days or weeks to get funds
Alternative Financing
What is alternative financing?
Alternative financing solutions provide diverse, flexible, and fast options to fund your business.
Types of alternative financing
Businesses can pick from many flexible financing options that suit their unique needs and break from traditional molds. Prominent types include:
- Venture Capital: Investors provide funds for equity.
- Peer-to-Peer (P2P) Lending: Connects borrowers with individuals online.
- Microloans: Small loans for startups and small businesses.
- Non-Traditional Loans: Loans with flexible terms, not typically offered by banks.
- Revenue-based financing: Advances based on future revenue.
Pros & Cons of Alternative Financing
Pros
- Speed: Even under 24 hours
- Eligibility requirements: Alternative lenders may only require six months in business; less emphasis on credit history
- Flexibility: Including payback that adjusts with performance
- Simpler application process: Many applications online; may not require a comprehensive plan detailing use of funds
- Less likely to require collateral
Cons
- Higher costs: May charge higher rates and fees due to increased risk
- Shorter terms may require a more aggressive payment schedule
- May not build business credit
- Variety may be difficult to navigate
- Potential dilution: Formats like venture capital require require giving up equity your business
Revenue-Based Financing (RBF)
Due to exponential growth spurred by SMEs (small and medium enterprises) we’ll look more closely at revenue-based financing (RBF) with a compound annual growth rate (CAGR) of 62.2%, for flexible funding. Unlike a loan, you can raise capital in exchange for a percentage of future gross revenues. Payback adjusts with business performance— higher when sales are strong, lower when they’re not.
Popular options include:
1. Revenue Advance
Referred to as a merchant cash advance (MCA) until very recently, this option provides funds upfront, which are repaid through a share of future sales. Deductions may occur automatically from credit card transactions or daily bank deposits in fixed weekly or monthly payments.
2. Invoice Factoring
Invoice factoring, also known as invoice purchasing, gives businesses immediate access to cash by selling outstanding invoices. A factoring company purchases outstanding invoices at a discount providing immediate working capital instead of waiting for customers to pay.
It’s a powerful tool for B2B businesses that deal with long payment cycles or clients who pay slowly.
Traditional vs. Alternative Financing: Grey Area
It’s important to note that some financial products fall into both the alternative and traditional categories, which makes choosing the best business financing even less clear cut for owners.
For instance, both banks and non-bank lenders offer lines of credit and term loans.
- A line of credit allows a business to draw funds as needed up to a limit.
- A term loan provides a lump sum that is repaid over a fixed period.
The structure of these products is the same regardless of who provides the financing. The difference lies in who provides the capital and how risk is evaluated. Below we show a comparison reflecting pros and cons of each financing type:
Get the Best Business Financing
Make sure more choices don’t lead to more problems. The growth of alternative funding shows small businesses increasingly choosing “new school” with flexible capital vs. “old school” with traditional bank loans.
VOX Difference
If you want to explore alternative financing options we invite you to explore some solutions offered by VOX Funding and its subsidiaries,* including:
- Revenue advance
- Invoice Factoring by VOX Factoring
- Term Loan by Chedr
- Business Line of Credit by Chedr
Or, simply contact us to learn more.
*VOX Funding, VOX Factoring, and Chdr operate separate and independent legal entities. Each company provides its own products and services under its respective terms and regulatory requirements.