Reasons non-bank lenders are ideal for small businesses
By Faruque Ahamed Mollick | Aug 15, 2023
Small and microbusinesses are often in need of immediate hard cash to ensure uninterrupted trading. A steady cash flow is crucial for running businesses of all scales, especially the small ones.
Small and microbusinesses are often in need of immediate hard cash to ensure uninterrupted trading. A steady cash flow is crucial for running businesses of all scales, especially the small ones. Getting bank loans is quite a struggle for start-ups or small businesses. Hence, they often opt for alternative financing options, which provide funds following structures and policies much more lenient than what banks adhere to. Traditional financialinstitutions follow outdated lending regulations that are mostly disadvantageous to small organizations that are new to the industry and do not have enough credit scores, elaborate business profiles and collaterals to prove their credibility for loans. On the other hand, alternative financing can be defined as any method through which small entrepreneurs can quickly acquire working capital with the least amount of application hassle, paperwork and stringent repayment structures. Mostly, online funding options come under alternative financing.
Primary reasons why non-bank funding options or alternative financing are desirable for small businesses:
- Banks always have specific criteria for credit scores. Businesses with credit scores below a certain threshold(600-650), often get disappointed by multiple rejections. Whereas, non-bank lenders are quite flexible when it comes to their requirements. Credit scores hardly matter to alternative financers. They are only concerned about the sales and profit statement of a business in the last few months or sometimes a year or two.
- From application, approval to final disbursement, it is quite a long process when it comes to traditional bank loans. The entire process often takes weeks and sometimes months. Therefore, small microbusinesses, who are in need of urgent cash, turn to alternative financing options which offer same-day approvals and fund disbursements.
- Traditional lending institutions generally ask for collateral, like business assets or equipment, to calculate the risk and then approve an application. However, the new entrants or small scale businesses often lack substantial assets as they mostly use personal properties instead of purchasing or renting out spaces at the initial stage. On the contrary, alternative finance institutions do not require borrowers to put up collateral to get loans approved and that makes them an ideal financing source for small businesses. Microloans are small loans sanctioned to entrepreneurs with little or no collateral. However, microloans sometimes come with restrictions on how the borrower can use the fund. But, they mostly cover operational costs and working capital for equipment, supplies and furniture. SBA microloans are an example of microloans.
Tips to prepare to apply for an alternative lending option:
- Firstly, one should figure out exactly how much money is required.
- Prepare a business plan with financial projections. Though not all lenders will require a business plan, some might ask for it.
- A borrower should do thorough research on the market and get ideas about the current market scenario. Often, lenders approve loans to borrowers who are stepping into the fastest growing industries. Also, considerable knowledge of the industry demonstrates the potentiality and dependability of an entrepreneur.
Factors that need to be considered before getting a loan from a non-bank lender:
- Non-bank lenders generally charge higher interest rates, compared to banks. But, the rates vary from one lender to the other. Therefore, one should compare multiple offers before locking one.
- They are often pushed for bigger loans, even if the borrowers do not need that big an amount or are not ready to take on that much debt. Hence, it is important to look for multiple options and skim the lender offering the exact amount required.
- Sometimes, certain non-bank lenders go out of business as the concept is relatively new. That is why one should investigate certain things like how many years a particular lender has been in the business, its financial capacity, the availability of reliable support staff and the reviews it got from the customers. Also, it is important to check if it is backed by a legitimate bank or source of funds.
- A borrower should work with a lender who gives a beforehand clarification on the repayment penalties or extra charges that might be applicable in case of early repayment.
- One should meticulously read the loan agreement before signing it, to make sure no hidden charges are tacked on.
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