The Pros and Cons of Alternative Lending Options for Small Businesses

Alternative options for financing for small businesses can come from various sources, including online lenders, peer-to-peer lending platforms, crowdfunding, invoice financing, and merchant cash advances. These sources typically have different underwriting criteria than traditional lending institutions, such as evaluating a company's cash flow or revenue history instead of just credit scores.
 
Also Read: Funding Options for Small Businesses and Start Ups

Pros of Alternative Lending Options

• Access to Capital

  Traditional lenders do not provide funding to the unorganised sector and start-ups, resulting in operational disruption. This is where alternative lending can come in handy. You can obtain immediate capital infusion by providing a blueprint of your company's future plans and the projects you intend to invest in over the next few years.

• Flexibility

  Traditional lenders typically provide funding within a specific range, with the minimum and maximum amounts clearly stated on their website. Most lenders do not provide funds for amounts less than Rs 50,000. However, businesses such as artisans and small weavers frequently require funds for amounts below Rs 50,000.
   
  Alternative lenders can assist here by providing flexibility to choose any amount. Furthermore, alternative lenders may be more willing to work with businesses having less-than-perfect credit or limited credit history.

• Faster Application Process

  Traditional lenders often require a lengthy and complicated application process that can take weeks or even months to complete. In contrast, alternative lending platforms usually have a faster and more streamlined application process. Often, it only takes a few minutes to reach an initial decision.

• Multiple Options

  Alternative business lending offers a wide variety of options for businesses to access capital. For example, you can use invoice financing to borrow money against your outstanding receivables or use merchant cash advances to receive funds based on future credit card sales. This flexibility allows you to find the financing option that best fits your needs.

• Approval Rate

  Traditional lenders have stringent qualification requirements. Prepare to face application rejection if your credit history is not perfect or you have multiple debts. Furthermore, in the context of the unorganised sector or startups, the majority of borrowers rely solely on government business schemes to meet their funding needs.
  
  However, you will observe a higher approval rate when it comes to alternative lending. The reason is these lenders evaluate a company's overall financial health, growth potential, and vision rather than just credit scores for disbursement.

• Risk Minimisation

  The lender here takes on fewer risks because they offer smaller loan amounts to the business in which they have a deeper understanding of specific industry. They can be advantageous for small businesses that lack a well-established track record or collateral.

• Reinvesting Capital

  Finally, alternative business lending can help businesses to reinvest in their operations and grow more quickly. Whether investing in new equipment, hiring more employees, or scaling up operations, the availability of capital can help businesses grow more quickly and take advantage of new opportunities.

Also Read: Top Government Business Loan Schemes in India

Cons of Alternative Lending Options

• Risk of default

  Alternative lenders typically work with high-risk companies. As a result, to mitigate the risk of loss, they offer funds at a higher interest rate. The increased cost of borrowing makes debt repayment difficult at times, leading to default. In rural areas, unorganised money lenders can charge monthly interest rates as high as 6%. In contrast, the annual rate for business financing is typically between 14-24%.

• Limited borrowing amounts

  Alternative lenders may offer smaller loan amounts than traditional banks. This can be a disadvantage for businesses that require larger amounts of capital to fund their operations or growth initiatives.

• Potential damage to credit

  Applying for multiple alternative loans can lead to a negative impact on a business's credit score, particularly if the applications result in several hard inquiries. It is essential to consider the impact of multiple loan applications on the credit score before applying for alternative business lending.

• Ownership sharing

  One potential harm of equity financing alternative lending is ownership sharing, diluting the control and decision-making power of the original owners or founders. With more stakeholders involved in the decision-making process, it can become more challenging to make quick decisions. This can hinder a company's ability to respond to market changes and take advantage of new opportunities. 
   
  Additionally, investors may pressure the company to prioritise short-term gains over long-term sustainability. Investors typically want to see a return on their investment, which can create a focus on maximising profits in the short term, even if it comes at the expense of long-term growth or sustainability.

Final Words