Startups can find themselves between a rock and a hard place when it comes to accessing financing. Traditional bank loans are often out of reach for many startups due to stringent requirements such as proof of profitability and strong credit history. However, with the rise of alternative lending options, startups now have more options than ever to access the funding they need to grow and succeed.
In this guide, we'll examine some of the top alternative lending options available to startups, and the key elements business owners need to consider when choosing one.
From online lenders to software financing and everything in between, we'll help you navigate the financing options maze to find the best solution for your business.
8 Alternatives to Traditional Business Loans
1. Merchant Cash Advances
Merchant cash advances (MCAs) involve a company giving you an upfront sum in exchange for a percentage of debit or credit card sales in addition to a fee. Instead of loaning you the money, the merchant cash advance company purchases your future sales through daily or weekly deductions until the advance is paid off. An alternative method allows the merchant cash advance company to make automatically fixed withdrawals from your bank account.
MCAs can provide an immediate influx of cash to cover cash flow shortages or short-term expenses for startups.
MCAs commonly carry annual percentage rates in the triple digits, leading to additional debt. Because of the high interest, you should take a look at other options before deciding to go with this option.
2. Invoice Financing
Invoice financing is an accounting method in which companies can borrow against their accounts receivable. A financing company provides a loan based on the revenue the company has earned but has yet to collect.
Invoice financing helps companies improve their cash flow by releasing the funds tied up in unpaid invoices, allowing them to pay bills, hire employees, and take on new projects.
You're not subjected to the same scrutiny as you would be with a bank loan or a line of credit.
Invoice financing can be more expensive than traditional forms of financing, especially for small businesses. Financial companies that provide invoice financing typically charge a fee for processing the loan and a weekly factor fee. These fees can add up to an APR of 50% or even more. Not all businesses qualify for this type of financing, and the cost of the loan can be unpredictable due to the fees involved.
3. Equipment Financing
Equipment financing is a loan for purchasing equipment. Like business loans, equipment loans are typically financed by lending institutions or specialized online lenders, meaning the company's and its founders' creditworthiness comes into play. Online lenders tend to have less stringent requirements but feature a higher interest rate.
Equipment financing can help you obtain the equipment you need for your company if you need more cash flow to purchase it outright and can also help you build business credit.
Equipment financing is far more expensive in the long run than saving and buying your equipment outright. However, the payments you make will impact your cash flow once the loan is paid off, and missing your payment could result in severe consequences, including damage to your company's credit and, ultimately, loss of the company.
4. Online Lenders
Many online lenders are technology companies. Online lenders use a slightly different approval process, allowing many startups to access funds that would be turned away by traditional banks.
Because there are many types of online lenders, borrowers can get competitive rates and have a wider choice of lenders. Applying for a loan from an online lender is typically streamlined, providing needed cash more quickly than a bank loan would.
Since these institutions live online, you won’t be able to get in touch with somebody face-to-face at a physical branch. Additionally, the interest rate is often higher.
5. Line of Credit
Unlike a traditional loan, a line of credit only charges interest on the amount you spend from the credit. You can use the credit to manage cash flow, purchase equipment or inventory, or even use it as protection against overdraft charges.
The requirements to obtain the funds are more relaxed than those involved in the traditional loan application process. Obtaining a business line of credit helps you have the cash on hand when an opportunity comes your way that is too good to pass up.
The interest rate on a line of credit is typically higher than that of a traditional loan.
6. Short-Term Loans
Short-term loans require no collateral, and you can pay them back within weeks or months. You’ll need proof of income, a bank account, and a driver's license. You can apply for one online, and lenders generally provide terms and a contract quickly.
The money you need can often be in your bank within 24 hours of applying for a short-term loan, making this a good choice in emergencies. Because the loan is not secured, you will not have to provide collateral. There are lower credit requirements with this option.
The interest rates on short-term loans can be extremely high—around 400% in many cases. This means you will have to pay back more for the loan than you borrowed. You will also be subject to high fees if you miss a payment. Short-term loans are generally not considered sustainable for obtaining your needed cash flow.
7. Software Financing
The software that startups purchase to make it easier to complete their work tasks and communicate with their customers is among the largest expenditures they make.
Most software subscriptions provide monthly, annual, and usage-based payments. If you pay for the subscription upfront, the vendor will commonly give you a discount, meaning you will have the software you need at a lower price than if you made monthly payments. The process of applying is simple.
Like any loan, you will need to make payments following the terms of the contract. However, because we allow you a choice of payment terms, you have more flexibility to manage your cash flow by determining how much you can handle and for how long.
8. Equity Financing
Equity financing is like a two-for-one deal. Not only do you get the cash needed, but you also gain an investor (whether it’s an angel or VC) with insight into how to move forward best.
Investors don’t expect an immediate return on their investment; they’re in it for the long run. You’ll be able to reinvest the cash flow into operations to grow rather than focus on debt repayment.
In exchange for money, you’ll give up equity. That dilutes control, which could be a big chunk depending on the deal struck. Also, unlike traditional loans, dividends distributed to shareholders aren’t tax-deductible. Investors expect a higher return for their risk of investment.
Business Loan Alternatives and You
Traditional bank loans aren’t the only available option for your startup. With these choices, you won’t have to give up equity or shorten your cash runway because you lack capital. Get what you need when you need it without burning through profits.
At Gynger, we offer software financing that provides both convenience and cost savings for businesses looking to access non-dilutive capital. Use our calculator to find out how much capital you can qualify for.