As a small business owner, the day may come when you turn to outside sources for financing. Perhaps you’ve run into a cash flow problem and need a small business loan or line of credit to tide you over. Or you may be expanding your business and want a partner who can help you pay for the upfront costs.
Traditionally, small business owners have turned to local banks or credit unions for funding. Working with a bank is still a popular option. But business owners may not meet stringent borrowing requirements or they may need the funds quicker than that application process allows.
More recently, alternative online business lenders have made borrowing money easier and quicker, although it’s important to understand how these new forms of financing are different from traditional bank loans.
The Differences: Borrowing from a Traditional Bank vs. an Alternative Lender
You’re borrowing money to help your business thrive or grow. Where you get financing can matter. Traditional banks and alternative lenders each offer their pros and cons. The general differences can be broken down into four areas:
Banks tend to offer the lowest interest rates for small business loans. Partially, this is because they have access to a large pool of capital. But banks can also make money from a variety of products, such as business checking accounts or merchant services, so they don’t need to be as focused on lending margins.
Alternative lenders, on the other hand, may have to draw from their own funds, typically from investors or credit facilities, including banks, to issue loans, which raises their borrowing costs and the resulting interest rates. While online lenders have lower overhead costs because they don’t need to manage branches, overall interest rates tend to be higher than what you can find at a traditional bank.
Applying for a loan from a traditional bank can be a lengthy process. After collecting and submitting your documents, you may need to schedule a phone call or go to a local branch to discuss the application and your qualifications in person. It could take three to four weeks to hear back, and even longer to receive the funds.
Many alternative lenders have streamlined the application and approval process. You can submit everything online, connect your accounting or invoicing software so the lender can analyze your business, and hear back within a day. When the lender approves your application, it may be able to send you the funds within several days or expedite the delivery, and you’ll get them the same day.
Costs and fees
You might encounter a variety of potential fees when comparing loan options and lenders. Some are less common, such as an application fee (paid to submit the application no matter the decision). Others, such as origination fees (either a flat fee or a percentage of the amount), are somewhat standard, although if you shop around you’ll find that some lenders don’t charge them. An alternative lender is going to be inexpensive to apply for with higher interest. Whereas bank financing requires more upfront costs without the guarantee that you will be approved.
Qualifying for the loan
Whether you want to open a line of credit or apply for a term loan, you need to go through a lender’s underwriting process and get approved. Traditional bank loans may have stricter requirements than alternative online lenders.
For example, many banks will only lend to businesses that have been open for at least two years. You may also have to submit a formal business plan, have a good personal credit score, and show that your business has collateral (such as equipment, supplies, or invoices) to qualify.
Alternative lenders often make capital available for a wider variety of business owners. There may be a minimum credit score, but it’s often lower than the bank’s requirement. Alternative lenders also might not ask for a business plan and only require you to have been in business for several months.
Choosing the Best Lending Source
There’s no single best source of small business loans. However, there are a few guidelines that you can follow.
If you qualify based on your credit score and time in business, don’t need money quickly, and don’t mind the time it takes to complete an application, a traditional bank loan could offer you a lower interest rate, higher borrowing limit, or better terms. If you need funding quickly, want a simple and quick application process, or don’t meet the bank’s qualifications, consider an alternative lender.