Introduction

When it comes to obtaining traditional financing sources, small businesses face numerous challenges. This is due, in part, to the high fees and requirements that most lenders require. Fortunately, there are several alternative finance options available that do not have these restrictions.

Not every startup has or wants venture capital funding. However, this does not mean that these startups do not require funding to get started and grow. While there are many ways to secure money, such as applying for bank loans or seeking out investors, there are other options that allow you to retain more control over your company without giving up an equity stake.

In this article, we will explore ten of the most popular alternative finance sources for small businesses. By understanding these sources, you will have a better chance of finding the right financing solution for your business. In this guide, we will look at alternative ways of finding funding and growing your business with less risk than traditional methods. We will cover everything from grants and awards to crowdfunding.

At the end of this article, readers should be able to answer the following questions:

• What are some alternative sources of financing?
• What are several other sources of financing for a small business?
• What are the sources of business finance?
• What type of financing is best for a small business?

An Overview of Business Alternative Finance Options

A variety of financing options are available to business owners. This includes bank and other lender loans, investor equity financing, grants or subsidies, and asset auctions for cash. The most efficient way to obtain financing is typically a combination where you can qualify for many dissimilar sources.

Bank lending is the most common source of external finance for many SMEs and entrepreneurs, who are frequently overly reliant on straight debt to meet their start-up, cash flow, and investment requirements.

Traditional bank finance, while commonly used by small businesses, poses challenges to SMEs and may be unsuitable at certain stages of the firm’s life cycle. Small business financing is notoriously difficult to obtain. Most bank loans require excellent credit and two or more years of business experience, and even then, there is no guarantee of approval.

Traditional debt financing, long recognized as having limitations in responding to the various financing needs that SMEs face throughout their life cycle, has been supplanted by various forms of alternative financing.

Alternative financing refers to non-traditional methods of raising money outside the traditional banking system, including crowdfunding, invoice factoring, royalty financing, and more. Alternative financing is a type of financing that can be used by a business that does not meet the traditional lending criteria established by banks. It is frequently used by startups or small businesses with little to no credit history.

The main reason entrepreneurs seek alternative financing is that they require funds quickly and are unable to obtain them from a bank. For example, if a business has a slow or poor credit history or is a new company, there is a high probability that a bank will not lend it funds. If this occurs, alternative financing may be the best option.

Alternative financing is not necessarily riskier than traditional financing; it just depends on your credit history and the kind of capital you are looking for. It is important to evaluate your options carefully before signing up for anything—and make sure you do your homework!

The distinction between traditional and alternative finance methods

“Traditional” financing methods are the tried-and-true approaches to funding a business venture. These include loans from banks and credit unions, credit cards, and small business grants. “Alternative” financing methods are newer or less widely used sources of capital. While there is no universally accepted list of alternative financing methods, for our purposes, we will consider the following to be alternative methods: Crowdfunding, P2P (peer-to-peer) lending, factoring, asset-based lending, invoice financing, and merchant cash advances are all examples of alternative lending.

Traditional financing methods are the most common and well-established methods of raising capital, such as venture capital (VC), equity, bank loans, and debt financing. Alternative financing methods are less common but have gained popularity in recent years, especially in the startup community. Examples include crowdfunding, angel funding, and revenue-based financing (RBF).

Many startups are unable to obtain traditional financing because they lack a record of success or a customer base that has demonstrated loyalty to their products or services. But with alternative financing methods on the rise, there are more options than ever for entrepreneurs to get their ideas off the ground.

Both traditional and alternative methods of financing can be beneficial for businesses. The choice between them should be made based on your business’s needs as well as the cost and convenience of each option.

The reason for alternative financing

Financing for small businesses has traditionally taken the form of bank loans, but as big banks tighten their belts, so does the funding that startups and small businesses can receive from them. This means that if you do not have a strong credit score or a proven record of success, it can be hard to get the money you need to start or grow your business.

That is why it is important to know about alternative financing options that rely on different criteria and data points than what traditional banks use for loan approval. These methods are based on things like your monthly revenue and sales, not your credit history or assets.

While bank loans are still the most popular form of funding in today’s market, they are not always available to all businesses or all entrepreneurs—and they are not always the best fit for every venture.

Ten sources of alternative financing

1. Asset-Based Lending

Asset-Based Lending (ABL) is a form of lending that uses the value of your company’s assets as collateral. These assets can be things like equipment, inventory, accounts receivable, and real estate. ABL is a type of alternative finance for small businesses that are provided by private lenders rather than the government or banks. As a result, it can be a good option for businesses that are having difficulty obtaining loans from traditional sources, as an ABL lender will frequently offer loans to businesses with less-than-perfect credit histories.

With ABL, you can use your assets to secure a revolving line of credit that you can use however you need—to cover payroll during slow periods of business, to purchase substantial amounts of inventory, or to cover other expenses that might arise. While traditional lenders look at your credit score and cash flow when you apply for a loan, ABL lenders look more closely at your business’s unique assets and potential for growth instead of your credit score or other indicators of financial health. This means that you can get an ABL line of credit even if your credit score is low or your cash flow is unstable if you offer up the value of your company’s assets.

2. Alternative Debts: Corporate Bonds

Corporate bonds are a type of loan that businesses use to raise funds. They pay a fixed interest rate and use the proceeds to fund business investments. Investors make money if the company makes its repayments. If the company goes into liquidation or stops making payments, bondholders can claim assets before other creditors. This makes them attractive because they are less risky than most other forms of alternative finance. The investor receives a steady stream of income from their corporate bonds, which can be reinvested in the company or used for other purposes.

For the borrower to qualify for this type of financing, they must first prove that their business has been profitable over time—typically at least three years—and that they have sufficient cash flow to service any loan repayments. This type of financing is also preferable because it does not require collateral, as most other loans do; instead, it relies solely on future earnings as security against defaulting on repayments.

3. Debt Securitization-Alternative Debts

Alternative debts are assets such as debt securitization and covered bonds that small businesses use to raise money. Alternative debts are assets that have been packaged and sold by original debtholders, so the original debtholders no longer own the assets.

Debt securitization is when a business pools its assets into one large package and then sells them to investors. This allows the business to use its old debts as a source of capital, which is advantageous because it can borrow more money while keeping its current debt intact.

4. Crowdfunding

If you are looking for an alternative to banks and investors, crowdfunding is a fantastic way to get money for your business. If you are not familiar, crowdfunding is basically when you get money from a crowd of people who are willing to lend you the cash (usually via an online platform). There are several distinct types of crowdfunding, but if you are starting a business, you will be interested in either debt or equity crowdfunding.

With debt crowdfunding, you borrow money from members of the “crowd” and pay it back with interest over time. Equity crowdfunding is similar in that borrowers receive investments in exchange for shares of their company. It is a great option if you do not want to take on a lot of debt right away.

5. Alternative Debts: Covered Bonds

Alternative debts are assets such as debt securitization and covered bonds that small businesses use to raise money. Alternative debts are assets that have been packaged and sold by original debtholders, so the original debtholders no longer own the assets.

Covered bonds are another type of alternative debt. Covered bonds are like debt securitization in that they pool a large amount of assets, but instead of selling them to investors, they allow you to use those assets as collateral for new loans.

6. Grants

Governmental and non-profit organizations can give small businesses grants, which are also known as “awards.” Grants can be used to fund a wide range of activities, such as the start-up of a new business, the expansion of an existing business, and research and development. The purpose of grants is always the same: to encourage innovation and job creation.

There are two types of grants: discretionary and formulaic. Merit-based grants are made available through discretionary funds, whereas need-based grants are made available through formulaic funds. In either case, there is usually some sort of competitive process involved in choosing between applicants (or deciding whether they qualify for an award at all).

7. Subordinated Debts

Subordinated debt is a type of debt financing used by small businesses. This is because they are unsecured, so there is no collateral needed to receive this financing. Debt that is ranked lower than other types of debt is referred to as “subordinated debt.”

For example, if a company goes bankrupt and must sell assets to repay creditors, subordinated debt holders would be paid after bondholders and senior lenders. The advantage of subordinated debts is that the lender can negotiate a higher return on their investment in exchange for taking on more risk, which makes them an attractive option for businesses that want to avoid giving up equity or assets to investors or lenders. They can also help with raising money via loans when it would otherwise be difficult to do so because of poor credit scores or lack of assets.

8. Participating loans

A participating loan is a type of small business financing offered by multiple lenders that allows the lender to share in future profits. Lending has traditionally been done by lending the money and then getting paid back according to the terms of the loan. Participating loans, however, offer a different approach: they give lenders an equity stake in your company.

Private lenders who specialize in funding small businesses usually offer participating loans rather than banks and credit unions.

9. Convertible debt and warrants

Convertible debt and warrants are two types of alternative financing for small businesses. Convertible debt is a loan that can be converted into stock. Warrants are like convertible debt in the sense that they can be converted into equity shares, but they give the holder the right to buy equity shares at a fixed price. Convertible debt and warrants have advantages over other forms of financing, such as bank loans, in that they are non-dilutive. Non-dilutive means that investors do not get an ownership stake in the company immediately upon investing. Instead, these investors become shareholders only if the company does well.

10. Mezzanine Finance

Mezzanine finance is a type of financing that combines debt and equity. This means that it is a way to raise capital by selling part ownership in the business, but with a structured repayment plan like a loan.

The advantage that mezzanine finance has over other forms of financing is its flexibility. By combining debt and equity, mezzanine financing uses more than one formula for repayment. This means that mezzanine financiers do not have to take as much risk as they would if they were providing pure equity or pure debt financing. Additionally, this form of financing is often less expensive than other types of funding since investors typically expect higher returns from pure equity investments.

The disadvantage of this type of funding is that it still requires the owner to give up some ownership of the company. However, because mezzanine financiers will often hold their investment for only a few years before selling it back to the company or listing it on a public exchange, the effect on ownership may be minimized.

Conclusion

Alternative financing is great for businesses that are already growing. For example, companies often seek alternative financing when they can no longer afford a loan from a bank. Banks want to avoid unnecessary risk, so they will avoid lending to a company that is rapidly expanding. One solution is to seek alternative financing from other sources, such as factoring companies that will allow you to sell your invoices to them for an advance against their value or even sell your business. There is no reason a growing business must take on extra debt unnecessarily when this sort of finance is available.

So, there you have it, ten ways to help your small business secure financing. Of course, keep in mind that to apply successfully, make sure you know what you are getting into. If you would like any more information on any of these methods or how they might work specifically concerning your case, please do not hesitate to get in touch! We are always happy to help!