Key Takeaways
If you can't get approved for a business loan at a bank, there are alternative options. The SBA offers a Community-Based Loan Program that is generous in approvals. Bootstrapping, grants, and equity financing can help startups avoid debt.
If you want to start or expand a business, one of the most common ways of raising capital is to borrow money from a bank. Bank small business loans tend to offer low interest rates and favorable repayment terms.
But traditional banks have strict credit standards: They typically require a personal credit score of at least 670, two years in business, and annual revenue of around $250,000.
If you're having trouble qualifying for a traditional small business loan, try one of these alternatives.
SBA Loans
The Small Business Administration designed the SBA loan program to help small businesses access business financing, offering affordable interest rates capped by the SBA and long repayment terms, such as 10 years, for working capital.
However, SBA loans from banks often have the same strict lending standards as traditional business loans. For businesses that don't qualify, the SBA offers the following options for disadvantaged business owners:
SBA Microloans
The SBA Microloan Program targets at-risk communities and businesses that don't qualify for traditional business loans. They offer small loans of up to $50,000 that can be repaid over up to six years. Unlike regular SBA loans, microloans can't be used to refinance debt or purchase real estate. These loans can be found on the SBA's list of approved microloan lenders, which are usually nonprofit organizations.
Bankrate Insights
Although the SBA Community Advantage Loan Pilot Program ended on September 30, 2023, borrowers can still work with mission-driven Community Advantage small business lenders to take out 7(a) loans of up to $250,000. These lenders must operate as Certified Development Companies (CDCs) or Community Development Financial Institutions (CDFIs) and at least 60% of their SBA loan portfolio must be to underserved communities.
Credit union (Shinkin bank)
Credit unions are not-for-profit organizations. Instead of shareholders, credit union members own and control the organization. This allows credit unions to offer lower interest rates and lower fees on business loans than banks, but you must be a member.
Membership requirements vary by credit union. For example, Navy Federal is one of the largest credit unions in the U.S., but you must be an active military member, a veteran, or an immediate family member of a military member to join. You also must open a savings account with a $5 deposit.
Other credit unions have membership requirements that make it easy for anyone to join. For example, Affinity Federal Credit Union requires that you first be an employee of a participating company or a member of a participating association or club, such as the Affinity Foundation.
Bootstrap
Bootstrapping is the act of starting a business using personal resources, such as savings or borrowing from friends and family. The term comes from the idea of ”pulling yourself up by your bootstraps,” meaning that the business owner puts in the time and effort to make the business a success.
Bootstrapping also involves limiting business expenses and using personal equipment when necessary to carry out operations. Bootstrapping is beneficial because it keeps costs low and avoids the need to go into debt before revenue is established.
Equity Financing
Many small business owners turn to equity financing to raise capital to build or expand their business without taking on traditional debt. With equity financing, you raise money from investors, usually by transferring ownership of the company.
But to get approval, investors want to know your strategy for growing your business. As co-owners, investors may also have control over how the business is run and the decisions it makes. Investors understand the risks of funding your business, but they expect high returns once the business starts making a profit.
You can obtain equity financing in the following ways:
Angel investor: An individual who provides funding and guidance Venture capital firm: A financial institution made up of investors whose goal is to provide funding to promising startup companies Initial public offering (IPO): The offering of a company's shares to the public as an entry into the stock market
Subsidy
Grants are a great way to start or expand your business without having to take out a business loan from a bank. Grants are cash awards that you don't have to pay back as long as you qualify. Depending on the terms, there may be restrictions on how you can use the funds, or you may be free to spend them however your business wishes.
There are many places to look for grants. Many local, state, and federal government agencies offer grant programs that you can apply for. There are also private grant programs funded by businesses and nonprofit organizations.
Eligibility for these grants varies. Many non-federal grants are intended to help disadvantaged groups that have historically lacked access to business capital. These include:
Crowdfunding
Crowdfunding is a way of raising funds from the public rather than traditional lenders. There are four main types of crowdfunding:
Donation This is where you ask people to donate money to your cause. You don’t have to pay donors back or give them anything in return. Debt This is where you take money from contributors and promise to pay them back in the future. Typically, these crowdfunding campaigns outline a repayment timeline, offer interest, and give backers the opportunity to get a return on their investment. Rewards This is where backers give money to your business and receive something in return. Kickstarter is the best-known example of this type of crowdfunding. For example, you might offer stickers, digital content, or other prizes for funding. In effect, this allows you to sell your product before you manufacture it and raise funds to use towards manufacturing and shipping your product. Equity Popular with startups, this form of crowdfunding involves selling a portion of ownership in your business in exchange for funding. This means that investors may have a say in how your business is run.
Peer-to-Peer Lending (P2P)
In peer-to-peer lending, you borrow money from other people, rather than from a traditional lender like a bank or credit union. Borrowers and lenders usually transact through an intermediary or marketplace website, where borrowers apply for a loan and people put their own money into that loan.
The advantage of peer-to-peer lenders is that they have an easier qualification process and may offer better interest rates if you have good credit, plus an online application makes the process quicker.
The downside is that if you have bad credit, the interest rates and fees on peer-to-peer loans can be much higher. The fees can also be high.
Alternative Lenders
Most businesses turn to banks or credit unions to get business loans, but alternative lenders also exist, such as web-based companies, private lenders, or peer-to-peer lending sites.
Online lenders are very convenient because they offer a simple application process and quick access to loan funds. They also offer easy qualification requirements. However, online lenders often offer low loan limits and may charge very high interest rates to applicants who need a business loan with poor credit.
In addition to the more typical term loans, alternative lenders also offer other types of business loans, including lines of credit, invoice-based loans, and merchant cash advances.
Business Lines of Credit
A business line of credit is a flexible source of funding for your company. When you are approved for a line of credit, the lender sets a limit on the amount of credit you can draw down.
You can withdraw funds from your line of credit at any time up to the set limit. You only pay interest on the outstanding balance, and you can even leave the balance at $0 if you don't need the funds at the moment.
This makes lines of credit very useful for covering unexpected short-term expenses. However, interest rates on business lines of credit can be higher than term loans. If you carry a balance, you could end up paying a lot of interest.
Bankrate Insights
A business credit card is similar to a business line of credit but may have features like sign-up bonuses and the chance to earn rewards. Another potential benefit is that you can avoid paying interest as you continue to pay off your balance each month, making a business credit card one of the best ways to build business credit and cover short-term expenses.
Invoice Finance
If your company has to wait for invoice payments from customers, you can use invoice financing to get cash fast.
With invoice financing, you get a loan using the amount due based on the invoice you submit as collateral. The lender gives you cash up front with a set repayment plan and interest rate. Once you get your invoice paid, you can pay off your debt.
Invoice Factoring
Invoice factoring is very similar to invoice financing: it uses invoices to help businesses get financing.
The difference is that the factor actually buys the invoices from you. When your customer pays the invoice, the money goes directly to the factor, not to you. Factors buy invoices at 70 to 90 percent of their face value, giving them room to make a profit.
Merchant Cash Advance
A merchant cash advance (MCA) is an option for businesses that make a lot of their sales from debit or credit card purchases. With an MCA, a lender lends you a lump sum of cash. You then pay back the loan as a percentage of future card sales.
For example, a lender might loan you $10,000 with a 1.15 coefficient rate and require 10% of your sales until the loan is paid off, meaning you would have to give up 10% of your revenue every day or week until you pay back $11,500.
MCAs are useful for businesses because they provide a quick source of financing without requiring high credit, but there is little regulation of MCAs and the interest rates charged by MCA companies can be very high.
What’s more, they often find themselves caught in a vicious cycle of using MCAs to solve cash flow problems, only to have a large portion of their revenue taken by the MCA, exacerbating the problem.
When to Choose a Bank Business Loan Alternative
There are several reasons why you should consider alternatives to bank financing. First of all, bank financing is a good option for businesses that don't have enough time in business or revenue to get approved for a bank loan. Alternative financing is advantageous for time-sensitive businesses because it allows them to get funds faster without a lengthy underwriting process.
Conclusion
When it comes to obtaining small business financing, it may be more beneficial in the long run to consider financing other than long-term loans from major financial institutions. Traditional loans from major banks have strict terms, but alternative lending institutions and funding sources are introducing solutions for start-ups and businesses with poor credit.