Up until recently, traditional bank loans were the top lending source for most small businesses. Additionally, traditional banks generally only lent, and still only lend, money to individuals with excellent credit ratings, which typically means a credit score of 700 or higher. For most entrepreneurs with poor credit, this poses a Catch 22 type of problem—how do you survive the start-up phase of building a business if you can’t easily get a loan for capital, and how do you get capital if you can’t effectively start a business?
Thankfully, many creative individuals have realized that limiting funding to only those with a near perfect credit history is not the best way to help the economy flourish. As such, there are now many different alternative financing options for small business owners with bad credit—financing options that are often competitive with, if not better financing options than, traditional bank loans. The most popular types of alternative financing are as follows.
That is not to say there might not be some drawbacks to the emerging nonbank lending industry. The industry is still vulnerable, perhaps more so, to oscillations in the markets, particularly given the lack of regulation in some sectors. However, with credit extremely tight, that risk is increasingly far from the minds of fraught borrowers who want or need capital.
Banks classically rely on credit histories and a credit score system that’s harder and harder to rank with. Nonbank loans are a type of lending offered by independent companies to individuals who can’t meet bank requirements for a loan, because they either don’t have any credit built up, or they have bad credit. The alternative lending industry is expanding as people get away from the long waits and tighter scrutiny associated with banks, so tight even Ben Bernanke complains that he was rejected from refinancing his home despite his strong reputation and solid credit. Some governments, particularly the UK, have come to encourage the industry even more with investments of their own and non-bank informational resources on government websites.
Online Bad Credit Business Loans and Unsecured Business Loans
The online lending industry is growing rapidly and has likely not yet peaked even as potential regulators lay their eyes on the emerging alternative financing options. Despite the lack of current regulation, there is hope that there might be better price transparency and better rates due to stronger competition. That increased opportunity has extended most strongly to people whose credit scores are not strong.
To apply for a bad credit business loans, you typically just need to provide bank receipts to show that you make a minimum amount of money each month. The minimum amount of monthly profit you must make in order to get an initial loan varies from company to company, but generally starts around $5,000. Depending on the industry – where inventory and operating costs might be much more expensive – loans can be higher even for applications from borrowers with low credit. More players like my company or a number of other online financing companies. The loans typically gear toward borrowers with little to no collateral to offer and might be in the market to receive cash quickly.
Factoring, also known as asset-based lending, is probably the most popular type of alternative financing. Factoring allows companies to take cash out against outstanding invoices. In exchange, factoring companies obtain a large percentage of the value of the company (up to 90%), until all of the invoices are paid off in full. This is low risk for lenders, and a great option for borrowers who are serious about making their company profitable.
While factoring is a great option for business-to-business that can’t wait for invoice payments in order to keep their doors open, it is also a bit expensive. According to The New York Times, asset-based lending companies charge an annual interest rate of anywhere from 18% – 30%.
Microlending, on the other hand, is the practice of lending small amounts of money to individuals who don’t have any type of banking history. This type of loan is usually offered to those in poverty-stricken areas or 3rd world countries. Again, loans typically hover around $5,000, as seen from players like Accion Texas in Houston or non-profit Kiva based in San-Francisco.
Another type of alternative financing that has been gaining popularity the past few years is peer-to-peer lending. This is where individual investors lend money to small businesses through online vetting platforms. These types of loans are usually offered to small business owners who have decent credit scores, but need additional capital in order to make updates, buy equipment, or launch a marketing campaign. But among the major players in the industry like Lending Club, Funding Circle and Peerform, there is a lot of focus on personal loans as well.
While alternative financing offers a creative way to stay afloat during the start-up phase of business, it’s important to remember that these types of lending are often more expensive than traditional lending. As such, it’s smart to only use these options to survive a short-term cash flow problem.