For small businesses looking for capital financing, getting a bank loan can be a complicated, daunting process.
Often the demanding requirements, need for a business plan, and lengthy application process means that many small business owners are unsuccessful in securing a bank loan.
In fact, according to a British Business Bank survey, only 27% of small businesses successfully get approval for a bank loan. And 73% of these small firms would rather forgo growth than brave the bank loan system.
So here we’ll go over what a non-bank lender is, discuss eight alternatives to traditional bank loans - along with some key considerations to take into account when making your decision.
What is a non-bank lender?
Non-bank lenders include investors, online lenders, and financial institutions that provide loans and credit outside of the traditional banking system.
Non-bank lenders typically have more relaxed eligibility criteria and approval processes than banks, making it easier for business owners to access the capital they need. They also offer more competitive interest rates and terms than traditional lenders.
Because the business financing sector is so competitive, many small business owners find it easier to secure finance from a non-bank lender than a traditional bank loan.
When did non-bank lending take off??
The modern non-bank lending industry began in the early 1990s, when a number of entrepreneurs saw an opportunity to fill a gap in the market.
At the time, many small businesses were unable to get traditional bank loans due to their size or credit history.
However, non-bank lending exploded following the 2008 financial crisis. While banks struggled to recover, non-financial corporations were able to move quickly and offer more flexible financial products. Banks were also slow to go online – with non-bank online lenders rallying to fill this gap in the financial market.
This type of lending is now worth $2 trillion and is growing at a rate of 20% per year.
The above graph shows you how the number of non-bank lending institutions has grown rapidly in the period between 1999 and 2019 while the number of traditional financial institutions has mostly remained stagnant.
Why would anyone use a non-bank lender?
It’s simple: small businesses face a debilitating funding gap. The SME Finance Forum found that this finance gap has reached $5 trillion – or 1.3X current lending for small and medium-sized businesses.
How is non-bank financing different from venture capital?
A non-bank lender is often compared to a venture capitalist (VC) – but non-bank lending is a very different proposition to VCs and angel investors.
VCs don’t have a lot in common with non-bank lenders. For example, VCs do their own due diligence, and don’t expect to see your credit score or ask you to set aside collateral.
But the biggest difference is that VCs finance startups in exchange for a share in their company. Non-bank lenders will expect you to pay interest on any finance loaned, but rarely take equity.
Venture capital funding can be a vital part of small business funding. VCs offer large sums of money for rapid expansion and working out how to drive more profit. However, it’s a very expensive way to finance short-term growth, and often means giving up as much as 50% of your business!
Non-bank lenders vs traditional bank loans?
There are a few reasons to use a non-bank lender alternative over a traditional bank loan:
- Non-bank lenders can offer capital faster than a traditional bank. They’re not wrapped up in red tape.
- Non-bank lenders often have different criteria that do not look at credit scores. This makes it a great option for businesses with poor credit scores.
- The application process is usually a lot shorter, for many lenders it takes just minutes to apply.
- It’s far easier for small businesses without a concrete business plan or tangible assets to secure funding with non-bank lenders.
Non-bank lenders typically have lower interest rates and fees than banks. Also, non-bank lenders are more flexible on lending terms than traditional banks.
Now let’s take a look at what types of loans and financial support are available to your small business.
We’ll cover the following funding sources in detail:
- Revenue based finance
- Merchant cash advances
- Commercial loan providers
- Social/community lending
- Partnerships with other companies
- Equity financing
- Funding from family and friends
- Government grants
In order to fuel your growth, you’ll need to find funding that works for you. Every business is different, and your finance mix should reflect your longer term needs.
Revenue Based Finance
Revenue based financing sees businesses receive a cash lump sum in return for a percentage of their future sales. There’s no need to offer collateral with revenue based financing, and traditional cash advance providers let small firms borrow up to $500,000.
Businesses have to repay their debt through a revenue share. This is a percentage fee applied each month that varies depending on the risk involved in offering the advance.
Your business will need to pay back a percentage of sales until the full advance is repaid.
Uncapped offers between $10k-$10m revenue-based finance to businesses that sell online, such as ecommerce stores or SaaS providers. In exchange, we charge a flat fee of 6-12% on the capital provided.
The application process is far simpler than applying for a bank loan. As long as you’ve got at least six months of trading history, are generating at least $10k of monthly sales, and process +40% of payments online, you’re probably a good fit!
This is also a great alternative for healthy online businesses that don’t want to give up equity or lose ownership in exchange for short-term financing. For instance, Marshmallow, a leading car insurance platform, was able to grow their revenue by 56% in just two months after getting their first advance of $131k from Uncapped.
This growth helped them give away less equity when they decided to go for long-term, venture-backed financing. In 2021, they became a unicorn!
Revenue-based finance is perfect for small businesses who want to fund ads, inventory or hiring that will result in predictable revenue.
Merchant cash advance
Merchant cash advances are similar to revenue-based financing, but more popular among offline businesses.
Businesses have to repay their debt through a factor rate. This multiplier varies depending on the riskiness of providing an advance to your business, but are usually between 1.1 and 1.3.
Your business will need to pay back a percentage of your sales until you’ve completely repaid the advance.
Merchant cash advances can be a great way for small businesses to get quick funding, especially if they are confident about their future sales volume. This type of capital is also helpful for funding invoice receivables.
Commercial loan providers
The bulk of non-bank lending comes from commercial loan providers. They’re also known as non-banking financial institutions, or NBFIs. These firms are lenders who lack a banking licence.
Commercial loan providers include insurance firms, microloan organizations, and money service businesses.
Commercial loan providers offer more flexible, personalized loans than you’d receive from a bank. They also tend to have less restrictive lending criteria – which is perfect for small businesses.
However, to balance the added risk, they often charge high interest rates.
Really, there are so many non-bank lenders that fit into this category, such as microloan providers, inventory lenders, VAT lenders… And they all offer a very different service.
We’ve covered the different types of commercial loan providers in more depth, in case you’re interested in how each of these financing options work.
Social or community lending
Social or community lenders are non-profit organizations that offer loans or credits to local businesses. They usually focus on those SMBs providing value to the local community, or helping out other non-profits.
Community lenders are financial institutions that focus on lending to small businesses and entrepreneurs. They differ from traditional lenders in a few ways:
- Community lenders are typically more flexible with their lending criteria, and may be more likely to approve loans to small businesses that have been turned down by larger banks.
- Community lenders typically have lower interest rates and fees than traditional lenders – they aren’t aiming to make a profit.
- Community lenders often have closer relationships with their borrowers, and may be more likely to work with them on tailored repayment plans.
However, to qualify for social or community lending, your business will usually need to provide lots of value to your community. Secondly, social and community lenders usually offer far less funding. This makes their funding even more competitive, reducing the chance that your application will be successful.
Equity financing is when a company sells shares of ownership - or equity - to investors in exchange for money. Unlike a traditional loan and forms of debt financing, businesses don't have to pay back the loan with interest.
Angel investors or venture capitalists usually provide this type of financing. Angel investors are wealthy individuals who invest their own money into a startup in exchange for a stake in your business. They are involved in the early stages of your business, sometime when you’ve got little more than a proof of concept to show them.
Venture capitalist firms offer capital at a later stage, when you’ve proven that your business model has the potential to scale.
But whether you take finance from venture capitalists or angel investors, you’re exchanging a sizable chunk of your business for an opportunity to build long-term revenue.
Because these investors are taking a chance on you, they’ll take a bigger cut of your business than any other financing option. If you make it big, that is!
Family and friends
Asking friends and family for funding can be a good option too because they’ll probably give you the best lending terms (or none at all).
At a very early stage of your business, they’re also probably the only people willing to lend to you.
However, it’s important that you make it clear that they’re taking a risk by investing in you!
Crowdfunding sees a large number of people invest small amounts of capital to fuel your growth plan. Crowdfunding is a great way to fund startups, however it takes a long time to raise, and some businesses miss their targets, meaning they don’t get access to the capital they need.
Small business government grants, such as the startup grant, help new businesses get up and running.
Types of small business government grants include expansion grants, equipment grants, and training grants.
Most importantly, government grants do not need to be repaid.
However, the application processes may be long, and it can take a long time to receive the funding. Strict eligibility criteria also excludes many types of business.
Which Non-Bank Lending Solution is right for me?
Most non-bank lending solutions charge high interest. Because non-bank lending is inherently riskier than bank loans, creditors expect higher returns.
While government grants, community loans, and friends and family lenders don’t charge high interest rates, it is difficult to reliably secure enough capital through these methods.
The alternative is revenue-based finance. This model doesn’t require interest, personal guarantees or dilution. Instead, providers look at your back-end business systems to predict your future revenue, then advance funds with a flat fee to be paid back as a share of your future revenue.
This means that if the market slows or your sales drop, your repayments will slow (or stop) too.