One of the best assets a business can have is good credit, as it can make all the difference when seeking bank financing. However, a poor credit history isn’t a barrier to borrowing when it comes to alternative lenders. But what makes the two so different?
Why many banks won’t lend
Traditionally, a business needed a credit score of 650 or more to secure bank financing. At the same time, businesses traditionally looked for banks as their source of funding. The Coleman Report in 2013 indicated that 63% of small business owners went to their bank when looking for a loan, but only 27% of them were successful. The simple fact is that most banks use computerized models to assess creditworthiness, with personal relationships or outstanding business plans counting for very little. Further, they have become very risk-averse since the financial crash of 2008, and would sooner turn away marginal business than risk defaults.
Why alternative lenders will
Alternative lenders, in contrast, tend to apply different criteria when considering applications. This is a key reason why the alternative lending sector has grown rapidly: according to Forbes magazine, alternative lenders’ balances have grown by 175% in a year in the States, whie traditional banking has declined by 3%. So how come alternative lenders take such a different view of business’s viability?
The answer lies in the actual products they offer.
With asset-based lending, a loan is secured on plant or equipment belonging to the business; if the borrower cannot repay the loan, the lender can seize the asset and cover its costs.
Alternatively, invoice factoring and discounting allow businesses to borrow against the value of their outstanding invoices: in effect, they get paid as soon as invoices are issued. In general, they can borrow up to 85% of the value of their invoices, with repayment being made as soon as their clients pay. The difference between invoice factoring and discounting is that with factoring the lender takes over the debtor ledger and deals with the borrower’s clients to secure payment.
Finally, alternative lenders can offer traditional loans with set repayments, with terms typically between three months and ten years. As with a bank loan, the interest rate can be either fixed or variable, but unlike banks traditional lenders tend to be more flexible in considering factors for eligibility. A straightforward loan can be an ideal solution when you need to buy more inventory, purchase equipment or consolidate your debts, whilst an emergency loan can provide cash within 24 hours to overcome a cash flow obstacle and be repaid as soon as your finances are on track.
Find the right solution for your business
Of course, there is no perfect borrowing solution, and it is important to remember that alternative lenders may charge higher rates of interest than banks. It is certainly in your interest to build your credit score and repay your debts in time and on full – but where this isn’t possible, alternative lenders may still be able to assist where banks will not.
Carl is a business recovery specialist and as Managing Director of Cashsolv he offers advice, support and alternative finance options to overcome cash flow problems and identify possible underlying problems that can be addressed to ensure a positive future for your business.