What is Alternative Lending?

Alternative financing for payroll due

Last Updated August 26, 2021

Alternative lending refers to any type of financing outside of traditional bank loans. For a number of reasons, a business would either choose, or be unable, to secure traditional financing with a bank. Things like poor credit, limited operating history, or a lack of hard assets can make a business unfit for most bank loans.

However, there are plenty of options for businesses that fit this “unbankable” profile. Alternative lending can provide fast access to cash flow when it’s needed most – for things like payroll, or other routine expenses. Alternative financing is also a great fit for businesses that suffer from slow paying customers and/or long invoice terms which make it tough to stay cash flow positive.

Types of alternative lending you may encounter:

Before deciding on a form of financing, traditional or alternative, consider all your options carefully. Not all non-bank financing companies are reliable or trustworthy, and some kinds of alternative lending can be risky or predatory.

MCA loans

An MCA loan, or a Merchant Cash Advance, is a cash advance based on anticipated future credit card sales. It is typically delivered in a lump sum. The provider will look at daily credit card receipts to determine that the loaned amount can be paid back in a designated amount of time. MCA loans are typically very expensive in terms of APR, with rates anywhere from 10% – 150% depending on payback terms and amount borrowed. Some providers can be predatory with extremely high interest rates, taking advantage of businesses desperately in need of fast cash. Borrowers should beware and be careful if choosing an MCA lender.

The loan is typically paid back in a monthly percentage of credit card sales. For example, the provider may charge 10% of your monthly sales to be paid back against the loan. Because MCA loans are so expensive, it’s important to weigh the value of the immediate cash flow provided by the loan against the amount of interest paid.

For more information about MCA loans, check out this article.

ACH loans

Much like merchant cash advances, ACH (or Automated Clearing House) loans are lump sum cash advances. However, unlike an MCA loan which is determined by daily credit card sales, an ACH loan is based on the average daily balance of your business checking account. ACH loans are paid back by form of direct deposit from your business checking account at agreed upon intervals. This type of financing also comes with high interest rates and potentially shady vendors, so businesses should be selective about choosing a provider.

For more information about ACH loans, check out this article.

Invoice Factoring

Invoice factoring is the process of selling your receivables (or outstanding invoices) to a third party in exchange for cash up front. This is a preferred option for B2B companies who suffer from long payment terms or slow paying customers, but who need working capital in the meantime.

A factoring company will evaluate a business’s invoices and customers, determining their past history and likelihood of paying the invoice (through credit checks, etc.) If approved, the factoring company purchases the invoices, then advances 80-90% of the cash value to the business. Once the factoring company collects payment on the invoices (from the end customer) it advances the remaining 10-20% minus a “factoring fee” of anywhere from 1-5%.

This type of financing is a sale, not a loan. Therefore, it’s a favorable option for businesses looking to avoid further debt or credit balances.

Read more about invoice factoring.

Accounts Receivable Financing

A sister of invoice factoring, accounts receivable financing operates in much the same way. However, accounts receivable financing is a loan, not a sale of your invoices. A bank or independent financing company uses your outstanding invoices as collateral against a loan. Unlike invoice factoring, where the factoring company owns your invoices, you retain ownership and collection for your receivables.

This is generally a preferred option to invoice factoring for businesses who are able to secure bank lending, as A/R financing typically has higher credit standards and minimum financed amounts.

Read more about accounts receivable financing.

Asset Based Loans

Asset based loans (ABL) is similar to A/R financing because it falls somewhere in between traditional and alternative financing. It is a loan (not a sale) based on the value of designated assets – like machinery, heavy equipment, or real estate. The bank or other financing provider will hold the assets as collateral for the loan. With higher credit standards, some businesses may not be able to secure this type of loan.

Asset based lending is generally a fit for larger businesses with hard assets to borrow against. These business would likely not be a fit for any of the other alternative financing options listed within this article. That said, many businesses may graduate from a different type of alternative financing to asset based lending.

Read more about asset based lending.