Alternative business financing is stigmatized, but that’s changing fast
Many business owners still see alternative financing options as a last resort. But as traditional financing becomes harder to access, business owners are recognizing that these alternatives are an important and beneficial part of their financial toolkit.
Before Oculus was purchased by Facebook for $2 billion, the company got its start thanks to $250,000 in crowdfunding.
The business world is full of success stories that were made possible through alternative business financing, which includes crowdfunding, merchant cash advances (MCAs), online loans, invoice factoring, venture capital and venture debt, and angel investors.
Yet these financing sources have often been stigmatized and viewed with suspicion by many business owners, even if they have no qualms about obtaining a secured or unsecured loan or line of credit from a bank.
In this article, we’ll look at why alternative financing has been stigmatized in the past, why those perceptions are starting to shift, and how businesses can use alternative financing responsibly to stabilize and grow.
Top 3 concerns about alternative financing
When business owners shy away from alternative financing options, it’s often because of three main concerns.
High costs. Alternative financing is seen to impose predatory rates and fees that take advantage of businesses in crisis and end up costing the business a lot of money. In fact, different types of alternative financing offer widely varying rates and fees, from MCAs, which can climb as high as 350% annual percentage rate (APR) to invoice factoring, which charges fees as low as 1%.
High risks. Alternative financing is also seen as being riskier than traditional forms. Angel and venture financing, for example, can dilute the business owner’s future profits as well as the control they have over business decisions, while MCAs and online loans can destabilize companies that are unable to keep up with repayment schedules, fees, and the snowball effects of compound interest. However, not all types of alternative financing are high risk, and each financing opportunity should be evaluated on its own merits.
Credit impact. Business owners often mistakenly believe that using alternative financing options will have a negative impact on their own credit score or that of their business. In fact, carrying and responsibly repaying debt of any kind can improve these scores. In the case of invoice factoring, the improved cash flow and financial health of the business can actually enhance the business’s creditworthiness and make the business more attractive to traditional lenders.
3 reasons why stigma is declining
However, the negative perceptions of alternative financing are changing, with three key trends working to reduce the stigma and replace it with a more balanced view.
Lending criteria is tightening. The first reason for the change in the way business owners view alternative financing is related to the growing challenge they face in accessing traditional forms of financing. According to Reuters, banks have been imposing stricter lending criteria in order to improve their own liquidity. Add to this the fact that many modern digital and ecommerce businesses are operating with fewer fixed assets that can be leveraged, and it’s no wonder businesses are feeling the pinch. A 2023 survey of small business owners found that more than three-quarters are now concerned about their ability to access capital.
Alternative options are maturing. Another reason for the growing acceptance of alternative financing is its increased adoption among both personal and business users. As financial technology (fintech) has matured, alternative options have become more varied, reliable, and accessible than ever before. As a result, the number of individuals and businesses who have used and are familiar with alternative financing has grown, which in turn has boosted acceptance levels. This trend has helped to grow the alternative financing market significantly over the past few years. Already valued at $10.82 billion in 2022, it is predicted to see a compound annual growth rate of 20.2% from 2023 to 2030.
Trust in banks took a hit. The traditional banking industry saw some major crises over the past couple of years, and it shook public confidence in these institutions. A 2023 survey found that 43% of small and midsize businesses say the recent banking closures will fundamentally change how they approach traditional financing. As the levels of trust shift away from traditional banks, many of these businesses are exploring how alternative financiers can meet their needs.
How to use alternative financing wisely
As the stigma surrounding alternative financing lessens, businesses are rethinking their financing options and taking a closer look at a wider range of choices. That’s a good thing, because it gives them more flexibility, whether they need more working capital to get through a rough patch or seize an opportunity to grow. It’s also important to remember that this is not an either-or proposition: in fact, many businesses end up using a combination of traditional and alternative financing products to meet their needs.
Here are some considerations to help you make an informed decision about the type of financing you choose.
What are the costs? All financing comes at a cost, whether it’s interest, fees, or a combination, and it’s important to understand what the total cost of financing will be. Are there hidden fees? Do the interest rates fluctuate? What are the penalties for late payment or contract violations? It’s a good idea to evaluate two or more options to see how the total cost of financing compares.
How quickly can you access the cash? If you need to access cash within a day or two in order to make payroll or pay for supplies and materials required to deliver on a contract, you’ll want to consider financing options that accelerate the qualification process, such as invoice factoring or an MCA. In this case, bank financing is unlikely to meet your needs.
How much flexibility is offered? Both traditional and alternative financing can come with restrictions around how much cash you can access, what you can use that cash for, and how quickly or slowly you can repay it. Make sure you choose a financing option based not only on the total cost of financing but also the level of flexibility and freedom you need to achieve your business goals.
What assets can you leverage? While more and more businesses don’t have costly equipment, vehicles, or real estate to use as collateral, there are other assets you may be able to use to access cash, including inventory, purchase orders, and invoices. Learn more about these alternative financing types.
Add invoice factoring to your financing toolkit
One of the best things a business can do to protect and strengthen operations is to explore financing options proactively so that they can make the right choice quickly when the need for extra cash arises. To find out whether invoice factoring is a fit for your business, talk to a factoring expert in your area.