The idea of borrowing money, whether it be for the short or long-term, has been around for generations. So, it’s no surprise that many businesses will rely on external finance throughout their operation to maintain healthy cash flow and facilitate growth.
In the past, many businesses may have simply gone to their local bank to get the funding needed for their goals. However, the investment landscape has since developed somewhat in recent years and going to the same lender or bank as you’ve always dealt with is less likely to be the default option. Instead, a whole audience of willing lenders awaits.
Due to the spread of today’s lending market, there are more solutions available for businesses to use. These options pretty much sit between the two camps of traditional finance (associated with banks and well-known lenders) and alternative finance (loan or equity solutions that come from agile, innovative lenders that you won’t find on the high street).
If you are new to seeking finance, or if you have historically used solely traditional or alternative options, it may be challenging to understand which route you should go down. Both conventional and alternative lenders have unique pros and cons, meaning you need to consider your needs to find the best fit for you.
To help with the process, we have compiled the ways that each type differs on five critical areas of the funding journey, so you can determine which one is right for your business.
- Applying for traditional finance versus alternative finance
- Approval times
- Loan security
- Lender control
- Repayment
Applying for traditional finance versus alternative finance
When it comes to applying for a traditional loan, such as from a bank or other high-street lender, the application process can be complicated and elaborate. The requirement tends to be for you to be efficient with supporting documentation including possibly evidence of a comprehensive business plan (depending on the use of funds or phase of growth), financial and bank statements, tax returns, personal documentation and business credit profile. This documentation acts as proof that you can be relied on to repay the loan.
Traditional lenders have moved with the times and, as such, more of these applications can be done online via electronic applications. However, you will still need to source the appropriate information to be able to send it across to your lender. This is often time-consuming, which could be problematic for businesses seeking a quick fix for their financial issues.
Alternative lenders, on the other hand, tend to be primarily formed as digital companies, meaning that the entire application process can be done online. They also tend to use a simple application form, giving the benefits of speed and flexibility from the outset. Generally, less supporting evidence is required, which could be as little as filed accounts, including management accounts and bank statements. The pay-off here is that you will be less likely to secure higher sums of money and may face higher interest rates due to the level of due diligence carried out.
It is important to note that the application process will vary from one lender to the next, even if they fit under the same umbrella of ‘traditional’ or ‘alternative’ finance. So, it is worth taking time to review the process of an individual lender before you make a decision.
Funding approval
When it comes to securing fast finance for your business, such as in an emergency, alternative tends to come up trumps. The simplified application process for alternative finance inevitably means that funding requests are assessed much quicker, typically within 48 hours.
There are no restrictions on who can apply, so even those with bad credit scores may be considered, depending upon the loan value and type of finance being sought.
If the finance is approved, alternative lenders can make the funds available within hours, in some cases. Again, you must bear in mind that this speed may be counterbalanced by higher interest rates.
Traditional lenders, on the other hand, have been known to take weeks or even months to just evaluate a loan, mainly because of the strict criteria that must be adhered to and the number of people subsequently involved in assessing and approving an application.
In some cases, such as seen under the Bounce Back Loan Scheme, funding was able to be offered by banks in just a few hours, due to the urgency required. This suggests traditional lenders do have the capacity to shorten turnaround times for particular products, so it is worth checking this out in advance if you are interested in a specific loan.
It is also seen as more challenging to secure a traditional loan. Some funding requests will be rejected simply based upon the lack of supporting evidence available; there is little room for error when seeking approval from a traditional lender. If you are denied, this will put you back at square one – which is less than ideal if you have a deadline for your funding.
Loan security
Due to being naturally more risk-averse, traditional funders will seek an amount of collateral to secure against any loan being approved. This is held in case you default on your repayments and could come in the form of assets (such as property, equipment and so on) or a personal guarantee.
The amount of collateral required must be in place before a loan can be sanctioned and will be determined by the total value of the debt requested. In some cases, there can be scope to negotiate the level of collateral to be held, particularly concerning a personal guarantee.
Due to the level of security associated with traditional finance, it means you will be able to raise more considerable sums, as the lender is assured they will get their money back one way or another. There are also lower interest rates due to decreased risk.
Alternative lenders, however, tend to be more open to risk. As such, they are less likely to seek collateral against any finance approved (other than a personal guarantee typically 100% of the loan amount), which is of great benefit to any business. This is also beneficial for companies who do not have substantial assets to use as collateral. However, unsecured loans tend to carry higher interest rates, which must be considered as part of your research.
Lender control
With a more informal approach to finance, alternative funders tend to apply less stipulation about how the finance can or should be spent – which is also why they often ask for less supporting evidence. The money is viewed as your working capital with no restrictions or conditions about how you can use it within your business, even if this changes from your initial purpose when applying for the funds.
Traditional funders tend to operate much tighter controls. As well as requiring a well-executed reason for the funding in the first place, they generally insist that this is the only way in which approved funds can be spent. However, many won’t apply strict terms and conditions to the loan that dictate how they can be used, leaving some room for manoeuvre – though you should double-check the fine print first.
The flexibility of alternative funders means that businesses are able to seek more entrepreneurial ways in which to use their finance. This will be welcome to entrepreneurs who do not necessarily have a set path in place for their business and are instead willing to seize opportunities when they arise.
Unfortunately, this lack of lender control may lead many to see alternative lenders as being slightly cavalier in their attitude, however this is far from the truth. These alternative lenders use digital systems and lean operations to deliver a modern approach to underwriting the risk. While alternative finance is growing in acceptance as more and more people utilise them, it is essential to do your due diligence and make sure any lender you choose is reputable and credible.
Repayment
When it comes to how you repay your loans, there shouldn’t be drastic differences between traditional and alternative. Both will require regular instalments over the designated term of the loan, which you will be expected to meet each month (unless otherwise stipulated in your contract).
However, where they do vary is how much you may expect to pay back, thanks to their interest rates.
Both traditional and alternative finance solutions will apply repayment interest to any loan they offer, but it’s often the high street banks that can achieve the lowest interest rate. This is due to the increased underwriting and security on these loans, provided by the lengthy application process, your supporting evidence and any assets or personal guarantees you use as collateral, as well as their broader client base. This is also why you will have access to larger sums of funding under a traditional loan typically.
While alternative finance does usually have the upper hand in terms of agility and speed, this will come at the price of higher interest – meaning you can end up paying back much more than you receive. It is worth shopping around different alternative lenders, as they often have access to a wide range of products so can increasingly offer more competitive interest rates.
Get advice
External finance is a necessary aspect of most businesses’ growth journey, whether you’re expanding your team, buying new equipment, investing in marketing or simply managing your cashflow. But growing without the right kind of finance can be a hindrance.
Due to this, it is vital that you only utilise the funding options that truly make sense for your business. This means doing your research and understanding the unique characteristics of each type to discover which works for you.
Either way, there is room for both traditional and alternative finance in the business growth market, and between banks and alternative lenders, the chances of your financial needs being met are substantial; as long as you are financially stable with reasonable strategic projections. Both forms are continuing to evolve in line with changing funding needs, meaning that you may even end up switching between the two during your financial journey.
If you are struggling to identify the right solution for you, it is always worth seeking impartial advice. At Pegasus, our advisors offer independent guidance, tailored to your needs, so we can find the perfect fit for you.