A guide to alternative small business loans

Running a small business is a key part of the American dream for many people. However, in order to make money, you also have to spend money — and if you don’t have enough of your own, you’ll need to look into business lending products. 

In 2024, nearly half of small business owners applied for a business loan, according to the Federal Reserve. A third opted for business lines of credit, and one in five applied for an SBA loan. Traditional banks and lenders offer relatively affordable funding, but often set a high bar for many business owners to get approved. If you’re unable to qualify, you can consider other options for alternative business loans.

Alternative business loan options

Business owners are creative, purpose-driven people who often go to great lengths to solve various problems. The same is true for alternative lenders, who often rely on unusual and innovative strategies to help business owners get the funding they need to run a successful business if they don’t qualify for more traditional options. 

Alternative business loans can come with big drawbacks, though. They’re often more expensive, they can be more complicated to understand, and they come with fewer protections than you might be used to on the personal side of things. It’s important to compare your options thoroughly, but if you do your due diligence, it can really work out to your business’s advantage.

401(k) loan

If you have a sizeable amount of money saved in a 401(k) and you’re starting a business on the side of regular full-time employment, you may be able to borrow against those funds. Loans are fairly standardized, with five-year term lengths, loan amounts up to $50,000, and interest rates set just 1% to 2% above the current prime rate.

Pros:

• No credit check
• Low interest rates
• Loan interest paid to yourself
• Payments automatically deducted from your paycheck

Cons:

• Lower long-term retirement yields
• Extra IRS penalties and fees if you default
• Only available if you’re currently employed
• Job loss triggers immediate and full loan repayment

Personal loan

Personal loans are versatile and can be used for many purposes, such as purchasing inventory and equipment, especially if you’re just getting your business off the ground. Rates may be higher since these loans are typically unsecured, but on the other hand, you don’t immediately risk losing any collateral if your business goes under, either.

Pros:

• Fast funding
• Helps build personal credit
• Doesn’t use collateral that can be repossessed

Cons:

• Higher interest rates
• Requires good credit and income
• Loan amounts too small for many business purposes
• Many — but not all — lenders prohibit using loan funds for business expenses

Crowdfunding

If you’ve got a buzz-worthy business that sells smaller, more affordable products to the general public, one route might be setting up a crowdfunding campaign that you advertise on social media.

Pros:

• Relies on social capital, not credit or debt
• Can generate a lot of business interest, even before you launch
• Repay supporters with business-related gifts or perks, rather than cash

Cons:

• Not suitable for most businesses or those with B2B customers
• Crowdfunding platforms may take a cut of your revenue
• Requires good planning (or a good investment) to craft a successful campaign

Equity financing

You’ve likely seen the popular TV show Shark Tank, and while real life isn’t always as glamorous, the basic concept of this funding method is real. If you opt for this approach, you’ll look for an investor to provide funds for your business in exchange for a share of your revenue for a set period of time, often with the investor becoming directly involved in business decision-making.

Pros:

• Potential for a large sum of cash
• Mentorship and guidance from your investor
• Doesn’t require debt or regular cash repayments

Cons:

• Can be hard to find an investor
• Loss of some control over your business
• Requires giving up a share of your profits
• Investors demand a solid business plan with high growth potential

Business grants

Many nonprofits and government organizations offer business grants to spur economic development within their communities. Business grants are often small and hard to come by, but if you can secure this type of funding, it’s often a best-case scenario since it’s quite literally free money that you don’t have to repay.

Pros:

• Doesn’t create a debt liability
• Options more plentiful for disadvantaged business owners

Cons:

• Funding is often scarce or nonexistent
• Significant time investment required to apply
• Grant may convert into a loan if you don’t uphold ongoing requirements

Invoice factoring and financing

Invoice factoring, also known as accounts receivable financing, is essentially a cash advance on invoices that your business sends out for payment. They can be structured in a few different ways, all of them difficult to understand at first, but the basic gist is this: you get a reduced payment on your invoice in exchange for receiving immediate cash for the work your business performs.

Pros:

• Doesn’t require good credit
• May allow you to outsource collections on unpaid invoices
• Fast, frequent, and smaller funding helps you smooth out cash flow

Cons:

• Not suitable for all industries or B2C businesses
• Very expensive compared to traditional loans
• Confusing pricing metrics make it harder to compare costs
• Can sow confusion among customers if they’re required to pay another company

Merchant cash advance

Many online lenders, and even payment processors, offer quick and easy access to working capital loans in the form of merchant cash advances, or MCAs. It’s essentially, as the name implies, a cash advance based on your current sales volume. You repay the funds as a share of your sales, which are automatically withdrawn through regular ongoing payments until the debt is satisfied.

Pros:

• Quick approval and fast funding
• Payment amounts scale to actual sales volume
• Relies on your business cash flow, not credit, for approval and pricing

Cons:

• Requires daily or weekly payments
• Not suitable for all industries or B2B businesses
• Very expensive, often bordering on predatory

Home equity investment

Homeowners have the additional option of tapping into home equity to fund their business. A home equity investment (HEI) can be a good vehicle to borrow money if making ongoing payments is a concern for you. Instead of making monthly payments, you’ll repay the funds in 30 years’ time in a lump sum, along with a share of your home’s future appreciation in value. Homeowners can choose to settle the investment by refinancing, selling , or using another source of funds (like a HELOC or cash savings).

Pros:

• No monthly payments
• Flexible 30-year term
• Doesn’t require excellent credit
• No income requirements

Cons:

• Your home serves as collateral
• Repayment is a lump sum, requiring a buyback plan
• What you'll owe is tied to your home's change in value, so less predictable than standard interest payments

Home equity loan or HELOC

Another option for homeowners who want to leverage their personal assets for more affordable financing is to take out a home equity loan or line of credit (HELOC). Rates may be more affordable than with other types of personal debt financing, such as a personal loan, though it puts your home at greater risk if your business fails.

Pros:

• Low interest rates
• Ability to use funds for other purposes

Cons:

• Requires good credit and income to qualify
• Limited funding unless you have significant home equity
• Puts home at risk of foreclosure if you don’t repay funds

Business credit cards and lines of credit

It’s not appropriate for every funding need, but business lines of credit (including those available through a business credit card) can often serve as excellent business loan alternatives. You may be able to fund very small businesses entirely from the ground up with a business credit card. Even for established ventures, business credit cards are often an integral part of everyday operations, especially once your business has employees.

Pros:

• Helps build business credit
• Offers extra perks and spending protections
• Employee cards enable workers to make business purchases
• Borrow, repay, and borrow again without applying for new credit

Cons:

• Funding size may be smaller than with a loan
• Risk of borrowing more than you can easily repay
• Variable interest rates introduce payment uncertainty

Tips to improve your chances of qualifying

Even though you have other financing options if you don’t qualify for traditional bank loans, it’s still worthwhile to try pursuing those first. They’re often much more affordable and business-friendly than alternative lending products, and that can help alleviate future strain on your business. 

Here are some ways you can boost your creditworthiness as a small business owner, so you’re better able to qualify for traditional business financing products:

• Improve your business cash flow: Lenders want to see a history of strong, consistent cash flow sufficient to maintain monthly payments. Most traditional bank loans require a monthly business income of $10,000 or more. 
• Check your business credit reports: Business credit uses different credit bureaus and reports different metrics than your personal credit. It’s still important to check them periodically for errors, however. 
• Work on your personal credit score: Small business lenders check your personal credit, too, and often set a minimum credit score requirement of 700 or higher.
• Improve your business credit score: Small business credit works differently, and you may have several scores to track. A FICO Small Business Scoring Service rating of 180 or higher (out of 300) is considered good, for example. ‍
• Apply with a Community Development Financial Institution (CDFI): This network of banks, credit unions, and other lenders receive government funding to offer loans to disadvantaged business owners and may have relaxed approval criteria. Find one here.