Understanding Alternative Finance
Updated on June 2, 2023
Written by
At a Glance: Alternative financing provides entrepreneurs with funding options outside of traditional institutional finance, such as banks. It includes fintech services like consumer lending, equity financing, money transfers, payments, regulation management, and wealth management. Non-equity financing options like credit lines and invoice factoring help businesses preserve ownership while accessing capital. Examples of alternative financing include crowdfunding, P2P lending, invoice factoring, lines of credit, merchant cash advances, and term loans. Alternative financing also benefits consumers, offering tailored options like loans for underserved markets and financing for medical care, home improvement, and automotive needs. These alternative options expand access to finance and enhance consumers’ quality of life.
It’s no secret that the world of finance, especially BaaS, has been evolving and growing at a rapid clip over the last few years. Alternative finance is one of the biggest factors driving these changes. Now, more than ever before, customers – both commercial and consumer – have a vast array of financial options designed to broaden spending power without sacrificing financial security.
What exactly is “alternative” finance, though?
In this blog, we’ll take a look at both commercial and consumer alternative financing, what each is, and how each has given its respective customer expanded financial power.
What is Alternative Financing?
Alternative financing encompasses all types of funding that are not part of the conventional institutional finance system, which includes banks and capital markets. By offering a diverse range of funding channels, such as embedded finance, alternative finance options enable entrepreneurs to secure financial support for their enterprises.
Fintech and Alternative Finance
Fintech operates within the alternative finance framework and consists of businesses, technologies, and methodologies designed to enhance or challenge conventional forms of funding. This encompasses a broad range of financial services, including but not limited to:
- Consumer Lending and Credit (Earnest)
- Equity Financing and Crowdfunding (AngelList)
- International Money Transfers (Wise)
- Payments and Invoicing (Stripe)
- Regulation Management (Elliptic)
- Wealth Management (SoFi)
Non-Equity Financing
Alternative financing empowers entrepreneurs and financial partners to preserve equity in their enterprises. Various alternative funding alternatives, such as credit lines and other debt instruments, enable founders to secure funds without relinquishing ownership in their businesses. This approach enables founders to maximize their access to capital while reducing their dependence on VC firms. By relying on predictable revenue streams to manage cash, instead of solely relying on funding, businesses can better prepare for unforeseen circumstances, as demonstrated by the impact of the COVID-19 pandemic on industries and companies. Utilizing non-equity financing enables businesses to maintain greater stability while maximizing their options.
Alternative Financing Examples
Alternative financing is available in various shapes and forms. Some of these options resemble traditional financing methods, while others represent the evolution of alternative financing options. Below are some of the most noteworthy examples of alternative financing:
- Crowdfunding – Crowdfunding offers founders and creatives to generate funds for operations and production through crowdsourcing.
- Invoice Factoring – Also known as invoice financing, invoice factoring helps founders and businesses that rely on accounts receivable to create smoother cash flow operations, to avoid payment delays.
- Lines of Credit – Lines of credit are a credit product available through alternative finance marketplaces and tend to rely on atypical funding criteria compared to major banks.
- Merchant Cash Advances – Merchant cash advances are a short-term financing solution designed to provide funds to businesses quickly. Repayment terms are based on an assessment of the company’s credit card receipts.
- P2P Lending – Peer-to-peer (P2P) lending enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman. P2P financing partners tend to be individual investors and companies.
- Revenue-based financing – Revenue-based financing, or royalty-based financing, is a method of raising capital for a business from investors who receive a percentage of the company’s ongoing gross revenues in exchange for the money it invested.
- Term loans – Term loans allow founders to apply for fixed-amount loans that are repaid of a specified loan term. Term loans are similar to bank loans, but tend to have higher interest rates.
Alternative Financing and Consumers
Alternative financing isn’t limited to businesses seeking funding. Traditional financing options often fail to meet the needs of certain consumer groups, leading to the emergence of financing products tailored for underserved markets.
For instance, Stilt initially offered loans to immigrant borrowers, who were high-quality borrowers but unable to secure loans from banks due to their limited or non-existent credit history in the U.S.
Stilt’s loans represent only one example of alternative financing for consumers. Alternative lenders, merchants, and service providers continue to introduce new financing options, such as Buy Now, Pay Later (BNPL).
In the sections below, we’ll explore how consumer alternative financing options are being adopted in non-financial industries, such as healthcare, home improvement, and automobile maintenance and repair.
Medical Care and Alternative Financing
Medical care is widely recognized as one of the most expensive industries for consumers. In 2020, healthcare spending in the United States exceeded $4 trillion, with the average cost of a hospital stay amounting to $2,607 per day. This makes medical care a key focus area for alternative financing.
Through alternative financing options, patients can split the cost of hospital stays, surgeries, and a range of other costly medical requirements. Additionally, alternative finance not only helps alleviate the financial burden of medical care for patients but also enables doctors, hospitals, and other healthcare providers to offer services that foster healthier communities.
With one in five Americans unable to access medical care due to financial constraints, alternative financing is expanding healthcare options and enhancing consumers’ quality of life.
Home Improvement Alternative Financing
While some home improvement projects are driven by aesthetics and comfort, many others are necessitated by maintenance and repair needs. The average spending on home repairs surged to $10,341 in 2021, making home improvements another area of finance that can potentially burden consumers with significant debt.
Alternative financing offers flexible options for consumers, whether it’s to cover the cost of expensive tools and materials required for home repair projects or to finance essential home improvement services that the average homeowner cannot perform. In addition, contractors and other merchants in the home repair industry can benefit from offering alternative financing options that enable clients to take on larger projects and make more frequent purchases.
Automotive Alternative Financing
In the U.S., the automotive industry has long been dominated by traditional financing options, including car loans and leases offered by major banks. However, owning a car involves more than just the initial purchase cost. Substantial expenses, such as maintenance plans, car upgrades, and major repairs, can affect car owners throughout the vehicle’s lifespan, highlighting the significance of alternative financing options.
For auto dealers, selling maintenance plans, aesthetic upgrades, and other post-sale products presents tremendous revenue opportunities beyond the initial car sale. However, such offerings can be expensive for consumers, particularly when purchased from dealerships. This can deter consumers, even if they acknowledge that the quality of the service is better.
Alternative financing alternatives, such as Buy Now, Pay Later (BNPL) or payment plans, can enhance customers’ access to higher-quality services while increasing dealers’ revenue potential. Moreover, this is not only limited to major dealerships. Smaller third-party businesses, such as mechanics and parts dealers, can now offer similar alternative financing options more conveniently than ever before.
Final Thoughts
Alternative financing has been, and will continue to be, a game-changer for businesses and consumers when it comes to financial freedom and security. And that will only become more true over time. The advances being driven by fintech innovation will continue to grow the number of alternative financing options available, producing financial products for every niche, market, and type of buyer. This is just the beginning.
Frank Gogol
A seasoned SEO expert, Frank has a long history of working with and for startups. Starting in mid-2018, Frank served as the SEO Strategist for Stilt, a fintech startup that provided fair loans for immigrants in the US and other underserved markets. While with the company, he scaled site traffic from zero to more than 1.5 million unique visits per month, driving the bulk of the company’s lead generation until it was acquired by J.G. Wentworth in December 2022. As employee #5 at Stilt, Frank was witness to, and part of, the successful building and sale of a fintech company, uniquely positioning him to create content for founders about all things startups.