“Alternative credit” or “alternative lending” refers to a type of specialty private financing available for corporate borrowers or for individuals looking to borrow against their real estate assets. The funds are obtained from an alternative finance company (e.g., private lender), rather than from a traditional bank or banking institution. Borrowers turn to alternative credit to secure financing they might not otherwise qualify for in the traditional lending and public credit markets. Some common examples include direct lending, venture debt, structured equity, debt financing, and mezzanine financing.

 

Unlike traditional mortgages or other types of business lending, alternative financing often has non-standard, purpose-built terms, and approval is generally not dependent on typical factors used to evaluate creditworthiness (like credit score). This non-traditional financing type gained prominence in the wake of the 2008 financial crisis, as conventional lenders sought ways to diminish risk by changing how they lend and elevating underwriting and approval standards, which made obtaining loans more difficult for borrowers.

It’s no secret that access to capital is drying up. As the Fed raises rates, borrowing becomes more expensive, and institutional lenders are less willing to take on risk, whether in financing real estate loan portfolios, new development, or real property acquisitions. Businesses seeking access to capital need to get creative in this market, with access to traditional lending becoming more restricted, and many leveraging alternative credit to fund operations or expansions. This need for capital has created significant opportunities for alternative credit providers, mostly because of their novel lending structures, including flexible terms and underwriting criteria.

     1. Direct Lending

With direct lending, a borrower obtains a loan much like a traditional loan, but without an institutional lender (bank). Instead, the direct lender uses investor funds to fund leveraged, private loans. Direct loans often come with higher interest rates and shorter loan terms than conventional loans.

     2. Venture Debt

Typically used by startups and new companies, venture debt is a complement or alternative to equity financing, which does not dilute a company’s existing equity interests and generally follows one or more successful equity raises. Rather than employing traditional collateral to secure repayment of the loan, venture debt is secured by stock warrants (options) on the company’s common stock, which may be exercised in the event of default. Due to the high risk of default, venture debt is also generally given senior liquidation priority over the company’s common equity shares.

     3. Structured Equity 

Structured equity is an alternative capital option to traditional private equity, which does not require a company to surrender control or material governance. Structured equity products offer flexible funding backed by bonds or debt securities issued by the borrowing company. Structured equity falls between senior debt (like venture debt) and traditional equity in the capital structure, including both a debt/repayment component and an equity participation component.

     4. Debt Financing

Debt financing applies to several types of loans or lines of credit backed by a company’s performance, revenue, value, or similar factors. Similar to the leveraged investor capital a direct lender uses to fund loans, debt financing is a form of “leveraged funds” that must be repaid with interest, and which are secured by company assets.

     5. Mezzanine Financing

Mezzanine financing allows a business to fund the purchase of commercial real estate while reducing the amount of equity the company needs to contribute to the purchase price. The mezzanine loan bridges the gap between traditional bank financing covering a portion of the purchase price, and a company’s contribution of its own funds to cover the remainder. Lower in repayment priority than other loans, and without the property as collateral, a mezzanine loan typically has a much higher interest rate and shorter repayment term than a traditional loan, due to its higher risk to the lender.

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