Alternative Financing Options for Small Businesses
Whether you're trying to get a new business off the ground, or you’re currently experiencing financial challenges in an established small business, you may need a funding lifeline. And chances are, the first place you'll go for help will be a bank or credit union.
And there are good reasons for this. Loans from traditional sources have defined repayment schedules, reasonable interest rates that may be tax deductible, and variety that allows you to choose an option customized for your business needs.
However, these loans aren't necessarily easy to obtain. New businesses that haven’t yet established a credit history may not be able to get a loan from a bank or credit union. Other strict lending criteria—which may include having collateral, a detailed business plan, and minimum annual revenue—also make approval challenging. In addition, these loans can take weeks, even months, to process, so if you're experiencing a business emergency, waiting for the funds can make matters worse. As a result, you may need to be open to other funding opportunities to get the money you need.
Alternative Funding Options for Small Businesses
If you fail to get a loan from a traditional bank or credit union, there are a number of alternatives you may be able to take advantage of.
Angel investors. A new small business can get funds from angel investors in exchange for equity in the company. The benefit of this type of funding is not just monetary: when angel investors provide capital, they tend to also give guidance to business owners to ensure they get a return on their investment.
Crowdfunding. While you may be familiar with sites like GoFundMe because of the personal campaigns that tend to be associated with crowdfunding, this alternative source can also help small businesses. By using a crowdfunding site, you’re able to quickly bring in cash from a large number of people without necessarily giving funders a stake in your business. Instead, business owners may provide merchandise in exchange for funds—which can also be a great way to raise brand awareness.
Equipment financing. Equipment financing won’t bring money into your business, but it will help you keep it in your bank account. Some equipment companies allow customers to pay for products over time, so you can get what you need to operate your business right away, even when your budget is tight.
Invoice factoring. When a business needs cash quickly and has outstanding invoices that can be leveraged, it can sell them to a third party. The funder gives you the cash you need, minus a percentage, and collects money from your customers.
Online lenders. Like traditional banks, online lenders provide business loans. Oftentimes, the borrowing criteria is less stringent, so small businesses with low revenue and credit scores can get access to capital. However, the tradeoff may be a much higher interest rate.
Pros and Cons of Alternative Funding
Alternative funding can be extremely useful when you need an infusion of cash in your business, and there are several benefits of getting financing in this way.
- First and foremost, you’re able to receive funds quickly, and in some cases, you can get approved and receive the money within days.
- Additionally, the eligibility requirements tend to be more flexible, so if you have bad credit or a brand-new business with no credit history, you have a better chance of being approved.
However, there are also some downsides to alternative financing.
- The repayment terms can be extremely short—one year or less in some cases. You also may be required to make payments on a weekly, or even daily basis.
- Another downside to alternative funding to keep in mind is that it may not contribute to establishing or improving your business credit rating because payments aren’t always reported to credit bureaus.
- In addition, alternative funding sources may offer less access to customer service than traditional financial institutions, so if you have questions or concerns about your account, it may be difficult to get the support you need.
Mitigating Alternative Financing Risks
Although alternative financing does come with multiple risks, there are ways you can protect your business from them.
Educate yourself. As with a traditional bank loan, it's imperative that you understand what you're signing up for when you choose an alternative form of funding. Be sure to review all the terms, such as the repayment expectations, fees, and interest rates. You’ll also want to do thorough research on the organizations that offer financing, so you know what their business practices are and what kind of reputation they have.
Make a plan. Although some alternative funding companies may not require that you draft a plan for how you’ll spend the money you borrow, it doesn't mean you shouldn’t have one. For your own benefit, you can create a plan detailing how you’ll manage monthly payments based on your cash flow and business goals. This way, you’ll have a realistic picture that can help you decide which financing route to take, and how you’ll stay steady on the road to repayment.
Get legal advice. Different financing arrangements can carry different legal and regulatory requirements. For example, raising may implicate federal and state securities laws, or involve disclosure requirements, liens, personal guaranties, or other contractual and regulatory considerations. Before accepting financing, make sure you understand the legal requirements and obligations associated with the particular funding arrangement.
No matter what type of business financing you consider, you want to make an informed decision by getting advice from experienced legal advisors who understand the complexities of each choice. Before committing to a plan and signing on the dotted line, consult a member of Foster Swift 's Finance, Real Estate & Bankruptcy Law group to better understand the legal terms, risks, and obligations associated with the proposed funding.
