Finding money in unexpected places
The economy might be in a recovery mode, but small business lending still hasn’t returned to pre-recession levels. Last year, the Federal Reserve Bank of New York reported that the number of small business loans was at three-quarters of its 2008 peak. The Bank’s 2013 Small Business Credit Survey found that even among profitable firms, gaining access to credit remains a challenge.
Many small businesses instead tap personal savings and friends and family to finance their ventures. But what happens when those sources of funding run out?
Venture capital might be an option for technology-oriented firms doing truly groundbreaking work, but for the broader masses, it’s not a viable funding mechanism.
The good news for entrepreneurs is that a growing number of alternative funding vehicles are cropping up to fill the gap. Here’s a look at the options for small business owners who aren’t having success obtaining capital through traditional routes:
Online Lending & Crowdfunding: These alternative funding sources have grown by leaps and bounds in the last few years. Structures vary – some companies in this arena (such as Kabbage and Amazon) will lend money directly to businesses after reviewing an online application, while others offer online platforms where businesses can post their profiles and funding needs in an effort to attract investors.
The advantage of this approach is that businesses can gain access to capital much faster than through traditional means (Kabbage claims that the applications are processed and approved within seven minutes on average). Business owners can reach a larger audience of investors without having personal relationships with those investors. On the flip side, sometimes the amount of funding available is limited and entrepreneurs have to feel comfortable divulging typically confidential financial information online. Big players in the crowdfunding world include: Amazon, Kabbage, Lending Club, Dealstruck, Prosper and IOU Central.
Crowdsourcing: The success of Kickstarter has made more entrepreneurs aware of the potential benefits of crowdsourcing. Instead of plugging in your financials in an online form, crowdsourcing depends on your ability to present your project or funding pitch in a powerful way. Investors in crowdsourcing projects typically don’t receive a loan repayment, but other “rewards,” such as a free sample of the product you’re producing.
Crowdsourcing is a great way to obtain feedback on your product and gauge potential demand. But it doesn’t work as well if you’re seeking financing to fund ongoing operations or some other non-project oriented expense. Because of the public nature of crowdsourcing, it’s also essential for entrepreneurs who receive funding to follow through on their projects.
Merchant Cash Advance: This financing method involves the factoring of future sales. It’s typically very easy to qualify for a merchant cash advance and business owners usually receive funding much faster than they would though a bank or more traditional source. The cons of a merchant cash advance include very high interest rates and short payback periods. It’s well suited for $20,000 to $100,000 cash needs though often difficult to obtain in larger amounts. The typical repayment period for these advances is anywhere from three to 12 months. Companies specializing in merchant cash advances include Advance Me and On Deck.
Revenue-based financing: A relatively new financing option whereby you raise capital by selling a small percentage of future revenue. The faster your business grows, the more return for the lender. Conversely, if your business slows down, the lender experiences a slower rate of repayment – sharing in the potential risk.
This emerging alternative works best for young, growing company seeking flexible financing – even if it’s potentially more expensive than a traditional loan. The other positive of this structure is that entrepreneurs are not giving up ownership or voting rights in their companies in order to acquire funding. There aren’t a lot of providers yet, but Lighter Capital and BizCash are starting to establish names for themselves in the revenue-based financing niche.
Factoring: Let’s say you’ve sold your goods or services and now you’re awaiting payment. You still have expenses you need to cover in the interim. With factoring, you sell the invoice – so you get paid now and the invoice buyer agrees to wait for the invoice to be paid.
This option helps cash flow at times when capital is crucial. Rates, however, will vary based on the credit of the customer and the business. As a business owner, you’ll also need to show strong consistent sales to convince someone to take a risk on buying your invoices. Factoring providers include Bibby Financial and Rivera Finance.