There are only a handful of traditional ways to finance your small business. But if you’ve already exhausted the tried-and-true routes and hit a wall (or just consider yourself a bit of a rebel), this article is for you.
There are a few reasons to choose alternative funding:
You tried to secure traditional bank loans, investors or lines of credit and were denied.
You have a less-than-stellar business credit score.
You need funding in a hurry—alternative funding usually takes less time to process and the approval rates are higher.
You think outside the box and are willing to put yourself and your business on the line (the rewards could be greater than the risk).
Alternative funding is a fairly new and unregulated, so it’s important to know the lay of the land before you commit. In this article, we’ll share the most common types of alternate funding, and the pros and cons to consider.
Microfinancing is just a smaller version of a larger traditional bank loan. Designed for small businesses, banks and other lenders offer microloans between $5,000 and $50,000. The Small Business Association (SBA) reports that the average microloan is $13,000—which could be just enough to start that hand-knit hammock ecommerce business.
How do you get ahold of these micro-lenders? Peruse the SBA’s list of certified sources, by state.
The pros of microfinancing
Microloans tend to get approved faster than traditional business loans (think 24 hours versus a month or more).
They’re easier to pay off. If all you need is a few thousand dollars to invest in a piece of equipment, this is perfect.
Smaller loan amount = less total interest. Interest is like the tax you pay for getting a loan. The smaller your loan, the less interest you pay.
The cons of microfinancing
The small amount may not be enough to grow your business in a big way.
Smaller loans often mean shorter terms—some microloans require weekly or even daily installments, which could be a cash flow risk.
Plan out your repayment schedule meticulously. Remember: missed payments on a microloan can still come with some macro-sized consequences to your credit score.
Sometimes it’s more about who you know than what you know. If you have an extensive personal network—or a group of dedicated fans—crowdfunding could be a viable option. Simply put, it’s an institution-free, human-to-human exchange.
Crowdfunding means putting yourself (and your business idea) out onto the worldwide web, asking the public to make a small personal investment—usually with no guaranteed return. It might sound risky to share your idea with potential naysayers, but you could also be exposing your business to an untapped source of enthusiastic backers. When crowdfunding platforms like Kickstarter burst onto the scene a few years ago, they democratized the process of financing for small businesses in a completely new way.
Top crowdfunding platforms to check out:
Kickstarter: the most popular crowdfunding platform.
Indiegogo: Kickstarter’s main competitor, useful especially for new inventions.
Fundable: crowdfunding designed for small businesses
RocketHub: billed as “the social network for entrepreneurs”, RocketHub offers specialized crowdfunding campaigns if your application is accepted.
The pros of crowdfunding platforms
When someone decides to fund your idea through a crowdfunding site, they don’t expect a share of ownership in your future business (like a traditional investor would). That means you get to fund your business while staying in the driver’s seat for the long haul.
These “investors” have no expectation to be paid back. Crowd-funders are motivated by a genuine interest in the product you’re creating (and want to secure one of the first editions).
The cons of crowdfunding platforms
Crowdfunding is a lot of work. Successful funding campaigns usually require some kind of enticing promotional video, and a lot of time communicating with funders who may have contributed as little as $10 to your mission.
Platforms like Kickstarter have also created the expectation of a “perk” for funders—meaning you may need to provide a gift in return for contributions or write hundreds of thank-you notes—time you could be spending on building your business.
Also worth noting: while you won’t need to repay your Crowdfunders, you will need to pay taxes on all revenue (money leftover after your business expenses) collected via crowdfunding.
Peer-to-peer (P2P) lending
You can thank the internet (and the recession) for financial inventions like P2P borrowing. The social media network of the lending world, P2P services match your business idea with individual investors (AKA regular people. You won’t get randomly matched with the investors from Shark Tank). These services connect lots of investors and do the matchmaking for you, so you can spend less time searching for backers and more time focusing on business development.
P2P lending platforms to check out (in order of popularity):
The pros of P2P lending
P2P loans are free from the regulatory involvement of banks, making them a good option if you want to avoid high interest rates and endless signatures.
Unlike sneaky bank loans, you’re free to pay back the borrowed amount as soon as possible.
Everything happens online, which speeds everything up.
The cons of P2P lending
- There are very few regulations in place, so they could be unstable and even slightly risky. You never know for *sure *if the person you’re dealing with is trustworthy.
Like any type of borrowing, the terms of your loan will depend on your credit rating and/or your financial history, so get your credit score in shape before venturing into this space.
Borrowing from friends and family
Thinking about making a withdrawal from the Bank of Mom and Dad? Applying for a loan at Friend’s Credit Institute? Borrowing from Buddy Brian’s Brokerage? The friends and family route is a viable option. But there are a few things to consider.
The pros of borrowing from friends and family
Depending on how close you are with the lender, you might be able to get an interest-free loan with generous pay-back times.
The terms are completely flexible between you and your lender/friend. You can draw up a contract that works for both of you.
The cons of borrowing from friends and family
It could get awkward. Sometimes just asking for a loan creates pressure and awkwardness with friends and family.
If things go south and you’re not able to repay the loan, you could be putting financial pressure on someone you care about. And an awkward situation would be made even more awkward.
There’s a time and place to borrow from the people closest to you, and when that time comes you’ll need to create and enforce an invisible line between the deal and the relationship—ideally in the form of a proper legal contract.
Merchant cash advances
If your business accepts credit card payments, then you might consider taking on a merchant cash advance. To help your business through slower times, a private lender would advance a lump sum to you in exchange for a percentage of your daily credit card income. These arrangements come with short terms—under 24 months—and require small regular payments, based on your credit card sales.
Looking for a good lender? Check out Merchant Maverick’s breakdown of the best Merchant Advance companies.
The pros of merchant cash advances
You get fast access to cash.
The loan payment comes right out of your credit card sales, so you don’t have to put together loan payback schedules. This gives you flexibility around how you handle your cash flow.
The cons of merchant cash advances
Cash advances are the wild west of the loan world. They’re mostly unregulated, and they’re not subject to interest rates rules. Which means you’re probably paying *a lot *more than a traditional bank loan.
You’re giving up a daily percentage of your revenue. Depending how much your business makes, this could hinder everything else in your business.
Working Capital Loans
Every business has high times and low points—but seasonal businesses in particular* *may need a helping hand to cover operating costs (like salaries and rent) in the low season. Banks and other lenders will provide short-term working capital loans to carry you through the times when cash is going out faster than it’s coming in.
Pros of working capital loans
When you don’t have cash on hand to cover daily operations in October, but you know 80% of your revenue comes in the holiday season, this is a quick fix.
Working capital loans are relatively easy to get your hands on. If you have good credit, you can get an unsecured loan—so your assets aren’t on the line if you fail to repay in time.
Cons of working capital loans
Unlike other forms of alternative funding, you can’t use these funds to invest or buy long-term assets.
This won’t grow your business, it will just keep it afloat.
If your credit rating is poor, you may have to borrow against existing assets—which puts you at risk of losing those assets if the high season doesn’t deliver the return you expect it to.
Like other forms of quick cash, interest rates are high on these loans. We’d recommend first trying to cut back overhead and operating costs before applying for a high-interest working capital loan.
Further reading: The Seasonal Business Owner’s Guide to Going with the (Cash) Flow
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This technically isn’t “funding” but we’d be remiss to not mention it. Bootstrapping simply means self-funding your business using your own resources (financial and otherwise). Whether you’ve been building your small business as a side hustle while holding down a full-time job, or have been saving your own start-up fund for years, most small businesses could benefit from some degree of “pulling up their bootstraps”.
Pros of bootstrapping
You’re in total control. You won’t have to answer to investors, so you can make the decisions that feel right and grow at your own pace—it’s your business, after all.
You will run a much leaner business, with fewer costs.
Cons of bootstrapping
You won’t be able to grow as fast. If you have big growth plans, they’ll have to wait until your profit alone is able to fund your ambition.
You’ll be busy. Choosing to self-fund means hiring gradually and forgoing a lot of outsourcing that would lighten the load.
Bootstrapping might mean you aren’t able to hire experts you really need or buy raw materials that are cheaper in bulk. Do a cost benefit analysis—borrowing a little cash up front could make you more in the long run.
Bootstrapping works best when there’s a clear plan for turning profits quickly. The faster you can top up your own account as you’re spending it, the better your business will be able to stay afloat.