Among the many challenges that startups face, the problems of securing adequate and inexpensive financing are right at the top. 2008, because of the financial turmoil that ensued all across the globe, was a year that marked a massive change in the startup financing and small business financing ecosystem. That’s because banks started being very conservative about issuing loans to startups and small businesses.
Today, things are better, but startups still face a lot of challenges, particularly because traditional lending institutions are not keen on investing in startups operating in an unproven market. Plus, startups could always face unforeseen needs for financing because of events like a payment default by a large buyer, a new market opportunity, a price war with a competitor, etc. To tackle all these challenges, startups need to know and make use of alternative options to bank loans. This guide covers some of these options.
Seasoned entrepreneurs, who’ve seen the fruits of their toil, and with the will and money to stay in the entrepreneurial landscape, can be nothing short of angels for your businesses. That’s why they’re called angel investors. These investors, if they like your idea, and believe in your startup’s potential, are able to provide the necessary funds in return for equity holding in your business.
Apart from the investment, angel investors bring their business expertise to the table. Because they now have vested interests in your business’ success, they will be willing to offer you their business connections and the necessary mentorship to help you succeed. Plus, these investors have been in entrepreneurial shoes for most of their lives, and hence will be patient with your business. Pitching to angel investors requires you to be very realistic and hands-on with everything you do and the numbers you project.
Peer to Peer Lending
Just like banks invite deposits from the public in return for small interest rates and issue loans to those who need it on larger interest charges, peer to peer lending platforms connects borrowers with lenders. On a typical peer to peer network, you just need to sign up to the platform, specify your financing requirements, and leverage the opportunity of having the target met by individual contributors. By cutting out lending institutions from the system, peer to peer lending platforms deliver the following benefits to startups and businessmen:
- They can get loans of up to $25,000 (typically) at more attractive terms as compared to banks.
- The loan approval lifecycle is much shorter on these platforms as compared to traditional bank loans, which helps startups meet sudden cash flow deficit problems.
- As your credit ratings on a peer to peer lending platform improve, you get more attractive deals on loans.
- We recommend you check out lendingclub.com and prosper.com – two of the most credible peer to peer lending platforms.
Friends, family, business-school colleagues
For many entrepreneurs, it’s the last option to ask friends and family members for financial backing, even when their startup is in dire need of the money. Agreed, borrowing from friends and family comes with the risk of straining your relationships. But that’s only when the terms of the personal loan remain ambiguous, and the expectations among the involved parties remain unstated. Here are some best practices to help you manage such situations:
- Keep the option of loans from family members open as a last resort for financing
- Clearly mention the amount you need, the purpose you wish to fulfill, the duration and terms of paying back the loan, and the interest you are willing to give.
- Steer clear of friends without stable income sources; they’re likely to float the idea of premature payments of the loan when the going gets tough for them.
- Leverage the services of platforms like VirginMoney.com; it eases the process of borrowing money from people you know and is acquainted with.
- Done rightly, the art of getting short term and small loans from personal contacts can put your startup in a great position, because of the time and hassle it saves you.
Cash In Your Retirement Funds
Though this might sound way too risky for many entrepreneurs and businessmen, there are situations when using your retirement nest becomes a smart option. To put things in perspective, note that government’s ERISA law exempts you from early distribution charges and penalties as long as the investment of the money is done in your business. You can also consider combining your retirement account savings with other loans, earnings on shares (don’t forget to check live share prices) to finance your startup’s cash needs with greater flexibility. Also, entrepreneurs consider their startups as a mode of diversification of their retirement holdings portfolio. Particularly for these entrepreneurs, there’s a lot of useful advice to be had at GuidantFinancial.com.
Startups are bound to face fluctuating income patterns in the initial stages. A bank overdraft can be a great asset for such businesses, particularly when they know what seasonal highs and promotion-driven sales surges will enable them to pay off the overdraft amount. That’s the core idea that overdraft accounts work on – get help during leaner times, and repay it when the surge appears. Most banks are open to offering flexible overdraft account terms to new businesses, so look for a good deal.
Chances are you’ve already read about success stories of startups that have made it big, riding on successful crowdfunding campaigns. Crowdfunding completely inverts the traditional funding model. Whereas bank loans are about one institution putting in all the money you need, crowdfunding is about bringing together hundreds and thousands of believers, each of them contributing a reasonably small amount of money, to meet your financing goal. Because each contributor only has a small stake, the conditions of the ‘loan’ become highly favorable. Plus, in most crowdfunding models, you only need to reward the contributors and don’t need to pay the money back. Some of the reward options are:
- First versions of the finished product shipped to the contributors
- Merchandise of the brand
- Preferential pricing or discount coupons
Financing from Community Schemes
There are many community development finance initiatives (CDFIs) that issue small to medium sized loans to startups and entry-level businesses, apart from helping existing businesses overcome cash crunches. For businesses whose credit requests are turned down by banks and traditional lending institutions, CDFIs can be just the lease of life they need to raise capital for setting up shop, buying equipment and raw material, and even purchasing a new property. One restriction, however, with most CDFIs is that they are focused on businesses with a social goal and those that aim at the betterment of specific sections of the larger community. From bridging loans to working capital finance CDFIs can solve a lot of financing problems faced by startups.
There you have it; we’ve covered some of the alternative financing options for small businesses and startups. When you’re stuck with an immediate cash need, and can’t get a bank to approve your loan, you’d do well to try out some of the options covered in this guide. Irrespective of the alternative financing model you choose, make sure you properly research and understand the terms.