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Small businesses have numerous funding options, but some of the most conventional ones—like bank loans and lines of credit—aren't always available or desirable. Alternative funding options can give businesses in growth mode access to capital when they need it most.
The trick to vetting unconventional funding options is to do your research and run your numbers. Many of these options come with very high costs, so they may not be worth pursuing except in specific situations. Other options may seem like excellent avenues to pursue but come with hidden dangers or drawbacks.
Check out whether the following funding options may be a fit for you.
Alternative online loans and lines of credit
A growing ecosystem of online funders is competing with traditional banks in both personal and business lending. These companies usually have no brick-and-mortar presence, and in many cases lend to business owners without so much as a phone call.
Online funding is often extremely fast—you can sometimes get a business loan the same day you apply. Some of these lenders work with those who have less-than-stellar credit. Prospective borrowers fill out an online application form, which is followed up with a request for further information and perhaps a phone call. Once a borrower is approved, the lender sends money directly to their bank.
The flip side of the speed and ease of these loans is that their interest rates are often high—some can reach upwards of 50% APR. As with bank loans, however, the terms you get for your loan will depend on various factors, including your credit score.
How crowdfunding works
Crowdfunding is a very promising prospect for those who have an excellent and eye-catching business idea. Business owners can post their ideas on a site like Kickstarter or GoFundMe to get individual investors to give them small amounts of money in exchange for benefits such as being first in line for the product, or promises of gifts or other benefits. With enough microinvestors contributing, business owners may be able to amass enough funding to make a go of it.
Many high-profile products have drawn headlines for launching this way, such as Pebble smartwatches and The Micro 3D printer, which blew past its $50,000 funding goal to raise more than $3 million.
If this option seems too good to be true, that's because in many cases it is. Most companies don't have the kind of inspirational product that is likely to go viral on one of these sites. And, if your venture isn't going to go viral, you have to find other ways of attracting attention—and investment—to your campaign, which is an uphill battle in a packed crowdsourcing field.
Formalized borrowing from friends and family
It's fairly common for small businesses that are just starting out to look to those they know for some funding help. Perhaps your friends and family are willing to invest for the promise of a nice payback or a stake in the company. Just don't expect them to give you money out of the goodness of their hearts. And don't take their need for repayment any less seriously because they love you.
It's critical that borrowing from friends and family be as formally structured as borrowing from any other lender. Leslie H. Tayne, financial attorney, author, and founder and director of Tayne Law Group, notes that taking money from family members can put pressure on your social interactions. She recommends putting everything in writing so that expectations are clear and casual comments about the business won't be misconstrued.
"Every time they walk in the house and say 'How's business?' the person who borrowed the money is going to think it has to do with the money," she says. "The big mistake with families is not putting things in writing."
Invoice factoring or merchant cash advances
Businesses that aren't well qualified for traditional or online loans or lines of credit may turn to alternate funding structures for capital. Online lenders have developed products known as invoice factoring and merchant cash advances, which come with very high—if not exorbitant—interest rates and strict repayment rules.
In invoice factoring, the lender looks at the business's accounts receivable—the money owed to the business—and uses those promised dollars as collateral for what is essentially a loan. The money is often required to be paid back extremely quickly, sometimes on a daily basis, as the payments are received.
A merchant cash advance provides funding based on projected sales instead of invoices. The business pays back the sum on a fast, set schedule as a percentage of sales.
Business owners will likely want to avoid these options unless absolutely necessary. The cost of borrowing is extremely high, and it is difficult to operate in growth mode when much of the money that is yet to come in the door is spoken for.
"These types of loans are very prevalent and very easy to get because they're not based on credit," says Tayne. "They're very expensive; very, very expensive. The risk is so high that it could put you out of business in a minute, and I see that often."
Looking for unconventional sources of funding for your small business is an exercise in research and discernment. While there are many options, not all of them will be a good match, in part because many of these avenues come with high costs, high risk, or other barriers. If you're willing to grow your business slowly and steadily—as many successful business owners have done before you—then bootstrapping still may be your best option.
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