Entrepreneurs face challenges when obtaining financing for their businesses. Some 69% of small business owners cover startup costs with personal savings, while 60% rely on credit cards.
Many startups have trouble getting financing from traditional lenders. Goldman Sachs found that 77% of small businesses are worried about access to capital. About 61% of companies that applied for loans were either denied or weren’t able to get affordable rates.
Many entrepreneurs look to alternative financing to get their business off the ground or expand operations. In addition to more accessible capital and flexible terms, alternative lending and investment often provide other advantages, such as access to advice and networking opportunities.
The Advantages of Alternative Financing
Alternative financing sources offer access to capital when businesses can’t obtain loans from traditional banks. However, the benefits go beyond easier access to capital. Here are the advantages of applying for alternative financing.
- Flexibility: Alternative lenders and investors are often willing to make terms and arrangements that fit an individual company’s needs.
- Different criteria: Alternative lenders and investors may look past credit scores and financial statements. They might consider a business’s plans or ideas, or they could look at the pattern of past development to assess a company’s potential for repayment or equity growth.
- Better terms: Alternative lenders may offer more business-friendly terms. For instance, they could provide non-recourse loans, which are secured loans that limit the settlement to the agreed-upon collateral, protecting all other business assets and income.
Finally, in many cases, alternative financing can help entrepreneurs get capital without forcing them to dilute ownership during the early stages of development. Here is a look at seven alternative financing options for entrepreneurs.
Stock Loans
Securities-based loans are secured by your stock portfolio. The lender holds your stock as collateral until you pay the loan. One advantage of this type of borrowing is the opportunity to raise funds without selling stock. Also, you can protect other assets, such as property or business equipment by using your securities instead.
Stock loans are available through reputable lending institutions or securities-based brokerage organizations. Borrowers submit estimate requests using investment portfolios and loan amounts.
The loan amount, interest rate, and payback schedule are determined by the value of the securities, your creditworthiness, and the loan-to-value ratio.
Crowdfunding
Crowdfunding is a rewards or equity-based financing model, usually using online platforms (Kickstarter, for example). Rewards-based crowdfunding focuses on offering goods or services in exchange for individuals’ support. For instance, supporters on a crowdsourcing platform may invest a specific amount to get a company’s new product during a pre-release sale.
Equity crowdsourcing, on the other hand, provides investors with a stake in the company. This can be attractive to individuals who don’t have the income for venture capital investments.
Crowdfunding also lets you test product concepts and interact with customers. You can potentially build relationships with supporters and reach out to them when funding different products or a business expansion.
Angel Investors
Angel investors offer a more specialized form of nontraditional financing. Wealthy individuals support startups in exchange for equity in the company. These angel investors seek companies with innovative ideas and unrealized potential. Since they usually invest their own money, they usually only deal with companies with a high potential for profitability.
You can find angel investors through networking in your industry or at industry conferences or events. You need to be prepared to discuss your long-term prospects, business plan, market potential, and unique selling point.
In addition to cash investments, angel investors often serve as advisors or mentors. They actively seek to help the company grow (because their equity will grow along with it). Many angel investors have extensive professional networks, and you can use these connections to form partnerships or collaborative relationships.
Peer-to-Peer Lending
Peer-to-peer (P2P) lending allows individuals to offer credit or obtain loans from one another, eliminating the need for financial intermediaries. You find lenders and apply via online platforms (P2P lending websites).
Terms and rates still depend on your credit score and financial history, but without underwriting costs and intermediaries, interest rates may be lower than with traditional banks or credit cards.
P2P loans may not require collateral, and they often come with fixed interest rates, making repayment terms and budgets clear at the start of the loan period. However, you need to carefully assess terms before agreeing to a loan with any lender on a P2P platform.
Revenue-Based Financing
Revenue-based financing (RBF) allows businesses to borrow money in exchange for a percentage of future income. Unlike traditional loans, which have set payments, RBF payments depend on the business’s revenue and cash flow.
Flexible revenue-based financing is best for startups that have fluctuating sales. You will never have to make payments that exceed your income. Because it focuses on revenue, RBF does not require collateral, making it suitable for startups and businesses that focus on services and have few assets.
The loan could have a payback cap or a maximum repayment amount for a given period, allowing you to keep additional profits. Some lenders allow you to temporarily stop payments if you experience financial difficulties.
Microloans
Microloans are short-term, small-amount loans for small business owners. The idea was developed to provide financing for those who lack access to traditional banks. It has now expanded to include small businesses and entrepreneurs who may not get funding from banks.
Most microloan providers give funding for business setup, equipment purchases, expansion or development, or hiring employees.
Microloans may have qualification criteria but are often more accessible than bank loans. Lenders may look beyond credit score or collateral and consider business plans and earning potential.
Grameen Bank in Bangladesh pioneered microfinance by providing small loans to entrepreneurs in underserved areas. Other organizations now serve this specific niche. For example, Kiva is a nonprofit organization that facilitates microloan crowdfunding worldwide, and the Small Business Administration’s microloan program provides funding for entrepreneurs in the United States through intermediaries.
Incubators and Accelerators
Business incubators and accelerators assist entrepreneurs in ways that go beyond traditional banking. Incubators give brand-new startups office space, advice, networking opportunities, financial planning, and legal services. These programs can also provide financial support for product development and other early-stage processes.
Accelerators help startups that are already past the initial development stages. In accelerator programs, startups receive advice and specialized training to help them scale their businesses quickly. As a participant, you may also have access to investors.
To participate in incubator or accelerator programs, you must demonstrate the viability of your business ideas. You typically need a convincing business plan outlining market opportunities and your competitive advantage.
Tailoring Financing Options to Your Needs
These alternative investment options allow you to choose an arrangement that best fits your business needs. If you need a bridge to fund operations while you get more clients, a stock loan or peer-to-peer loan could be the best choice. If you need additional support as you grow, incubators or angel investors may be able to help.
If you want to protect your assets and revenue, a non-recourse loan might prove beneficial, while a stock loan could prove convenient if you have an investment portfolio and wish to use it as collateral instead of your business assets.
The best option is the one that provides you with the necessary financing with fair terms while not requiring you to give up control of your company or risk necessary assets as collateral.
Alternative financing provides access to capital for small businesses and entrepreneurs who may not be able to get loans with reasonable terms. These options often allow you to retain ownership and fund startup and expansion without traditional financing from banks.
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