Creative Funding Options for Startups and Entrepreneurs

Startups and small businesses are a vital part of the U.S. economy: they serve as an incubator for innovation, make a significant contribution to the national GDP, and provide opportunities for diverse groups of people. In fact, nearly half of the nation’s private sector workforce is employed by small business and a 2015 SBA study reported that SMBs add more net new jobs than large businesses.

While more than 543,000 new businesses are started every month, statistics show that only about two-thirds of startups will survive two years in business, half will survive five years and only one-third will survive 10.

This isn’t for a lack of trying. Capital management is one of the most difficult challenges for SMBs and startups due to uncertain cash flow and various capital needs. An underinvestment in growth capital makes it difficult to seize opportunity as it arises, and insufficient working capital can cripple daily operations.

Finding the right balance is difficult, especially when considering that SMBs are far more sensitive to volatility. If a startup cannot resume operations within 10 days of a natural disaster, it probably will not survive, and more than half of business owners believe it would take at least three months to recover if they are able to weather the storm.

Has a lack of accessible capital been killing startups?

The need for capital is apparent, but historically, access has been limited. Although it is debated whether the “credit gap” for startups and small businesses exists, there is evidence to suggest that the banking industry has been less focused on lending to this segment over the past decade due to the associated cost and risk.

In December 2017, big banks reported the highest approval percentage for small business loans since 2011, but that approval rate was still only less than 25 percent. Despite SMBs playing a major role in the financial recovery following the 2008 crisis, it’s clear that the effects of the “Credit Crunch” are still looming for this segment, and the statistics are even scarier for minority-owned businesses:

  • Women-owned businesses make up more than one-third of the nation’s SMBs, but receive only about 4 percent of all business loans
  • On average, minority-owned firms are less likely to be approved and experience higher interest rates and smaller funding amounts
  • Minority-owned firms are more likely not to apply for loans due to fear of rejection

Even in the case that SMBs are approved, bank loans are often characterized by daunting processes, lengthy times to funding (around 90 days) and lofty requirements, none of which truly accommodate the needs of startups. The truth is, SMBs and newer businesses do not always possess the credit history or other requirements necessary for approval, and they often have more immediate needs than what traditional financial institutions can satisfy. The result? Many healthy business with a promising future do not develop as fast as they should (or fail) due to a lack of accessible bank capital, and an increasing number of business owners have been refraining from applying for their loans entirely.

Related: Why Every Entrepreneur Should Open a Business Line of Credit

Alternative lenders fill the void for SMB lending

Fortunately, alternative lending has erupted as a go-to debt financing solution for entrepreneurs because of the ability to provide immediate access to capital in a seamless and intuitive manner.

Unlike big banks with bleak approval rates for loans under $250,000, these entities can provide smaller funding amounts as they do not abide by the requirements put in place by financial institutions and regulatory bodies. Rather than focusing on the most profitable market segments, they strive to truly meet the capital needs of SMBs.

The ability to choose who can borrow and how much to offer puts these lenders in a unique position. Instead of focusing heavily on the traditional requirements, they use their own models and methods. By looking at transaction history, invoice volumes, geographic and industry trends, historical data and other predictive information, they can more accurately score business health and play to the borrower’s strengths while matching them with the best creative financing options for their specific needs.

Creative small business funding options

From the application and approval process to product structure and repayment methods, the industry has been focused on providing startups with capital solutions that address their short-term needs and catalyze their long term goals. In turn, this has resulted in a growing suite of alternative financing solutions.

Debt financing alternatives for SMBs

  • Unsecured Business Loans are issued without collateral but may request a personal guarantee. While the approval process and time to funding are more appealing than traditional bank loans, interest rates are typically higher due to the associated risk.
  • Lines of Credit may be secured or unsecured and allow business owners to choose how much they would like to borrow and when. No interest is owed until money is borrowed, but SMBs seeking “just in case funding” should know that there may be annual or setup fees.
  • Merchant Cash Advances provide immediate, short-term financing that is repaid as a portion of future credit card transactions. Automatic payments are remitted from future receivables so seasonal businesses don’t have to worry about keeping up with fixed payments.
  • A/R Financing, also called factoring, is the practice of selling future account receivables (amounts owed by customers for goods and services) in return for immediate cash. The invoices act as collateral and allow you to improve cash flows, but they are more labor intensive than other debt financing alternatives and the financing company will typically contact your clients.
  • P2P Lending services leverage a technology platform to operate a credit market where users can borrow and lend money without the use of a financial institution as an intermediary. Borrowers typically experience better rates than they would through a bank, but must apply for the loan as an individual (personal credit score).

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Equity financing for SMBs

  • Equity Crowdfunding allows SMBs to raise money quickly by selling shares of their business. New equity crowdfunding provides a transparent process and huge growth potential if you can build a community. The downside is that with so many shareholders there are a lot of people to keep updated, and they are unlikely to provide expertise.
  • Venture Capital can be a good solution for early-stage companies with a high potential for growth. Keep in mind that while VCs provide funding, stability, and expertise, you will be giving up equity and a seat on your board — your business could change dramatically.

Over the past few years, alternative lending has become more and more mainstream and has helped hundreds of thousands of startups easily and quickly secure the necessary capital they need to grow and sustain their business. The days of filling out laborious paperwork and continuously getting rejected by traditional sources are over.

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