A small business can't grow without proper funding. Funding can come from many sources – friends, family, banks, crowdfunding sites – but it's not always easy to find the right kind of funding from the right lender. Private funding sources are, essentially, non-bank lending sources. That can be family members, angel investors, venture capitalists or other private lending institutions.
Depending on the type of investor, you could get more than just funding.
"Private funding provides small business owners with more than just capital to get their venture moving," said Carly Frieling, financial advisor with Northwestern Mutual. "The mentorship that is involved with private loans can make the difference in creating a successful company."
This type of mentorship is especially present when working with angel investors or venture capitalists. There are some clear advantages and disadvantages to working with private lenders. While you may have access to quicker capital, your interest rate may be higher, and you may have a demanding payment plan. Regardless, private funding sources serve to help small businesses that may not qualify for a bank loan get up and running.
"Obtaining sufficient capital could literally be the factor that makes or breaks a business's ability to grow," said Simon Goldenberg, an attorney who specializes in debt relief and financing law for small businesses and individuals. "Without private funding, many of those businesses could struggle to get off the ground or keep their doors open."
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Pros and cons of private funding sources
Private funding sources provide a valuable service for small businesses by having more relaxed lending requirements and providing quick funding. Some banks have rigid lending requirements and will only issue loans to the most qualified small businesses. By working with a VC, angel investor or online lending institution, it's possible to qualify for exactly what you need.
"If you need capital quickly, private funding is a good option for your venture, because the approval time is much shorter than that of a bank loan," Frieling said. "The rigidity that comes along with bank loans is much lower with a private loan from friends, family, angel investors or venture capitalists."
While funding speed and overall requirements are ideal attractors, Frieling also said that lenders who understand your business can help you grow in the right direction.
"Another advantage is the ability to align with an investor who understands your business – often a mentor who understands your business's industry and can provide advice as well as capital," she said.
Still, these advantages come with a price – literally. Loans from private sources may have a different rate structure, additional fees or other costs that aren't typically found in bank loans. Goldenberg emphasized the importance of reading and digesting all aspects of your loan agreement before signing.
"Some agreements will state that attorney's fees, collection costs and other considerable fees could be assessed on an account that enters default," he said. "Some go as far as requiring the borrower to sign a confession of judgment, which would allow the court to enter an expedited judgment against the borrower, without a trial, in the event of default."
While these types of terms and conditions may be present with VCs or angel investors, they're more likely in agreements with online private lending institutions.
You may also have a more demanding payment schedule than you would for a traditional bank loan.
"The disadvantage of private funding lies in the payback schedule and the risk of damaging your relationship with your investor," Frieling said. "As with any loan, if you pledge business assets and you have a hard time paying back the amount, you may lose these assets if you have trouble reimbursing the loan." [Interested in alternative small business loans? Check out our best picks.]
Advice and how to get a loan
Getting a loan from an angel investor or venture capitalist will likely stem from networking. Some firms reach out to startups and other small businesses, but if you're starting a business, it's a good idea to start networking and searching for investors.
If you're in need of quick funding options, there's a whole host of alternative online lenders that provide various loans to businesses. These include merchant cash advances, where a lender advances you cash against credit card receivables, as well as traditional short- and long-term loans. Depending on which lender you work with, you may not get the same attention and development as you would with angel investors or VCs.
Frieling recommended having detailed financial planning to be transparent with lenders. Having financial goals for the business and safeguards like emergency funds can boost a lender's interest in your business.
"Create a financial planning roadmap closely aligned with [your] business plan," Frieling said. "When I counsel my clients, we first solidify their financial goals for the business."
Goldenberg said one of the most important parts of any small business loan agreement is understanding exactly what you're on the hook for. Be aware of personal guarantees, UCC-1 liens and other forms of collateral before you agree to a loan.
"The bottom line is, if you see a term that you don't feel comfortable with, don't sign the agreement," he said. "You might not be able to back out of it."
Private funding sources offer small businesses and startups valuable funding options. You can get access to funds quickly, but you may have a higher interest rate and more demanding payment plan. Overall, experts say partnering with a firm that has your business's best interests at heart is crucial.
"If you need private funding," Frieling said, "do your research and find a trustworthy investor that can provide valuable guidance along the way."