Learn why private funding is a viable option for small business owners and what lending sources are available.
- Private funding is an option for small business owners that allows them to grow their enterprises.
- It encompasses many types of funding, including bank loans, cash from family and friends, and investments from individuals on crowdfunding sites.
- There are several benefits to using private funding for your business, including the ability to access cash faster and the guidance you may receive if you work with an investor.
- This article is for small business owners who want to know what funding options are available to them outside of government sources.
A small business can't grow without capital. Capital can come from many sources, but it's not always easy to find the right source for the funds you need. Private funding sources are, essentially, non-bank lending sources. That can be family members, angel investors, venture capitalists or private lending institutions.
Private funding is a source of cash that a business owner can access to bankroll operations, grow and meet cash flow needs. Private funding sources serve to help small businesses that may not otherwise qualify for a bank loan.
"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."
Types of private funding sources
Options abound for small business owners who are looking for private funding. Sure, it's not a government grant, but when you need cash for your small business, there are several possible sources, including:
- Personal investment. For some small business owners, taking out a loan or borrowing from friends and family are nonstarters. They may not want to accrue debt and instead use their savings (or sell an asset, such as a vehicle) to get up and running. Some use a portion of their retirement savings. Using your personal savings can be risky, since you could lose your life's savings if your business fails.
- Family and friends. Funding from family or friends could be provided as a gift, an interest or interest-free loan, or in exchange for an ownership stake in your enterprise. However, be careful. If the investment doesn't pan out or you can't repay the loan, it could cause permanent strife with those whom you care deeply about.
- Angel and venture capital investors. There are many angel investors and venture capitalists who willing to give small businesses funding. Instead of lending you money and charging interest, they get an equity stake in the business. These investors typically provide insight and guidance, but if you want complete control over your business, venture capital funding isn't for you.
- Term loans and lines of credit. Term loans, in which you pay a fixed amount each month to a bank, credit union, or online lender, are popular with small business owners – as are lines of credit, in which you draw money when you need it. Your credit score, years in business, and sales revenue dictate how much you can borrow and at what interest rate.
Crowdfunding. There are several crowdfunding websites that enable entrepreneurs to raise money for their idea. Investors on platforms like Kickstarter or Indiegogo invest sums in exchange for helping a product come to life. The companies usually offer rewards in exchange for contributions. Crowdfunding may not make you rich, but it may also serve another purpose and that is testing consumer interest in your product.
- Alternative financing. Term loans and lines of credit aren't the only private funding sources small business owners can access from lenders. Merchant cash advances and microloans are other options. With a merchant cash advance, lenders give a business owner cash in exchange for future sales. Microloans are small loans, typically $50,000 or less, that are available to businesses that aren't likely to be approved for a loan from banks and mainstream lenders.
Key takeaway: Small business owners have several options for private funding, including using their savings, asking friends and family for a loan, taking out a bank loan or line of credit, running a crowdfunding campaign, or pursuing alternative financing, such as a merchant cash advance or microloan.
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What is private funding?
Pros and cons of private funding sources
There are advantages and disadvantages to working with private lenders. You may have access to capital more quickly, but the interest rate may be higher, and you may have a demanding payment plan.
Benefits of private funding
Private funding sources provide a valuable service for small businesses – they have more relaxed lending requirements and extend quick funding.
Unlike with bank loans, the amount of time to get the money into your hands is much quicker. There are often lengthy approval processes with bank loans. Private funding options typically don't have those same guidelines.
Additionally, if you are using a venture capitalist or angel investor there is the added benefit of being able to get advice from those who have seen it all. Venture capitalists and angel investors typically have a deep level of experience in how to run a business. They have a lot to offer in terms of the knowledge and resources they can provide.
Downsides of private funding
Private business loans come with a price – literally. Loans from private sources may have a different rate structure, additional fees or other costs that aren't typical with bank loans. Goldenberg emphasized the importance of reading and understanding the 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."
These types of terms and conditions may be present with VCs or angel investors; you're also more likely to see them in agreements from online private lending institutions.
Another drawback of a private business loan is that you may have a more demanding payment schedule than a traditional bank loan.
Before making a final determination whether private funding is the right option for your business, weigh the benefits against the drawbacks.
Key takeaway: A pro of private funding is that you can get funding quickly, and if you use venture capitalists or angel investors, they may provide helpful advice. The drawbacks of private funding are that you may pay more fees and higher interest, and if you bring on investors, you give up control and equity in your business.
Advice on 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, but if you're starting a business, it's a good idea to network and search for investors.
If you need funding fast, you may be able to get a merchant cash advance, 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 mentoring that you would with angel investors or venture capitalists.
Goldenberg said one of the most important parts of any small business loan agreement is understanding the terms of the loan. Be aware of personal guarantees, UCC-1 liens and other forms of collateral before you agree to the 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."
Key takeaway: You need to have a detailed financial plan that you can share with lenders and investors. It's also important to understand the terms of the loan and to find trustworthy partners.
Additional reporting by Matt D'Angelo. Some source interviews were conducted for a previous version of this article.