Startups have a lot of funding options besides bank loans. There are even options outside of business credit cards and borrowing from friends and family.
Below are seven alternative financing methods for startups that go beyond the traditional bank loan.
Community Development Finance Institutions (CDFI)
There are thousands of nonprofit community development finance institutions (CDFIs) across the country, all providing capital to small and micro-business owners on reasonable terms, according to Jennifer Sporzynski, senior vice president for business and workforce development at Coastal Enterprises Inc. (CEI).
"A wide variety of applications for loans come across our desk every week, many of them from ambitious startups," Sporzynski said. "As a mission-oriented non-bank lender, we know from experience that many viable small businesses struggle to access the capital they need to get started, thrive and grow."
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Lenders such as CEI differ from banks in a few ways. First, many lenders look for certain credit scores, and that rules out a lot of startups. If banks see "poor credit," they will almost always end up in the "no" pile. CDFI lenders look at credit score too, but in a different way.
"We look for borrowers who have been fiscally responsible, but we understand that unfortunate things happen to good people and businesses," said Sporzynski. "We seek to understand what happened and assess its relevance." [Want help choosing the right small business loan for you? Check out our buying guide.]
Factors such as personal or family medical issues or job losses can all impact accounting in a negative way, but can all be explained. CDFI lenders also do not seek nearly as much collateral as a traditional bank loan would. There are other things that can compensate for a lack of assets to be used as collateral.
Venture capital (VC) is where an outside group takes part ownership of the company in exchange for capital. The percentages of ownership to capital can be negotiated, and are usually based on a company's valuation.
"This is a good choice for startups who don't have physical collateral to serve as a lien to loan against for a bank," said Sandra Serkes, CEO of Valora Technologies Inc. "But it is only a fit when there is expected for demonstrated high growth potential, and a competitive edge of some kind, like a patent or captive customer."
There are other benefits to going with a VC over another alternative. If you go with a VC firm, you will usually receive more than just capital, as some firms provide entrepreneurs with additional resources like hands-on assistance from the firm's network of advisors and accelerators, said Deborah Sweeney, CEO of MyCorporation.
According to PricewaterhouseCoopers' most recent MoneyTree Report, the U.S. market experienced a record second quarter in 2018 for VC funding deal activity.
With strategic partner financing, another player in your industry funds the growth in exchange for special access to your product, staff, distribution rights, ultimate sale or some combination of those items. Serkes said that this option is usually overlooked.
"Strategic funding acts like venture capital in that it is usually an equity sale (not a loan), though sometimes it can be royalty-based, where the partner gets a piece of every product sale," she added.
Partner financing is a good alternative because the company you partner with is usually going to be a large company, and may even be a company in a similar industry, or an industry with an interest in your business.
"The larger company typically has relevant customers, salespeople and marketing programming that you can tap right into, assuming your product or service is a compatible fit with what they already offer, which would surely be the case or there would be no incentive for them to invest in you," Serkes said.
Many think that angel investors and venture capitalists are one and the same, but there is one glaring difference. While venture capitalists are companies (usually large and established) that invest in your businesses by trading equity for capital, an angel investor is an individual investor who is more likely to invest in a startup or early-stage business that may not have demonstrable growth like a VC would want.
"Securing a loan from an angel investor uses the same business proposal model, but usually has to have a greater element of human interest," said Nate Masterson, marketing manager for Maple Holistics. "The angel investor is someone with a lot of capital who is interested in an equity stake in your company. You are leveraging your idea on their capital."
Finding an angel investor can also be good in a similar way that gaining funding from a venture capitalist can be good, albeit on a more personal level.
"Not only will they provide the funds, they will usually guide you and assist you along the way," said Wilbert Wynnberg, an entrepreneur and speaker based in Singapore. "Remember, there is no point in borrowing money just to lose it later. These experienced businesspeople can save you tons of money in the long run."
With factoring, a service provider will front you the money on invoices that have been billed out, which you then pay back once the customer has settled the bill. This way, the business can keep going while waiting for customers to pay their outstanding invoices.
Eyal Shinar, CEO of small business cash flow management company Fundbox, said these advances allow companies to close the pay gap between billed work and payments to suppliers and contractors.
"By closing the pay gap, companies can accept new projects more quickly," Shinar said. "Our goal is to help business owners grow their businesses and hire new workers by ensuring steady cash flow." [Check out our guide to choosing a factoring service.]
Crowdfunding on sites such as Kickstarter and Indiegogo can give a boost to financing a small business. These sites allow businesses to pool small investments from several investors instead of seeking out a single investment source.
Read the fine print of different crowdfunding sites before making your choice. Some sites have payment-processing fees or require businesses to raise their full financial goal to keep any of the money raised.
Businesses focused on science or research may receive grants from the government. The SBA offers grants through the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs. Recipients of these grants are required to meet federal research and development goals and have a high potential for commercialization. [Learn more about applying for a small business grant in our guide.]
Benefits of alternative lending
Serkes said startups can enjoy a few key benefits in securing funding from a nontraditional source. She told Business News Daily that with alternative loans, a business owner gets a strong, invested partner who can help introduce you to new client, analysts, media, etc. These are some other benefits:
- Market credibility. The startup gets to "borrow" some of the goodwill that the strategic partner has built up.
- Infrastructure help. The larger partner likely has a marketing team, IT, finance, HR – all things a startup could "borrow" or utilize at a favorable rate.
- Overall business guidance. It's likely the strategic partner will join your board as part of the investment. Remember that they have been guiding a much larger and proven successful business in your industry, so their advice and viewpoint will be helpful and invaluable.
- Relatively hands-off. A strategic partner especially still has their own business to run, so they are unlikely to be very involved in the day-to-day running of the startup. Occasional updates, such as monthly or quarterly, are sufficient.
If you're looking for an alternative lender to help you finance your business, check out Business News Daily's best picks.
Additional reporting by Carlyann Edwards and Adam C. Uzialko. Some source interviews were conducted for a previous version of this article.