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Start Your Business Startup Funding

Small Business Financing Options Without a Traditional Bank

image for fizkes / Getty Images
fizkes / Getty Images
  • Venture capitalists are startup company experts. They can provide massive funding, networking and professional guidance to launch your business rapidly.
  • Generally, angel investors don't ask for any company shares or claim to be stakeholders of your business.
  • The SBA loan guarantee program serves as credit insurance and will cover up to 90% of any losses the bank incurs.

Starting your own company can be a daunting but rewarding process. While a great business plan is crucial for founders, financing is one of the most important elements a small business needs to succeed.

If your small business needs capital but doesn't qualify for a traditional bank loan, there are several alternative financing methods and lenders that may meet your needs. Here are some of the top financing options for small businesses.

There are thousands of nonprofit community development finance institutions (CDFIs) across the country, all providing capital to small business and microbusiness 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."
 

Editor's note: Looking for information on business loans? Fill in the questionnaire below, and you will be contacted by alternative lenders ready to discuss your financing needs.

 

Lenders like 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," that business will almost always end up in the "no" pile. CDFI lenders look at credit scores 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.]

For instance, personal or family medical issues and job losses can all negatively impact a lendee's accounting, but those can all be explained. Also, CDFI lenders do not need nearly as much collateral as a traditional bank would. Other things can compensate for a lack of assets to be used as collateral.

Venture capitalists (VCs) are an outside group that takes part ownership of the company in exchange for capital. The percentages of ownership to capital are negotiable and 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 a demonstrated high growth potential and a competitive edge of some kind, like a patent or captive customer."

The benefits of a VC are not all financial. The relationship you establish with a VC can provide an abundance of knowledge, industry connections and a clear direction for your business.

"A lot of entrepreneurs lack the skills needed to grow a business, and even though they can make money through sales, understanding how to grow a company will always be a lost cause in the beginning," said Chris Holder, author of Tips to Success and CEO and founder of the $100 Million Run Group. "The guidance from an experienced investor group is the best thing, as the mentorship is key for everyone."

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 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 business and may even be 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 VCs are companies (usually large and established) that invest in your business by trading equity for capital, an angel investor is an individual who is more likely to invest in a startup or early-stage business that may not have the demonstrable growth a VC would want.

Finding an angel investor can also be good in a similar way to gaining funding from a VC, 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 fronts you the money on invoices that have been billed out, which you repay once the customer settles the bill. This way, your business has the cash flow it needs to keep running while you wait 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 platforms such as Kickstarter and Indiegogo can give a financial boost to small businesses. These platforms allow businesses to pool small investments from several investors instead of seeking out a single investment source.

"As an entrepreneur, you don't want to spend your investment options and increase the risk of investing in your business at such an early age," said Igor Mitic, co-founder of Fortunly. "By using crowdfunding, you can raise the necessary seed funds to get your startup through the development phase and ready to be pitched to investors."

It is important to read the fine print of different equity crowdfunding platforms before choosing one to use. Some platforms 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 U.S. Small Business Administration (SBA) offers grants through the Small Business Innovation Research and Small Business Technology Transfer programs.

Recipients of these grants must meet federal research and development goals and have high potential for commercialization. [Read related article: How to Secure a Business Grant]

Peer-to-peer (P2P) lending is an option for raising capital that uses websites to connect borrowers with lenders. Lending Club and Prosper are two of the most notable P2P lending platforms in the U.S.

"In its simplest form, a borrower creates an account on a peer-to-peer website that keeps records, transfers funds and connects borrowers to lenders," said Kevin Heaton, CEO and founder of i3. "It's Match.com for money. A key difference is in borrower risk assessment."

According to the SBA, recent data suggests that P2P lending can be a financing alternative for small businesses, especially given the post-recession credit market. One drawback of this solution is that P2P lending is only available to investors in certain states.

This form of lending, made possible by the internet, is a hybrid of crowdfunding and marketplace lending. When platform lending first hit the market, it allowed people with little working capital to give loans to other people – peers. Years later, major corporations and banks began crowding out true P2P lenders with their increased activity. In countries with better-developed financial industries, the term "marketplace lending" is more commonly used.

Convertible debt is when a business borrows money from an investor or investor group and the collective agreement is to convert the debt to equity in the future.

"Convertible debt can be a great way to finance both a startup and a small business, but you have to be comfortable with ceding some control of the business to an investor," said Brian Cairns, CEO of ProStrategix Consulting. "These investors are guaranteed some set rate of return per year until a set date or an action occurs that triggers an option to convert."

Cairns believes another benefit of convertible debt is that it doesn't place a strain on cash flow while interest payments are accrued during the term of the bond. A drawback of this type of financing is that you relinquish some ownership or control of your business.

A merchant cash advance is the opposite of a small business loan in terms of affordability and structure. While this is a quick way to obtain capital, cash advances should be a last resort because of their high expense.

"A merchant cash advance is where a financial provider extends a lump-sum amount of financing and then buys the rights to a portion of your credit and debit card sales," said Priyanka Prakash, lending and credit expert at Fundera. "Every time the merchant processes a credit or debit card sale, the provider takes a small cut of the sale until the advance is paid back."

Prakash says that, while this appears to be convenient, cash advances can be very expensive and troublesome to your company's cash flow. If you can't qualify for a small business loan or any of the options above, only then should you consider this option.

Startups can enjoy a few key benefits in securing funding from a nontraditional source, according to Serkes. She believes that with alternative loans, a business owner gets a strong, invested partner who can introduce them to new clients, analysts, media and other contacts. These are some other benefits of working with a nontraditional lender:

  • 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 teams for marketing, IT, finance and 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 more successful business in your industry, so their advice and viewpoint will be invaluable.
  • Relatively hands-off partnership: A strategic partner 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 on your business, such as monthly or quarterly, are usually sufficient check-ins for them.

All businesses need working capital to thrive. Without the appropriate funding, startup companies are likely to fail early. Avoiding the traditional bank loan route might seem like an impossible feat, but there is a plethora of small business financing options readily available for entrepreneurs. Gathering the right market data research and implementing the best financing option for your company increases the chances of your business surviving for the long haul.

Additional reporting by Jennifer Post. Carlyann Edwards and Adam C. Uzialko also contributed to this article. Some source interviews were conducted for a previous version of this article.

 

Joshua Stowers

Joshua is a staff writer based in New York City. He is a former entrepreneur who started a fashion and art, print and digital publication called Elusive Magazine, serving as the features editor for several issues. Previously, he worked in product development for DirecTV and for a content agency writing for Verizon and Google. He is a New Jersey native in love with the city lights and skyscrapers.