As bank loans become harder to come by, more and more small businesses are looking elsewhere. With Kabbage having just raised $50m and Prosper having raised $70m, we thought it would be a good time to take a look at the alternatives.
Banks have become a pretty hostile place for small business since the recession. They have tightened lending standards for cash flow, credit scores and collateral. We’ve reached a point where just 24% of small businesses believe that it will be easy for them to secure a loan, compared to a massive 58% back in 2007, according to the Wells Fargo/Gallup Small Business Index survey. The thing is, they’re right – and that’s a problem.
There’s a lot of talk nowadays of ‘bootstrapped’ approaches to small business, and ‘doing more with less’. At Counter Culture we’re big believers in being smart about marshaling limited resources (that’s why our CEO wrote Lean Retail 101 – a guide to incorporating this kind of thinking into your brick and mortar). However, the truth is even the smartest, leanest operator will require a capital injection at some point in the life of their business. Whether you need an initial pot just to get your idea off the ground, or you require bridging funds to take things to the next level, a cash injection is something most SMBs will need at one point or another.
The good news is that there are alternatives to the traditional bank loan. We’ve listed some below.
1. Equity Financing
Probably the most common alternative to a standard bank loan, especially at the start of your business, is equity financing from an angel investor or potential business partner. Here’s an excerpt from Small Business 101 that goes into the key differences between debt and equity financing:
Debt vs. Equity Financing
Debt vs. Equity Financing
There are essentially two types of financing available to a small business owner: Equity or Debt.
Equity financing is money raised in exchange for a share of ownership in your business. The core benefit of this type of funding is the lack of debt. You won’t have to worry about those pesky monthly repayments. The downsides? You are giving up total ownership of your business, you are giving up the rights to part of the ongoing profits of the business, and you are potentially giving up some control of how your business is run.
Debt financing involves borrowing capital that must then be paid back over a set period of time, most commonly with interest. The key benefit of this arrangement is that you, the business owner, typically maintain complete control over your business. Your only ongoing obligation is to repay the loan with interest. The downside? If you fail to keep up with those repayments, the loan (often secured against your assets, savings, property, etc.) can put you in very dangerous financial waters.
Excerpt from Small Business 101: Financing and Accounting
2. Credit And Charge Cards
It’s not uncommon for small business owners to rely on credit cards to get their business off the ground. And as long as you are keeping within your limit and paying off the balance in 30 days, this kind of credit can be useful in your ongoing operations too.
New small business owners are prone to leaving themselves exposed to cash shortfalls that don’t reflect the actual underlying receivables coming in. In this case, having easy access to a convenient credit line can be hugely beneficial.
Most credit card companies will issue small business owners with checks that can be used as cash equivalents, making it possible to cover payroll or supplier payables in a pinch.
3. Credit From Suppliers
In a sense, every time you order from your supplier and agree to pay at the end of the month, you are taking out a small line of credit with your supplier. There are multiple ways that this line of credit can be extended, including negotiating for a longer payment schedule, say 60/90 days instead of the traditional 30.
Remember: suppliers want to see your business grow too, as it will lead to you buying more from them in the long run. As you establish a trusted relationship with your main suppliers, it is worth exploring how you can extend a credit line to help free up your capital for things like marketing and growth.
4. Peer-to-Peer Lending
Another avenue to explore is peer-to-peer lending options like Prosper or Lending Club. These companies allow individuals and small businesses to list loan requests between $2,000 and $35,000, which are then offered out to the general public. The general public are then able to become ‘Investors’, often investing as little as $25 in each loan listing they select.
There is nothing to suggest that it will be easier overall to secure a favorable loan if your credit rating isn’t on point. However, lenders are also able to take into account other criteria, such as borrowers’ personal loan descriptions, endorsements from friends, and community affiliations, so it may be worth exploring even if you’re local bank says no!
For those with a less established credit rating, Prosper’s rates go all the way up to 35% APR but that kind of onerous repayment can leave even a successful business swimming in dangerous waters, so you’ll want to strongly consider other options.
5. Online Lenders
OnDeck specializes in delivering loans to small businesses, so the customer care is well versed in dealing with brick and mortars across the country. Their central point of differentiation is that they utilize their own proprietary algorithm to help them understand the health of your business, rather than rely on a simple credit check. So if you’re looking for someone to take a look at your business holistically, this may be a good bet.
Kabbage differentiates by providing a credit line that you can draw down against specific costs, rather than an outright loan. So if you’re thinking of investing in inventory, equipment, or expanding your staffing roster, this is potentially a good option. The great thing about this kind of loan is the Return On Investment (ROI) can be clearly calculated as you assess the benefit of each purchase.
Where NOT to go for a loan
The last resort for some small business owners is the so-called ‘payday’ loan. With annual APRs in the neighborhood of 365%, these loans are potentially crippling and to be avoided if at all possible.
The important thing with all financing is to know two things:
1) Why you are raising the funds
2) Know exactly how and when you intend to make your repayments
If your goals are concrete, ultra-short term and there is no viable alternative, these loans can serve a purpose but for the vast majority, they represent a false economy at best.
Good luck and if you’re looking for more information about small business financing, make sure to check out our Small Business 101: Finance and Accounting Section.