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Alternative Small Business Financing 101

Written by: Gary Barzel

Article Overview: When it comes to small business finance, the spotlight usually shines on the high profile world of venture capitalists and angel investors. Even the more traditional financing methods, such as small business bank loans, will get attention whenever the economic winds begin to shift. But what you may not realize is that there are plenty of alternative forms of financing available to small businesses.

Alternative Small Business Financing 101

When it comes to small business finance, the spotlight usually shines on the high profile world of venture capitalists and angel investors. Even the more traditional financing methods, such as small business bank loans, will get attention whenever the economic winds begin to shift.

But what you may not realize is that there are plenty of alternative forms of financing available to small businesses. Many are viable options for those small businesses that are unable to get funding through traditional means because they lack the required collateral, good credit and business history.

If you own a small business, and you are seeking additional capital, then you should consider alternative financing. You should keep in mind, however, that while some options provide excellent opportunities for business owners to get the capital they need, other methods are more risky and should be used with caution.

First, here are some popular alternative financing methods that should be used with caution:

-Credit cards. With high interest rates, debts can spiral out of control, leaving you with a bad credit history that can hinder your chances of getting traditional financing in the future.

-Bad credit business loans. There are many companies that will offer you a loan against your bad credit, but be aware that these loans carry very high interest rates (usually in the range of 20%). With these loans you are also more likely to encounter predatory lending, so make sure you are clear with the terms of the loan before you sign any documentation.

-Home equity lines of credit. A home equity line of credit is a form of revolving credit in which your home serves as collateral. The inherent risk associated with this line of credit is obvious

-Cash in the value of your life insurance policy. Your insurance policy can also be used as collateral to secure a loan. But here again you bear the risk of losing your policy should your business plans fall through.

-Ask family/ friends. This may be a viable option for you. But keep in mind that money can put a real strain on relationships. It is generally best to make the transaction as formal and professional as you can, complete with documentation.

So now let's consider some more attractive methods:

-P2P Lending. Peer-to-peer lending sites, such as Virgin Money, Prosper.com, and Zopa.com, create a online marketplace for borrowers and lenders to find each other while avoiding banks or credit cards. Even among friends and family, everything on these sites is carried out formally and professionally. These sites also provide identification and verification services as well as an assessment of the credit risks. Clear, precise documentation covers the loan’s terms and conditions as well as the repayment schedule and tax payments as determined by both parties.

-Equipment leasing. This is an attractive option for small business owners who do not have enough capital to pay for the expenses of operating and expanding their company. By leasing their equipment, instead of purchasing it, businesses can free up their working capital and thereby take advantage of opportunities to expand or improve operations.

-Taking on a partner. You can alternatively acquire funds by having someone invest in your company and become a partner. The investor can be either an active parter or a "silent" one who is not involved in the business' daily operations.

-Seller financing. If you are looking to start or buy a new business, then seller financing is something to look into. Sellers of small businesses generally allow the buyer to pay some of the purchase price of the business in the form of a promissory note. Sellers will usually finance between one and two thirds of the sale price that can be paid back with interest over several years.

-Invoice factoring. If you are looking for a way to free up capital that is tied to customer invoices, then invoice factoring is a viable option. In this case, a business sells its accounts receivable at a discount to another company. This company then provides instant payment.

-Merchant or Business Cash Advance. This type of small business finance comes in the form of a cash advance base on future credit card sales. Since funding is based on future transactions, credit and sales history generally do not effect your chances for approval. Moreover, since payments are based on sales volume, this means when sales are slow, then the required payment for that period is accordingly reduced.

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