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Unconventional Funding Paths for Entrepreneurs

General Business News

December 2012

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Unconventional Funding Paths for Entrepreneurs

The traditional path to fund a small business startup is to use personal savings and so-called sweat equity, followed by seed money from personal contacts, bank and Small Business Administration loans, and ultimately angel investors and venture capitalists. But with today’s credit crunch, the traditional path for financing is becoming more and more difficult to follow. Perhaps in response to these difficulties, other funding methods have become increasingly available to entrepreneurs, including microlending, crowdfunding and alternative lending companies. These unconventional financing vehicles do have risks, but some of their impressive success stories indicate that they can be a worthwhile avenue to explore.

Microlenders are organizations that make small loans at higher interest rates than banks to entrepreneurs who are unable to obtain financing from traditional lenders. They tend to take on greater risk, lending to people who lack collateral or have little prior experience. Most microlending takes place in developing nations, but many nonprofit microlending networks have now established themselves in the United States. In addition to financing, many microlenders such as the Accion U.S. Network promote mentoring relationships that help their clients connect with experts in the field and with other like-minded business professionals. Microlenders are especially valuable for minority and women-owned businesses that are unable to obtain traditional financing.

Crowdfunding refers to Internet-based businesses that provide online funding platforms to connect entrepreneurs with potential lenders. The entrepreneur puts his or her idea on the website and sets funding goals and deadlines. Visitors to the website can evaluate the idea and make a contribution if they like it. In exchange for the promotion, the websites keep a percentage of the funds raised. The goal for the entrepreneur is to get small contributions from a large number of individuals. Because banks typically do not provide loans for unproven projects, crowdfunding sites such as Kickstarter have proven to be especially valuable at identifying underserved markets. However, the public nature of the funding platform can end up putting excessive pressure on the entrepreneurs to meet their goals. Although some online forums can be very supportive, anonymous website comments can be vicious. Entrepreneurs also take a risk by sharing their ideas and products with the public before they have taken hold in the market. It is vital that would-be entrepreneurs perform a thorough risk assessment before trying crowdfunding; and if they receive funding, they must carefully manage the expectations of their investors.

Finally, alternative lending companies such as On Deck have proliferated on the Internet in recent years. These organizations offer alternatives to bank loans by looking beyond the owners’ personal credit record to the business’ cash flow and the ability to make timely bill payments. They offer extremely fast decisions on whether to fund the enterprise and equally rapid access to the capital once a loan is approved. Alternative lending companies typically lend relatively small amounts for short time periods, often no more than 18 months, but can have competitive lending rates. Repayment of the loan is usually not a typical monthly payment, however. Some alternative lending companies make daily withdrawals from the business’ bank account or the client sells a portion of future credit card receivables to the lending company to pay back the loan. For this reason, only businesses with strong cash flows are encouraged to explore this lending avenue.

When starting or continuing a business, everything comes down to risk assessment, both for the business itself and for its financing partners. If the typical funding options are not available or are exhausted, there are alternatives. Seasoned professionals are also available to help small business owners assess their risks and weigh the pros and cons of various finding avenues.

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These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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