Capital is the lifeblood of all businesses. Entrepreneurs and small business owners depend on it to start, operate, and grow their firms. Yet, there is an $87 billion gap in financing for small businesses, according to Next Street. The firm advises cities, foundations, large institutions, lenders, and nonprofits that serve small businesses on how to do it better. “We consistently see that the greatest gap is for working capital between $25,000 and $250,000,” said Marina Linhart, CEO at Next Street.
Undercapitalized companies have lower sales and profits, generate fewer jobs, and are more likely to fail. Debt is by far the dominant form of outside funding. Evidence finds that women entrepreneurs are dissuaded from applying for credit, ask for less financing than men do, are approved less often, and pay more for credit.
Loans to small businesses were already in decline before the great recession. Still, the financial crisis accelerated the process and slowed small businesses’ recovery. Seeing a market opportunity, an array of alternative financing startups are using technology to make more financing options — not just debt — available to entrepreneurs and small business owners.
“This is a rapidly changing market,” said Linhart. You need to understand all your financing options so you can use the right financing option in the right amount at the right cost. Yet, “small business owners don’t know where to find them. And, because they [financing products] don’t market themselves in the same way, they are hard to understand and compare.” Here are the basics.
Online lenders provide simplicity and convenience in applying for a loan, a speedy decision process, and a greater focus on customer service. They go beyond looking at traditional measures such as credit score, character, capital, capacity, collateral, and conditions. They look at the transaction history in the business bank account, credit card swipe and shipment activity, payment invoice fulfillment on tech platforms (e.g., Venmo and PayPal), volume of invoices in accounting software programs, etc. Based on positive cash flow, these companies can lend to borrowers with low personal credit scores with no collateral.
Some companies, such CAN Capital, Kabbage, and OnDeck, lend from their balance sheets. They offer products such as loans, lines of credit, and merchant cash advances. A merchant cash advance provides funds in exchange for a percentage of the businesses’ daily credit card income. Other companies are peer-to-peer lenders. They don’t make loans directly. Instead, they facilitate a loan between the borrower and an individual or an institutional investor, such as a hedge fund or investment bank. Intermediaries include Funding Circle, Lending Club, and StreetShares. Still, other companies are retail / payment processors, including Amazon Lending, PayPal Working Capital, and Square.
Invoice and payable financing help businesses with late-paying customers. These include C2FO, BlueVine, and Fundbox. Another model is American Express’*, which pays the vendors of small businesses, delaying payment for up to 90 days.
While these new options can be more expensive than traditional bank loans (because online lenders charge more to cover the risk they take), ultimately they make more money available to more businesses — not just filling a void left by banks, but increasing the likelihood that a small business will qualify for a loan.
Financing Marketplaces enable small businesses to shop for a loan. They include Fundera, Intuit QuickBooks, and Lendio. If you’re not sure if you want to go with a traditional or online loan, these companies help you compare financing options.
Women-owned businesses are nearly as likely as their male counterparts to seek financing but are more likely to seek capital from online lenders, according to the Small Business Credit Survey: 2019 Report on Employer Firms. Here’s how a woman could weigh her financing options. Perhaps her business is under 3 years old, making a bank loan highly unlikely. However, a loan from a Community Development Financial Institutions (CDFIs) may be a more affordable alternative. However, even if it is a more expensive option, if a speedy decision process, a more straightforward application, and the convenience of applying from your computer are more relevant to you, an online lender may be the better option.
Revenue-based financing or royalty-based financing (RBF) is a type of funding that works for established growth businesses in an array of industries, including technology companies, tech-enabled companies, healthcare, business services, and consumer products. Companies need to have a proven revenue model from which they can accurately project sales and are typically raising more than $100,000. They pledge a percentage of future revenues in exchange for money invested. A portion of revenues is paid to investors at a pre-established rate until a certain multiple of the original investment has been repaid. The typical repayment period is four to five years. It is more expensive than a loan but less expensive than equity. Examples of companies that provide this type of financing are Decathlon Capital Partners, GSD Capital, and Lighter Capital.
Rewards-based crowdfunding, using platforms such as iFundWomen, Indiegogo, and Kickstarter. It’s advantages include:
Crowdfunding’s disadvantages include the time, effort, and money campaigns take, and, of course, you may not be successful.
Regulation Crowdfunding enables small businesses to raise up to $1 million every 12 months from Americans, regardless of their wealth. Before May 16, 2016, such investments were limited to wealthy “angel” investors, with a few exceptions. Offerings must be conducted via an SEC-sanctioned intermediary such as Republic, StartEngine, and Wefunder. Platforms founded by women include Crowdfund MainStreet and EnrichHER. Some platforms specialize in equity offerings, others debt, and still others do both. Disadvantages include that this type of funding takes time, effort, and money for legal fees and, perhaps, some marketing.
Access to affordable capital is essential for small businesses to start, operate and expand. Which financing options will you consider?
*American Express is a client of the author of this article.
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