A Quick Guide to the Confusing World of Alternative Business Finance

After the credit crunch and subsequent housing meltdown in 2008, the banking industry made a much publicized move to reign in small business lending. What had once been a moderate flow of small business finance to the nation’s smallest companies, then almost completely dried up. In it’s wake, various alternative lenders and other loan arrangements have all been clamoring for a slice of the business financing pie.

Though today, bank loans to small businesses seem to be making a come back, the truth is traditional financial institutions are still refusing to service countless small business owners- especially newer companies, companies with poor or little credit history, or those that operate in industries considered to be high-risk, such as food services or retail.

Thus, it’s no surprise that alternative lending among small businesses continues to surge. But even as alternative lending gets airtime the definition of just who qualifies as an “alternative lender” can get murky. The reasons: any non-bank lender technically qualifies for that description, and the alternative financing industry keeps expanding. Small business owners now can choose from a whole crop of new (yet similar-sounding) financing products that have only emerged in recent years.

So how can you as a small business owner looking for non-bank financing make sense of it all? The following are 10 explanations of the most popular forms of alternative financing available to small business owners:

Non-Bank Financial Institutions:

1. Credit Unions
Though they may look like banks from the outside, credit unions are non-profit cooperatives owned by their members. In order to maintain their non-profit status, credit unions have to restrict membership to a particular group of people, such as those attending or working at an educational institution, or residents of a particular community. The tax advantage associated with being a non-profit typically allows credit unions to offer lower interest rates on loans, and higher rates on savings accounts and other savings products.

Lately credit unions have been more aggressive in soliciting new accounts. The National Association of Federal Credit Unions (NAFCU) provides a list of its members online.

2. Community Development Financial Institutions (CDFI)

CDFIs are financial institutions that offer credit and financial services to economically disadvantaged and under-served communities within the US. These institutions may take on many forms including: a community development bank, a community development credit union, a community development loan fund, a community development venture capital fund, a micro-enterprise development loan fund, or a community development corporation. CDFIs are certified by the Community Development Financial Institutions Fund (CDFI Fund) at the U.S. Department of the Treasury, which provides funds to CDFIs through a variety of programs, yet they themselves are not government entities. The CDFIs were established by the Reigle Community Development and Regulatory Improvement Act of 1994.

To locate a CDFI near you, you can use this CDFI locator.

3. Micro Lenders

Microloans are short-term loans of small amounts, typically no more than $25,000 spread out over 5 years. There is a network of commercial microlenders and non-profits that offer these loans to small business owners. If you are a minority, have a low-income, or are seeking to start a business in an economically challenged area then your chances for being accepted for funding increase dramatically.

There are several umbrella organizations that deal with micro lenders and micro loans. The most popular are the SBA Microloan Program in the US, Accion USA, and Kiva.

Asset-Based Financing:

4. Accounts Receivable (AR) Lenders

Accounts Receivable (AR) financiers (also known as “factors”) purchase a company’s accounts receivable at a discount and in return provide the company with fast working capital. The financing comes in the form of a cash advance, often at 70-85% of the purchase price of the accounts. Interest rates generally are higher with factoring since the lender is assuming a higher level of risk. Many times, small business owners who have little or no credit history or who need a lot of money quickly will turn to AR financiers.

5. Business Cash Advance Companies

A business cash advance is a form of receivables financing typically based on future credit card sales. In this setup, the cash advance provider purchases some of the transactions from the business at a discount, which generally ranges between 20%-30% of the amount funded. In exchange, the business receives a predetermined amount of instant cash usually used as working capital. The cash advance company then collects a set daily percentage of future credit card sales until the full loan is paid off.

Cash advance companies usually require that a company be in operation between 3 and 6 months, and some financing companies may also require a minimum sales volume.

6. Revenue Based Financing

Similar to business cash advances above, revenue-based financing allows borrowers to pay off their loans based on a monthly allocation of the revenue their business generates. Though, unlike the cash advance, a business’ whole revenue stream is considered. While interest rates are again on the higher side, this financing setup allows business owners to maintain ownership of their companies while not being forced to borrow against their homes and possessions.

7. Purchase Order Financing

Also called inventory financing or PO funding, purchase order financing is a short-term commercial finance option that provides capital to pay suppliers upfront for products or inventory so the borrowing company doesn’t have to deplete its available working capital. The products or inventory then serve as collateral for the loan if the business does not sell its products or otherwise cannot repay the obligation. Inventory financing is especially useful for businesses that must pay their suppliers within a short payment cycle or a longer period of time than it takes them to sell off their inventory. It also provides a solution to seasonal fluctuations in cash flow and can help a business support a higher sales volume by, for example, allowing a business to purchase bulk orders of inventory to sell later on.

8. Lease-Back Programs

Also known as a “sale and leaseback,” lease-back programs allow the owner of a property or other valuable asset, such as equipment or vehicles, to “sell” it to a lender and then lease it back during a set period of time. Under this arrangement, the original property owner can quickly free up working capital while retaining possession and use of the property.

Some leaseback arrangements allow the lessee the option to buy back the property at a future date. During the life of the leaseback, however, the buyer derives tax benefits from the arrangement, such as being credited for depreciation of the property.

Peer-Based Alternative Financing Arrangements:

9. Peer-to-Peer Lenders

Peer-to-peer, or P2P lending is a form of financing that occurs directly between individuals or “peers” without the involvement of a traditional financial institution. Loan amounts are typically small, up to $25,000 and have loan terms typically lasting anywhere from 1 to 5 years.

Much of the success of P2P lending is a result of the social networking power and infrastructure of the Internet. P2P lending sites, such as Lending Club and Prosper, offer an online marketplace where borrowers and lenders can come together. Often, there will be several private lenders per borrower who each share in partially funding a a given loan amount.

These sites typically provide identification and verification services as well as an assessment of the borrowers’ creditworthiness and the risk involved in lending to them. Clear, precise documentation covers the loan’s terms and conditions as well as the repayment schedule and tax payments as determined by both parties.

10. Crowd Funding

With crowd funding, business owners and entrepreneurs can raise the funds they need by requesting a small amount of money from a large number of people online. By tapping into the power of the internet, entrepreneurs can pitch their ideas to a large group of people, who, if interested will respond by donating a small portion of the money they need to help them reach their target.

Unlike more traditional forms of business capital, the money raised through crowd funding is not directly repaid. Recipients may instead offer their investors some specified item or service in return for their financial support, such as a free sample of their product. In some, crowd funding models, such as the one supported by Sellaband, investors also get a cut of the recipients’ future sales revenues.

So there you have. Any one of these ten alternative financing models can help you access the money you need to start, run, or grow your business. But not every model is suitable for everyone. So be sure to do a little research and exercise your due diligence before signing any dotted lines.

Businesses are Seeking Financing Alternatives

The recent economic crisis in the United States left a pall on small businesses all over the country. During the last couple of years, the usual credit lines and business credit cards which kept businesses afloat have seriously diminished



Common sense would seem to dictate that small business owners would be seeking more SBA loans these days but surprisingly, the opposite is true. According to a recent report, no less than 91% of small business owners stated that they have never applied for a SBA loan. When asked why this was the case, 54% stated that they did not need one; 13% said that they would rather use personal assets, 13% explained that they had taken a loan from another source, 11% admitted that they are unfamiliar with the programs, and 6% claimed it takes too much time.

This being the case, where are these small business owners getting the financing needed to keep their business going? The answer is they’re turning to financing alternatives. Here is a breakdown of the most popular options among small business owners today:

  • Taking on a partner – One of the most common ways to increase the asset pool is to allow someone to invest in your company by becoming part owner. The investor brings in much needed cash but also acquires an interest in your business. Partners can be either active or “silent,” but they definitely have a say in the operations. Partnership agreements should always be put in writing to avoid unpleasant hassles down the road.
  • Personal asset funding – Some business owners choose to fund their business by tapping into non-savings areas of their personal assets, home mortgages, life insurance policies, certificates of deposit, individual retirement accounts or pension plans. It is advisable to be cautious when mixing your personal assets and your company’s development. However, if funding is performed on the basis of a comprehensive plan for both the business and the personal assets, it can provide much-needed cash. It is important to regard this type of funding as a temporary or intermediate-term remedy rather than a permanent solution.
  • Angel investors – By definition, angel investors are individuals who choose to personally invest in a business for a variety of reasons such as the opportunity to use their years of expertise in a given field, access to tax benefits and to shrewd investment opportunities. Angel investors are not as stringent as the average lender but they want to be sure that your company will turn a profit. Before meeting with your angel, research his background, interests, and past investments. Be sure to do your homework – when you meet bring relevant written material such as business plans and projections, and make sure you are able to supply the right answers to tough questions.
  • Family members – They say that blood is thicker than water, so turning to a relative for financing is a reasonable step. On the whole, your relatives will probably demand fewer assurances and will be more susceptible to your ideas than professional investors. One way you can repay them is through profit sharing. Try to keep things professional; Draw up a formal agreement so that you will have the terms of the loan in writing. Make sure to always regard these family members as business associates rather than “mom” and “dad.”
  • Business Cash Advances – Business cash advances are less of a hassle than a bank loan. Most business loans require collateral, good credit and a long business history, which you may not be able to deliver. In many cases the business cash advance does not require you to be fixed to a repayment schedule. If things are slow, the financer often agrees to accept a smaller payment. Such advances often do not require collateral or a personal guarantee. Nor are you required to deliver require financials or tax returns. So in some cases, this may be the way to go.
  • Equipment Lease Funding – Equipment leasing does not infuse your business with cash. However, it does reduce the amount of cash that you need to keep your business afloat. If you are cash starved it might be wise to consider the option of leasing, rather than buying, equipment. By choosing to lease you gain access to many types of equipment from computers and copy machines to fax machines, trucks, and much more. An added plus is that due to the monthly payment structure, you can treat the payments as tax-deductible business expenses.
  • Accounts receivables– Accounts receivables financing enables a business to use its outstanding invoices as collateral for funding. The business can choose to either finance its customer invoices or factor them. If you follow the financing route, the business can apply for a short-term loan against its outstanding invoices at 65% to 85% of the invoice’s face value. In this arrangement, the financing company does not own the invoice nor is it responsible for collecting the outstanding debt. If you opt for accounts receivables factoring, the lender is responsible for collecting the outstanding debt from customers. In this situation, lenders usually provide financing reaching 70% to 90% of the total value of all outstanding invoices. Once the customer pays up, the lender must return the remaining balance, minus a small processing fee.

Bucking the Trend: Who is Thriving in the Credit Crisis?

With concern growing over the health of the global economy, many consumers and businesses alike are doing whatever they can to ride out the impending storm- and that can spell growth and financial opportunity for those who can capitalize on it.

So which sectors should still thrive in the current credit crisis?…

  • Financial consulting and tax planning. As the economic downturn forces businesses and consumers to focus on savings, the need for professional financial consultants and tax planners will only rise.

  • Accounting/performance management software. Any software applications that are designed to increase performance or efficiency, such as accounting suites and CRM packages, should remain in strong demand among businesses seeking to preserve their profit margins and maintain their competitive edge.

  • Outsourcing services. As businesses seek to reduce costs, expect a continued increase in infrastructure management and applications services. This also spells good news for free-agents, telecommuters, and “momprenuers.”

  • Telecommunications. Manufacturers of mobile devices and telecommunications equipment as well as supporting software should continue to perform strong as businesses rely more on telecommunications to reduce the ever rising cost of travel. Reliance on IP data, such as VoIP, is also expected to increase among small and mid-sized businesses due to the tremendous cost savings.

  • Online Marketing. By tapping into web-based marketing, businesses have several relatively cheap alternatives to traditional marketing at their disposal, such as e-mail marketing, blogging, and sending out newsletters, press releases, and articles. In fact, Google recently announced a 26% rise in their third quarter profits that they attribute to the fact that “targeted, measurable ads” are becoming more important to advertisers looking to reach as many possible customers while operating on a tight budget.

  • Entertainment. Video game sales are on the rise as consumers with tight budgets are foregoing travel, trips to the cinema, and dining out in favor of staying in.

  • Alternative financing. In this shaky financial climate it is no surprise that it is getting increasingly difficult for American small businesses to receive traditional bank loans. There has thus been an ever growing trend towards alternative financing ranging from the risky high, interest payday loans to the more mainstream invoice factoring, equipment leasing, and business cash advances.

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Unsecured Lines of Credit – Can You Get One?

One financing option which I have given less attention to in this blog than to other options is the “Unsecured Line of Credit”. This financing method has two things in common with business cash advance: “unsecured” and “financing”. That is where the similarities end.

Unsecured lines of credit are gaining in popularity (among those who qualify) because so many small business owners are finding that despite impeccable credit and excess equity in real estate, real estate just doesn’t cut it any more in today’s economy. In short an unsecured line of credit is supposed to make financing much more accessible to businesses. In reality… it is still pretty tough to get.

Here are some key things to keep in mind if you are looking at this option for financing your business:

  • It takes 4-6 weeks to obtain an unsecured line of credit. That is, if you are approved.
  • You can’t really apply for an unsecured line of credit yourself – generally, you need to hire a specially trained financial consulting firm to do it for you. Yes, it really is that complicated.
  • The minimum acceptable credit score is 680.
  • You generally have to have been in business for at least two years.

I stopped here. I suppose working for FastUpFront makes me a bit biased, but compare the above with the following points on credit card factoring and you’ll understand my disgust. With credit card factoring:

  1. It takes less than 24 hours to be approved.
  2. Application is simple, you can do it yourself and don’t need to pay anyone fees to apply for you.
  3. There is no credit check.
  4. You can have been in business for as little as four months if you have been getting credit card receipts for that time.

I hope you can see why I think credit card factoring is so great. However, there are cases when you may want to consider an unsecured line of credit… like if your business doesn’t take credit cards!