8 Types of Alternative Financing | Tory Burch Foundation

Need money to start a new business? Your first thought may be to borrow from a bank, but that isn’t the place for every entrepreneur to start. In a recent webinar, Geri Stengel of Ventureneer and Virginia Almendarez of crowdfunding platform iFund Women helped our community understand the wide array of options available to entrepreneurs and their dreams.

First, a note about why banks may not be your best bet: banks prefer to lend to businesses that are at least two to three years old and have the cash flow to ensure monthly payments, or significant collateral. If your business is in the very beginning stages, it’s likely to be overlooked. However, if you do apply for a small business loan and a bank turns down your loan application, be sure to find out why. Understanding the reason will help you understand what your next step will be.

Before choosing which kind or kinds of alternative financing to go after, it’s important to consider the following:

• The stage of your business
• The size of the market your business will serve
• How fast you plan to grow
• What you need the funds for
• Your business’ profitability

Stengel urged our webinar attendees to begin their research and assessment before they’re in desperate need of money, especially because certain sources of capital will take longer to get to your business than others. Entrepreneurs should also think about creative ways to combine different kinds of capital.

DEBT CAPITAL

Money borrowed to support a business is referred to as debt capital. Types of debt capital include loans from community development financial institutions (CDFIs) and small business-focused microlenders. Debt capital is tax deductible and allows you to retain control of your business.

Community Development Financial Institutions (CDFIs)

CDFIs, also called community lenders, are a great option for young businesses because they specialize in underserved communities like women, people of color and entrepreneurs in low-income and rural areas. Despite typically having interest rates that are higher than banks’, many community lenders are equipped to really help a new business owner with the technical aspects of running their business, understanding their financials and giving advice. “They really were created to serve the people they fund,” explained Stengel. Find your nearest CDFI with this map.

Family and friends

Many small business owners turn to friends and family when starting out. While it’s always great to get support from your immediate community, mixing personal and business relationships can be tricky. Be sure that relationship is solid before making your business a family business. “Don’t even ask them if you don’t think you can face them at Thanksgiving dinner,” Stengel cautioned.

If you do decide to borrow money from a friend or family member, make things official. Talk to an accountant or lawyer about drawing up an agreement so both parties are clear on repayment terms and other details. Also, be careful not to give up too much equity in your business at first, as that may make it harder to attract larger investors later on.

Microlenders

If you determine your business needs a small amount (under $50,000), then microlenders are a good place to start. Stengel suggests Kiva, a nonprofit microlender that she describes as “crowdfunding lite”. Business owners can apply for loans and, once Kiva approves and disburses the loan, your community can fund the loan in increments of $25. Other great microlenders include the U.S. Small Business Association and Accion USA.

Small business loans from big guys you know

Square, American Express, PayPal, Quickbooks and several other major companies you’re probably already using have added small business loans to their products. Because they make their decisions based on data they already have about your sales and other financials, they’re a great option for newer businesses or ones that haven’t built strong business credit. This emerging class of lenders is especially great for businesses that don’t need a lot of cash (Square Capital reported that their average loan size is $6,000). These vendors typically offer interest rates that are comparable to ones at a bank, have short applications and money reaches your business quickly. Investigate these services if your business needs working capital.

DEBT-FREE CAPITAL

Debt-free capital is money given to a business with no repayment terms. However, the person or entity providing the capital usually asks for equity, meaning business owners who hope to maintain full control for the long term (as in, building a business to pass down to the next  generation) should look into other means of financing.

Venture Capital and Angel Investors

Venture capital funding supplies capital to a company in its early stages in exchange for equity. Angel investors are venture capitalists who come into the picture when a business is still a startup. Angel investors are exceedingly rare. These kinds of investors are looking for what they think will be a billion-dollar business serving a huge range of customers.

The large amounts that usually accompany these investments are shouted from the headlines, making them a seductive option for entrepreneurs. However, as Almendarez noted, only 2.3% of available venture capital funding went to women-owned businesses in 2020, down from 2.8% in 2019. Not only do these investors tend to overlook small businesses from members of marginalized groups, they can also take a lot of control away from entrepreneurs. If you decide to pursue venture capital funding, be sure you have a clear idea of how you’ll use the funds, your scalability and where you want your business to go. That’s why venture capital funding may not be the best source of funding for small business owners who want to maintain control of their company or don’t plan to sell it within the next five years.

Grants

Many business owners consider grants “free money”, and that’s not a bad way to think of them. The capital that grants award to businesses don’t have to be repaid. There are many grants available for businesses owned by members of marginalized groups. Stengel recommends women-owned STEM startups especially apply for grants. There are many grants that run competitions to award recipients. However, grants typically have two major drawbacks: they often require a long application process and the funds take a long time to be disbursed.

Rewards-based Crowdfunding

You’ve seen crowdfunding campaigns all over social media–that’s because they can really work. Rewards-based crowdfunding campaigns offer supporters tiered prizes in exchange for donations that can be as small as $5. Remember, the rewards for your supporters can be as small (and cost-efficient) as an Instagram thank you. This approach to capital is great for small businesses in their early stages, maybe even before a product is ready for market.

To get the most out of crowdfunding, hone your pitch and carefully research a platform before launching your campaign.

Factoring or Invoice Financing

Factoring, also called invoice financing, allows businesses to borrow money against their order receipts. Factors purchase those invoices at a discount and are then responsible for collecting payment from the business’ clients. Because factors don’t look at credit to determine who they’ll work with, they’re often an easier solution for small businesses. Invoice financing is a great option for service-based businesses or B2B businesses. However, you may face high fees, especially if customers are late to pay.

Sign up for more small business resources, straight to your inbox.