Small businesses strapped for cash and impeded by a tight credit market are fast turning to alternative lending streams for both start-up and operating capital. Last month we explored debt and equity-based alternative funding options. In this issue we'll start taking a deeper look into the pros and cons of various forms of debt financing.
Credit cards
Pros: Personal and business credit cards are relatively easy to obtain. The main benefit here is fast and easy access to cash and credit. This remains one of the most widely-used forms of alternative financing for small businesses.
Cons: Don't be caught unaware: Credit card agreements often stipulate massive jumps in interest rates for late or missed payments and hefty cash withdrawal and balance transfer fees. Credit cards also have lower borrowing limits than traditional bank loans, so if you're using a credit card for a quick infusion of cash that doesn't fully meet your financial needs, you could just be working yourself deeper into debt. The final caveat: Credit card misuse can impact both your business and personal credit rating.
Friends and family
Pros: A bank will want to see credit scores and hard-core facts and figures before making a loan. Friends and family are more likely to negotiate favorable interest rates and terms, and less likely to charge fees or hike your interest rate if you're late on a payment.
Cons: Traditional lending institutions force you to evaluate the financial stability of your business and your long-term operating plans. While it may seem easier to forego these steps with friends and family, in doing so, you are far more likely to encounter unforeseen circumstances down the road, jeopardizing your funding, your business and your personal relationships. To avoid these negatives, create a formal business plan, ask a neutral third-party draw up the specific details of the loan agreement and consider hiring a management agency to handle invoicing, payment, late fees, and if necessary, collections.
Home equity borrowing
Pros: Falling home values are scaring many small business people away from this once-popular borrowing option. If you just bought a home with zero down, this is not the financing option for you. However, if you own your home outright or hold a tremendous amount of equity, it may be a smart move.
Cons: Understand that if you are unable to repay your loan, you put your business and your home in jeopardy. Due diligence is the key: Analyze the value of your property and the probability of that value increasing or decreasing over time; educate yourself on the differences between home equity loans and home equity lines of credit. Loans are lump sums that can have stipulations on what they're used for; lines of credit can be accessed as needed, though they can also be reduced, revoked or frozen due to market conditions, the stability of your financial institution, and assessed property values.
Next month we'll continue with in-depth explanations of debt-financing options.
Dave Archer is the chief executive officer of Nevada's Center for Entrepreneurship and Technology. Contact him through www.ncet.org. The information presented in this article is for informational purposes only and should not take the place of professional financial consultation.
