As world financial markets continue to founder, small businesses and entrepreneurs are finding it more difficult than ever to secure credit from traditional lending sources. Being ever-savvy, they're turning to alternative sources.
While traditional credit can still be found particularly for entrepreneurs and sole proprietors with solid credit ratings and for companies with established business bases many business owners are turning to various forms of debt and equity financing. In this issue of Northern Nevada Business Weekly, we'll provide an overview of the wide variety of funding sources available to entrepreneurs and small businesses, and in subsequent issues, we'll delve further into each of these options. We'll then provide specific information on how you can improve your chances of securing non-traditional financing.
Debt Financing Options
Credit cards
Entrepreneuer.com says financing business debt on a credit card is one of the most popular forms of funding for entrepreneurs and for small business owners with five or fewer employees. However, in most instances, even so-called "business credit cards" require the personal guarantee of the individual, which can mean if you're a sole proprietor or partnership you're linking your personal credit rating to that of your business.
Family and friends
Equally as popular as credit card financing is turning to friends and relatives for lending assistance. Beware: Taking money from those closest to you for a business investment can result in long-term emotional and financial implications. What's most important in this type of transaction is that all parties know exactly what they're getting into. Is it a loan or a gift? Is the relative a banker or an investor? What happens if you can't repay the loan? Involving a neutral third party to administer terms of the transaction is a wise first step.
Home equity loans
Although once a popular form of borrowing, today's housing market, paired with an escalating credit crunch, is making home equity borrowing a risky proposition. Home equity loans and lines of credit have been attractive to small business owners in the past because of their low interest rates. Numerous variables need to be taken into consideration, including current housing market values, tax implications and loan terms.
Borrowing against a 401(k)
Borrowing against a 401(k) carries some of the same risks as home equity borrowing that of trying your personal finances to your business finances though it's not a bad idea when done carefully. Most plans allow you to borrow up to $50,000, or 50 percent of your account, whichever is less. The borrowing will be structured as a loan with a regular payment schedule, usually a five-year term. You'll be paying interest, but you'll be paying it to yourself. If you are unable to repay the loan, you'll likely be charged a penalty for what would be considered an early withdrawal.
Peer-to-peer lending
Peer-to-Peer, or P2P lending, is quickly gaining attention for its efforts to match borrowers who don't qualify for traditional financing with investors looking for a better rate of return than offered by many of the usual savings and investment options. Bankrate.com estimates $100 million in P2P lending will take place this year. Still a relatively new phenomenon, many regulatory issues are still being worked out between third-party facilitators, so carefully research the viability of a company before proceeding.
Traditional bank lending still remains an option for highly-qualified small business owners. Additionally, the Small Business Administration offers a number of small business loan programs. SBA's fiscal year 2009 budget request will support a total of $28 billion in small business financing, which represents a 37 percent increase over business lending for fiscal 2007.
"Microloans" are also available through Nevada Microenterprise Initiative (NMI), a private non-profit community development financial institution. NMI loans can be used for start-up and business expansion, including equipment, inventory, supplies and some working capital.
Equity Options
Angel investors
Angel investors are people who invest in high-risk, high-reward businesses and are often interested in sharing their experience and expertise with other entrepreneurs. Angel investors often invest a total of $25,000 to $50,000 each year, and aggregate these individual investments with other members of their angel group to make total investments in a particular company in the range of $150,000 to $1.5 million.
Venture capital
Venture Capital is a type of private equity funding that typically invests in early-stage high-potential, growth companies, and often invests $1.5 million or more. Venture capitalists are investing for the long-term, with investments generally made as cash in exchange for shares in the invested company. Eric Litman, a serial entrepreneur and former head of the incubator WashingtonVC, notes that negative economic conditions trickle down to venture capitalists slowly, leaving them somewhat resistant to macroeconomic trends.
Next month, we'll start examining the pros and cons of the various debt funding options outlined in this column.
Dave Archer is the chief executive officer of Nevada's Center for Entrepreneurship and Technology, a statewide non-profit organization that helps Nevadans start businesses. Contact him through www.ncet.org.
