Alternative Financing

Alternative Financing

Financing a business is difficult. You are trying to FIND financing, in essence, you are trying to FIND money and is there anything more difficult? In this piece we’ll focus on the financing options and methods currently available to start-up businesses. We will focus on the smaller financing needs, ones not necessitating public offerings or large debt offerings.

I. Develop a Financing Strategy Before Asking for Money If you have the funds to start a business, then financing is not an issue, unless you are concerned about losing your money. Financing a business is the probably the toughest part of developing a business, not the most important, but definitely the toughest. It’s where the whole idea is tested. The time when the tires are kicked, the product poked, and when people are judging you as the proprietor as much as they are judging the business plan itself. A solid business idea and strategy is essential for success, but why stop there? Developing a strategy to finance this idea is equally as important. Think of it this way, it’s much more difficult to raise $50,000 to start a business with no record of success. But what if you raised just $5,000 to develop a prototype? Well now you have something to show for your efforts: a successful prototype. Then, when you need additional funds for the next stage, you’ve already developed a track record of success from the first financing. This is financing in stages. Developing or seeking financing for a business in stages allows you a greater pool of potential investors. (Its easier to find a $5,000 backer than a $50,000 one.) Financing in stages also showcases your ability to focus on a task, to tackle a large task by narrowing it down to smaller more manageable ones. It builds momentum and confidence. It will also show potential investors that you have thought this through and have developed the steps to lessen the risk the investor needs to take. The financing of a business is not a one-time task rather an ongoing component of owning a business. Regardless of the type of business, its size or age, financing is always going to be one of the most critical aspects of developing and running a business. So where do you start? Well, if “Dad, can I borrow $50,000 to start my business” is a sentence you can legitimately say, then your problems are less than most. But even if you can say that, the better question to ask is “Dad, can I borrow $15,000 for some R&D and perhaps another $10,000 for test marketing and developing a business plan.” If you can outline your financing needs in such a way, by developing a plan of financing steps or stages, your chances of finding the funds you need will dramatically increase. Think of this strategy as a way to define what your business focus is at this moment. For example, “my business right now is to find a suitable business to open.” Then your business might become “to develop the best way to service X particular need” and so on. For example, William G. McGowan, the founder of MCI identified his business as litigation. Not telecommunications, but litigation. So he didn’t organize and finance a telecommunication company, he financed a litigation company. He narrowed down his needs and determined he first needed to finance the litigation against AT&T to break up the monopoly before he ventured into developing a telecommunication company. Take a page out of this playbook. Try viewing your financing activities as steps toward a goal. Take the time to determine the reason why you need the money at this very moment. This exercise will help you focus your own energies to the task at hand. Not to over simplify the process but building a successful business can be broken down to very identifiable stages. Determine where you are, what stage of development your idea is at, and what next step is needed for you to accomplish your goal. For example, the stages in a developing a business can be summarized into the following:

  1. Research/Development stage: the development of the idea and market to which you will sell. Here you are trying to develop the basic product/service and determine what potential it has for success.

 

  1. Seed Stage: The idea and business plan are in place and funds are needed to develop a prototype or to test market the idea or product. Here you may have your legal, production, marketing, patent types of expenses.

 

  1. Start-up phase: this is generally what is thought of as the start of the business. Funds are usually needed for production, distribution, marketing, staffing, and general operations.

 

  1. Growth Stage: Proven entity. This is the building up of the business. The product/service is accepted within the market. In this phase, the idea is to duplicate what you have already done elsewhere to gain the benefits of size (e.g. economies of scale) either in production, marketing, distribution.


It may help to view the search or availability for funding as its own market. It’s no different than any number of markets that exist today, where resources go to those who want them most. And yes, there is going to be intense competition. But remember, there are always going to be many more bad ideas looking for money than there are good ones, and here is where your stage strategy will pay off. After all, failing to plan is planning to fail. II. Alternative Sources of Financing A. Government SourcesIf traditional bank financing is not available, Federal, State, and Local governments can be an attractive alternative. If the business is located in a business development zone or is a women or minority owned business government financing, particularly the Small Business Administration (SBA) is a great place to start. Small Business Administration Mircoloan Program The SBA Microloan program was created to nurture small business development. Microloans, are loans, generally $35,000 and under with an average loan size of about $13,000. Microloan terms can be negotiated but statistics show interest rates averaging in a range between 8% -13%. The SBA provides the funds which non-profit community lenders then use to make loans to local businesses seeking financing. Loans can be used for working capital, machinery, fixtures, inventory, supplies, just to name a few. For more information on this program you can visit the SBA site or contact Self-Help, a leading lender in the Microloan program. 
Small Business Investment Companies (SBICs)These are privately owned investment firms, which are licensed by the Small Business Administration.  SBICs provide financing to new and recently established small businesses through loans and equity financing. Remember, this is not grant money. SBICs are for-profit investment organizations offering loan/debit securities and equity (ownership) capital to small businesses. The SBICs benefit by the opportunity to participate in the future profits as the business grows. SBICs utilize their own capital and can receive additional funds borrowed from the Federal Government.  For more information on SBICs, visit www.sba.gov


B.  Friends and Family When speaking of financing a small business, you have to start with those who know you the best, family and friends. Because of this, family and friends may also be the least expensive form of financing you’ll find. But remember, you are seeking financing for your business so be sure to keep things professional. Take the time to think through the terms of any agreement and write it down. This is your business and having agreements in writing is well worth the extra effort. Samples of Promissory Notes and Equity agreements can be found in a variety of places including your local library. Find one and adapt it to your particular needs. Remember to include the amount borrowed, the interest rate, payment terms and dates, and a date when the debt is to be fully paid back.  
C.  Business Incubators When thinking of financing your business, saving funds is as important as finding funds. Rather than offering equity or debit financing, Business incubators offer businesses substantial savings for services during the start-up phase. Business Incubators offer below-market rent for office space and offer savings through the sharing of telecommunications, marketing, legal and accounting services with other start-ups.  Some will often have a staff available to review your business or business plan and help locating financing.  
D. Community Economic Development Funds Many states and local communities have established economic development funds. These are funding organizations designed to attract business to the state or particular local areas. Economic Development agencies exist in most communities, not just areas experiencing an economic downturn. These organizations provide loan products to assist small business owners who have difficulty in obtaining traditional financing. In addition to financing, development funds offer ongoing support in a variety of topics from public relations to accounting.  
E. Social Lending or Peer-to-Peer  (P2P) Loans A recent entrant in the lending industry allows participants to avoid traditional bank lending and obtain financing at a reduced rate. These sites allow individuals to exchange cash (i.e. loans) through some forum or facilitator.  Examples of these lenders are Prosper and The Lending Club.  Although business owners can obtain a peer-to-peer loan, the loan is essentially a personal loan with the proceeds being used for a business. Generally, in P2P lending, sites require potential borrowers to have a certain minimum credit score in order to participate. P2P lenders report repayments to the major credit bureaus and also utilize collection agencies in cases of delinquencies. The minimum FICO score required to join vary but are generally set high, in the mid 600 range and above depending on the site used. Once a borrower meets the standards set by the P2P lender, they are able to submit loan requests, which are rated or scored and assigned an interest rate by the facilitator with information obtained by credit bureau statistics. Lenders participate by purchasing notes or a percentage of the loan. In this way, the risk of the loan is distributed among various individual lenders. The facilitator collects and distributes payments received to the individual lenders. The facilitators make money by charging borrowers a processing fee and by charging lenders a percentage of the payments made by the borrower. There are many Peer-to-Peer lending sites so it is worth the time to investigate the terms each offers to a borrower. Below are examples of a few of the better-known P2P lenders:Prosper.comThe Lending ClubKiva.orgMicroPlace.com 
So financing isn’t a one-time event, a chore best to get over. It will be a permanent part of your business life. During the life of your business, any business in fact, there are different stages of development each with its own financing requirement. Whether your financing your start-up or financing your third store, developing a strategy is a key component of achieving your financing goals. Keep in mind, to obtain financing, you are selling yourself as much as your business idea, so you need to make a compelling story, in the form of a business plan that potential investors buy into. Large story lines are too complex with too many unknowns. So keep your focus on what your immediate financing goal is. Start small, seeking funds for particular activities. This will allow you to have manageable goals that are achievable. If there is anything a potential investor or lender is looking for, it’s a record of achievement. A financing goal, a strategy for obtaining this goal along with a compelling business idea - these ideas will be the basis of your starting point and don’t underestimate the power of determination. As we said earlier, finding financing: or finding money may be the most difficult part of your business career.

 

by Kevin D’Amato

Last modification: Sat 26 Nov 2011

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