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Making a stellar business idea come true isn’t easy. Despite innate talent and passion for making it marketable and profitable, launching it needs an external drive—capital. The problem is that not everyone has access to enough funds.
Lack of capital is a common business problem among small and midsize enterprises (SMEs) and startups. The good news is gone are the days when access to funds is stringent, time-consuming, and only available at banks. Here are the four most common non-bank loan alternatives for new and small businesses.
Small Business Loans
The Small Business Administration (SBA) is a US federal agency that supports small businesses. Specifically, SBA helps SMEs obtain financing and general business assistance to launch, grow, and build resilient businesses.
However, many business owners still get confused about SBA loans—or rather, SBA-backed loans. To be clear, SBA doesn’t issue loans but only partially guarantees them. SBA financially supports small businesses by setting loan guidelines and reducing lender risk.
SBA loans are considered the best small business loan for small business owners. Here’s why:
- SBA loans offer high capital, reaching millions
- Loans come with low interest rates, usually single-digit interest rates
- SBA loans have the longest repayment periods on the market, up to a ten-year-long (or so) loan period
These three terms may vary depending on the loan program and applicant. Nonetheless, they make SBA loans desirable among small business owners. This makes the competition fierce. In other words, it could be difficult to get an SBA loan.
While SBA doesn’t require a specific credit score since it aims to offer business opportunities to small companies, companies with a good credit score of at least 640 can be in the running. It’s recommended that companies should realistically have a robust financial profile to surpass other competitors and successfully obtain an SBA loan.
Personal Loans
If you’re looking for instant access to funds, personal loans could be your best bet. These loans are the go-to solution for any financial pinch, such as emergency expenses, medical costs, debt consolidation, large purchases, and business capital.
Besides its fund funding times and flexibility, personal loans won’t be based on a business’s history, finances, and future forecasts, so it’s ideal for SMEs and startups. Instead, they’ll be based on the business owner’s creditworthiness.
Although there are personal loans available for bad credit holders, it would be in the best interests of small and new business owners to have a good credit score and regular income. Bad credit personal loans usually come with higher interest rates, so they’re better off as a last resort. They may also have more restrictions, such as the inability to use funds for business purposes.
In contrast, business owners with a good credit score of 640 and above can enjoy the best personal loan terms. These include larger borrowing amounts, longer repayment terms, and low-interest rates. For example, some lenders may lend up to $20,000, payable for seven years at a 3% interest rate.
However, while personal loans can be used to fund any legal personal expense, including business, SME and startup owners must be careful. In certain instances, leveraging personal loan funds to finance new businesses may amalgamate personal and business assets, which likely causes bookkeeping, tax, and legality. Better seek professional help if unsure.
Venture Capital
Venture capital is a form of financing invested by affluent individuals or financial firms called “venture capitalists.” They invest in SMEs or startups that are about to commercialize their ideas but need larger funds. They can fund up to $100,000 as seed capital or $25 million for more mature firms.
However, venture capitalists have specific conditions for SMEs or startups to be eligible for venture capital. They must have long-term growth potential, specifically valued at $100 million, able to go public or sell for massive future business profits in five years.
Apart from huge funds, venture capitalists also help companies to bootstrap their early-stage operations. They help companies set milestones, grow, reach targets, and succeed by offering technical, managerial, and networking advice.
The problem with venture capital is that it’s an investment of equity capital or private equity. In simple terms, venture capitalists invest in a company in exchange for 25%-50% of ownership.
Angel Investors
Like venture capitalists, angel investors are wealthy individuals or organizations who invest in business ventures. They also take calculated risks before investing in SMEs or startups and demand business equity to gain a healthy return on investment (ROI).
What sets angel investors apart from venture capitalists is that they take more risks. Venture capitalists specifically target established companies to lower their risk of losing investments. Angel investors, on the other hand, help small and new businesses from the ground up, even if they haven’t proven themselves yet.
This willingness of angel investors to invest in small and new businesses can attribute to their lower return expectations. Compared to venture capitalists, they only ask for 20% and 25% of a company’s ownership, sometimes even lower. Another reason is that they lower borrowing amounts, averaging $330,000.
Final Thoughts
Alternative financing is a good source of capital for SMEs and startups that don’t have an established business history and stable cash flow yet. However, taking extreme caution is still advisable. Be wary of predatory business practices and scams that target small and new companies. More importantly, avoid using funds without doing the legal work properly. If confused and unsure, always seek professional help.