Beyond Crowdsourcing: Alternative Funding Sources

I’ve spoken before about the “Maker’s Catch-22.” In short, you have to sell widgets in order to make money, but you need money into order to make widgets. A frustrating situation for cash-strapped entrepreneurs! Especially those who don’t have existing sales to fund their very first purchase order.

Many brands turn to crowdfunding sites like Kickstarter to raise funds for production. However running a successful crowdfunding campaign is harder than it looks. A large amount of time is usually spent reaching out to potential backers and securing publicity, and the most effective campaigns pour substantial financial investment into compelling videos and graphics. Crowdfunding can also take months of planning and execution (with no guarantee of success), making it a poor fit for people who want to produce inventory as quickly as possible.

Here are some alternative ways to secure funds for your next purchase order. All are lending solutions that provide access to cash in a relatively short amount of time, and allow you to pay back what you’ve borrowed once your customers pay you. Like any debt-based financial product, you’ll have to pay interest and/or fees – however these costs may be less than say, the expense of making a Kickstarter video or interest on a credit card (not to mention saved time). I suggest that entrepreneurs explore several options in order to evaluate which is the most cost-effective method for their business.

Microloans

Microloans range anywhere from $500 to about $35,000 and are easier to secure than traditional bank loans. They are typically issued by non-profit organizations or mission-driven organizations committed to serving small business owners. Microlenders evaluate your personal credit and overall financial health, but they do not usually require collateral. They will also extend starter loans to entrepreneurs who haven’t started selling yet but have another source of income (like a full or part-time job), so business sales history is not required.

The application process takes between one to three weeks, and the standard repayment period is between three and six years. This allows you quick access to cash and a wide berth to pay it back, freeing up your cash flow for continued marketing and inventory purchases.

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When evaluating microlenders, pay attention to the interest rate they offer and any associated closing fees. Many organizations offer supplemental services like networking events, access to mentors, or support with publicity – all benefits that you can take into consideration.

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Here are a few highly rated organizations that offer microloans:  Accion East, The Tory Burch Foundation, and The Opportunity Fund.

Peer-to-Peer Lending

Peer-to-Peer lending is a relatively new (and exciting!) concept. Often called “P2P,” peer lending sites connect cash-flushed investors with cash-strapped borrowers, allowing the parties to set up a borrowing agreement without the involvement of a traditional financial institution. It’s the Uber or AirBnb of lending!

Unlike microfinance, where your business will be reviewed, P2P companies do not care what type of business you are running or what you will use the money for. Securing a loan is much like applying for a credit card; your income, debt, and credit history are what factor into your approval amount (up to $35,000). That said, some investors prefer working with people with poor credit because the interest rates on the loans are higher, meaning they get a higher return on their invested money if you pay it back.

Peer lending is an incredibly fast way to access funds – the application will take several days to process and money can be accessed a few electronic signatures later. It’s also a potential source of ongoing funding. Once a loan is repaid, a borrower can continue to take out loans at competitive interest rates, often better than most microloans and credit cards.

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The two biggest peer lending sites are Prosper and Lending Club. Similar to the case with microloans, borrowers should compare fees, interest rates and repayment termsacross platforms.

Friends and Family Financing

Some new entrepreneurs don’t have the credit or income to qualify for a loan, or are interested in structuring their loans in a more creative way. For them, friends and family can be a great source of funding. The “application process” is more about persuading people to support your business (or just support you) than it is about proving your creditworthiness, so it’s the arguably easiest way to borrow money. It can also be the cheapest if your friends and family members aren’t demanding high interest rates and fees. That said, owing money to a person rather than an impersonal company can be emotionally taxing and possibly more stressful if things don’t go as planned. This emotional burden is an invisible cost that should be carefully considered.

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When it comes to product-based businesses, my favorite way to structure a F&F loan is to tie the “interest” to your sales. For example, if you ask five people to give you $2,000 in order to purchase $10,000 worth of product, agree to pay back their original sum plus a percentage of sales on that same product over an established time frame. For example, 5% of sales (split equally between the investors) over 6 months. Just remember, formal contracts are a good idea, even when both parties have a very informal agreement.

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Seed Investments

Given its popularity among entrepreneurs, you are probably at least a bit familiar with this funding medium. Before pursuing seed investments, consider the pros and cons. While qualifying for a loan may be difficult, private seed investors are more willing than banks to take risks and will tie their returns to the outcome of the business. In other words, if your business tanks, you wont have to repay. Investors can also often offer a wealth of business experience, which is a great mentorship opportunity. You won’t be on your own.

On the flip side, investors may set high standards and require you to prove the worthiness of your venture upfront. They may also exert pressure on you to produce returns. Agreeing to an investment deal means giving up equity, or a stake in your company that is a portion of future earnings. Given this equity, the investor is likely to pay close attention to all of your business decisions, so you will likely give up some degree of managerial control. Be sure gauge your investors’ working style upfront!

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Bolstr and AngelList are two good resources for matching with accredited angel investors who may be interested in backing your business.

 


 

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