New Ways to Fund Small Businesses
The new year will hopefully usher in some lifestyle changes. Join a gym. Tackle that neglected booklist. Clean out the dusty attic. Maybe...start a new business venture?
But, before you start fantasizing about your new tricked out office workspace and slick business cards, you have to jump over the mountain-sized hurdle of acquiring funding.
Traditionally, if you wanted to start a small business or a new venture, there were a couple of options when it came to funding. You begin with the process of sketching out your business plan and once you laid out the foundations of your business concept -- what your business would do, where you would work, how big your team would be, for example -- the next big step was the issue of financing.
Self-financing your business-operation-to-be was, and still is, the first option most potential small business owners consider. Sometimes, savings and investments aren’t enough, and people often deferred to the next best thing, which is some combination of credit cards, friends and family.
But over the years, credit has gotten trickier to access. Credit cards and bank loans are harder to get; rates are abysmal and carrying debt is a much bigger burden now than it was before.
The number of loans offered to small businesses is decreasing sharply and the requirements are becoming more stringent. In a study released in July, the Small Business Association found that lending continued at a “subdued pace in June 2010-June 2011...although financial conditions continued to be supportive of economic growth.”
The economy hasn’t continued its downward spiral, but banks are still acting cautiously. They are particularly risk-averse, worried that small businesses won’t turn lucrative profits.
The biggest change to acquiring funding, then, comes when the traditional combination -- personal savings, friends and family and credit cards -- is not enough.
“What’s changed is when you go a little bit further down the stack. Usually when you get past friends and family, are the third sources of capital,” says Paul Kedrosky, senior fellow at the Kauffman Foundation, a non-profit organization that conducts research and provides education to support entrepreneurship.
“There’s a whole host of intermediating sources that makes it easier for you to get capital, whether it’s project-based or specific company-based. That’s really where all the excitement is right now,” says Kedrosky.
Crowdfunding for the Masses
One of those emerging options is crowdfunding. In recent years, crowdfunding has become an increasingly popular method for getting your projects off the ground. You have a project idea, create a proposal that details how you plan to put potential funds to use, and then see if strangers have faith in your product and will invest in it. Sites like Kickstarter and Indiegogo are just some of the many crowdfunding hubs where ideas are put into motion through successful funding.
The method seems easy enough, but crowdfunding is, of course, not without its drawbacks. Many sites like Kickstarter, for example, only allow campaigns that are project-based. So if I wanted to create a book on the history of oatmeal raisin cookies, Kickstarter is where I could find funding for putting the book together and getting it published. But if I wanted to create the Amy He Cookie Business, then I have to look elsewhere.
Some way that crowdfunding invites get-rich-quick scams with little oversight or regulation from the government. John Wasik writes on Forbes.com that if the government couldn’t even keep Bernie Madoff in line, who’s going to stop Joe Schmoe from going nuts on a crowdfunding site?
Others have criticized the project-based nature of many crowdfunding sites. But Kedrosky views it differently. “That criticism might be true,” he says, “but it sort of misses the point. The nature of a young company is that you always start with a single project and then grow from there. It doesn’t work the other way around, where you have a hundred products and then figure how to finance them.”
The Beginning Stages of P2P Lending
Another emerging method of small business funding is peer-to-peer (P2P) lending. It’s a different choice we’ve covered quite a bit on MyBankTracker. For some people, it’s a good alternative to deferring to traditional bank loans. We’ve suggested using P2P loans to consolidate debt and fellow colleague Debbie has documented her experience with acquiring a loan through a P2P lender.
Because P2P services are essentially in their infant stages, they’re operating in what Kedrosky calls a “regulatory black hole.” But the good news is that there should be more clarity regarding the rules and regulations of these practices as policy makers will be doing some rule making early 2013.
Tech Giants Lend a Hand
Large tech companies have also been encouraging of small businesses, though their assistance has come primarily in the form of providing access to products or programs rather than hard capital.
Microsoft has been providing discounts for software and hardware for a long time, and Google offers a good deal to developers and those whose businesses depend on online ads to attract customers through the internet. In October, Google rolled out its AdWords Business Credit Card, a card that lets small business owners track and pay for AdWords campaigns. Google’s VP Treasurer noted that 74 percent of those surveyed after the credit card’s pilot launch said that they would continue to use the card as their “primary form of AdWords payment.”
Amazon has its own lending program called Amazon Lending, which offers select Amazon merchants the chance to borrow money from the online superstore. The interest rates on the loans range from 1 percent to 13.9 percent depending on the seller’s credit history. The initial email loan offer from Amazon gives the customer the chance to use the loan these “to purchase inventory and increase your sales on Amazon.com.”
What’s Right For You?
Deciding on the right finance option for you depends on a lot of things: what your small business aims to do, how big you want it to grow to be, what your current financial health is, among others.
A general rule of thumb to consider when choosing, Kedrosky advises, is finance dilution. “Broadly speaking, you look for the least diluted financing you can get, meaning you want to give up as few shares as possible at the beginning of your company’s creation,” says Kedrosky. “Your company is worth such a modest amount of money that raising $200K might amount to 50% of the company. You’re essentially looking for the least diluted financing possible.”
So compare rates and terms for all the options you want to look into. Be realistic about your project and goals to avoid over-borrowing and accruing excessive debt, but do know that there is a larger array of options available today that won’t tie you to traditional methods of fundraising.