Borrow Money for Your Business Using these Seven Unusual Ways
For the longest time now, commercial banks have been the main source of business funding. However, not every business will get past the stringent requirements, especially after the 2008 financial crisis.
Not to worry though because since then, there’s been a rise of alternative sources of lending such as factoring and customer lending. However, you must understand that each method is well-suited for a certain business.
That’s why you must understand each of them before settling on any. In this article, we’ll take a look at some unusual ways of borrowing money to fund your business. Keep reading to find out what they are and how they work.
Factoring is a process where a financial institution buys your accounts receivable. It’s also known as accounts receivable financing and is in fact, one of the oldest means of in-house financing. The financial institution, in this case, is called a factor.
This is a great financing method if you’re facing cash flow issues or have customers who delay their payments. It works by the financial institution advancing between 75% to 80% of the accounts receivable face value.
The remaining percentage is called the “reserve” and the factor will hold on to this. Look at it as some form of collateral. However, the amount of reserve held by the factor will depend on the quality of the company’s accounts receivable and the clients’ payment history. Keep in mind, the lender will increase the reserve for late payers.
Afterward, the factor will handle the collections, credit assessments, transactions and even administer the account. Often, the factor will charge 2% to 3% in fees for the initial 30 days and a late fee of 0.067 to 0.125% each day you’re late after the 30 days expires.
Let’s use a live example to get a deeper understanding. Let’s say you own a grocery shop and sell $100,000 owed to you by EverGreen Hotel. If the factor decides to charge 4% as fees ($4,000), he’ll advance $75,000 in cash to the business. The reserve, in this case, is $21,000 and once EverGreen Hotel pays the total amount owed, the factor will release the $21,000.
The biggest advantage of this method is instant cash access, about 10 days. However, there’s a glaring disadvantage to using this method and that’s the high cost involved.
2. Peer-to-Peer Lenders
Peer-to-peer lending is the trendiest form of borrowing both for businesses and individuals. With this method, investors contribute to a certain loan application. However, investors will have to bid for the loan amount by providing the funds at certain interest rates.
Lending Club and Funding Circle are some of the peer-to-peer lenders in the market that act as a bridge between the borrower and the investors.
It can also be an informal agreement between friends and family with the upside to this method being quick cash access. In fact, you can get funds as soon as 24 hours on some websites. The other benefit is the flexible repayment terms than those offered by traditional lenders.
While the cash may be instantaneous, your credit score will determine the rates you’ll get. For instance, Funding Circle’s rates start from as low as 4.99% APR to 40% APR for borrowers with bad credit. The disadvantages of this method include publicizing your loan requirements, failing to establish a credit history with a single lender, and not knowing the lender.
3. Customer Lenders
The early 2000s saw the rise of customer lending but back then it was known as community-supported agricultural loans (CSAs). From the definition, it’s easy to pick out the customer’s contribution to the farmers because they provided the funds needed to grow crops. Once the farmer harvested, they’d get their payment in the form of produce but at discounted prices.
It was only a matter of time until the wave caught on with other retail sectors. The finest example is a grocery store in Boston that used this method in 2008 to finance store upgrades. Several customers agreed to fund the owner’s project.
In return, the store owner supplied a certain amount of food each week for the following year at discounted prices. The model not only made financial sense but also helped a homegrown business reach new heights.
As you may have noticed, this financing method requires the business to be in deep connection with the immediate local community. The biggest drawback to customer lending is customers dropping out of the arrangement and demanding a refund. Also, some customers may want an uneven supply of products or the store may lack the products in question.
4. Private Lenders
The 2008 financial crisis led to reduced lending from banks. As a result, many people and businesses were locked out and this led to the rise of private lenders to fill the gap. Their methods relied heavily on technology and this posed a great danger to traditional lenders.
In fact, according to a report from the Alternative Credit Council, these lenders are on course to hit $1 trillion worth of assets in 2020. This is all powered by double-digit growth.
Private lenders tend to finance big businesses, often those in need of loans starting from $25 million up to $100 million. According to the realisticloans.com, these lenders offer flexible repayment terms and quick approval times. These benefits are also the same reasons why these lenders have huge popularity among SMEs.
The associated drawbacks include high borrowing costs compared to traditional lenders. Also, you risk paying early payment fees for repaying your loan earlier than scheduled.
Another trendy source of funding, crowdfunding works by tapping into your network for funds. With this method, both parties meet on a website such as Indiegogo or Kickstarter. Afterward, the borrower must provide funding details such as which business you run and the purpose for the funds. People will then make pledges toward the amount.
However, before you can solicit funds using this method, you must keep in mind that there are some businesses well-suited for it than others. For instance, Kickstarter focuses on uplifting professionals in the creative industry. Indiegogo, on the other hand, helps tech startups to launch their businesses.
Most of the crowdfunding sites work on the “all or nothing” basis. This means if you fail to hit your target, you won’t get a dime. Nevertheless, creative advertising and a massive network will almost guarantee success.
Alternative business financing provides businesses and individuals a chance to get much-needed financing. However, the availability of the funds will depend on the credit history, capacities, needs and other variables such as asset bases and risk tolerances.
The bottom line is to research the best financing methods based on your business needs before putting pen to paper.