5 SMB Financing Options: Pros and Cons
From time to time, we like to partner with guest bloggers. Today’s article comes from Kiera Abbamonte- the Content Marketing Specialist for Grasshopper. She loves a good baseball game and finding new ways to make content awesome. Catch up with her on Twitter @kieraabbamonte
The Pros and Cons of 5 Alternative Financing Options for Small Businesses
Gone are the days where walking into a bank to get a traditional loan is the only option for financing your small business. Since the financial crisis, banks have become pickier about who they lend too, and may reject a small business loan applicant because they make more money off larger loans.
Thankfully, this lack of funding has birthed other creative forms of financing. Today, about half to two-thirds of businesses seek financing from outside sources, and there are more “alternative” options to pay for your business than ever before.
1. Term Loan: Straightforward Option for SMBs
A term loan is a standard commercial loan through an online company instead of a brick-and-mortar bank. It is one lump sum you borrow and repay on a set schedule. They usually last about four to five years.
Pros of a term loan:
- Set terms with a fixed annual percentage
- It is usually the least expensive
Cons of a term loan:
- Term Loans have a difficult approval process and require collateral.
- If you are borrowing more than $100,000 you may need to complete a full financial analysis by the lender
If you want a good, straightforward option, a term loan is a good bet.
2. Line of Credit: A Flexible Solution For Short-Term Needs
A business line of credit offers more flexibility than a traditional loan. The borrower sets a limit, and then pays interest on only the money spent. A line of credit is like getting a cash advance from a business credit card, but less expensive.
Pros of a line of credit for financing a small business:
- Very flexible: you only pay off what you use.
- Good for unexpected expenses.
- You usually don’t need to provide collateral.
Cons of a line of credit:
- If you are late with your payments or go over you limit, your interest rate will increase substantially.
A line of credit loan is great for buying inventory and other short-term business needs.
3. Invoice Financing: Alternative Option For Consistent Cash Flow
Invoice financing (also known as invoice factoring) is technically not a loan, but it’s an alternative way to bring in cash flow to your startup. The business owner offers the lender the business’ unpaid invoices as collateral. Invoice financing companies will usually advance a business 85% of the value of the invoices.
Pros of invoice financing:
- Easy application process—Some companies may not even run a credit check.
- Fast process
- Many invoice financing companies also offer collection assistance to help enforce unpaid invoices.
Cons of invoice financing:
- High annual interest rate, anywhere from 12 to 60%
- Negative customer reactions. Some companies experience alienation of customers after the invoice financing company sends them a notification.
It is better not to go this route if your customers are individuals. Invoice financing works great with B2B companies that deal with corporations on a consistent billing cycle.
4. Merchant Cash Advance: Cash For Future Sales
A Merchant Cash Advance (MCA) is an upfront sum of cash in exchange for a percentage of future sales. It is usually used for businesses whose revenue is mostly from credit and debit cards. The business owner agrees upon a fixed percentage of sales as a payment until the loan is paid off. You may also agree upon a fixed daily withdrawal from your bank account. The amount will depend on your revenue. This is not technically a loan either, but another way to finance your small business.
Pros of an MCA:
- Relatively easy and quick to get
- You don’t need to use collateral.
- When your sales are down, you don’t need to worry about unaffordable payments, because they are based on how much the business is making.
Cons of an MCA:
- Very high APR—anywhere from 70% to 350%
- It’s very easy to go into debt.
- Contracts can be confusing.
For some small businesses, MCAs are a last resort. Make sure you know what you’re getting into and you read your contract very carefully.
5. Crowdfunding: An Investment Community
Crowdfunding is a buzzword for a reason. This fairly new approach to funding a small business allows anyone to be an investor.
There are two main types of crowdfunding:
- Reward Based—Someone donates money and receives a reward, like an advanced or limited-edition product
- Equity Based—Someone invests and retains a portion of the new company
Pros of Crowdfunding:
- Gives you creativity and control
- Very quick—The average crowdfund lasts 90 days, so you can get your money fast.
- Establishes loyal customer base
Cons of Crowdfunding:
- Only works for simple business ideas—People won’t invest in something too complicated.
- All-or-nothing funding risk—On most platforms, if all the money isn’t raised, investors will be reimbursed and you get nothing.
- Inflexible—Once you put it out there and people start investing, you can’t really change details.
Crowdfunding is great option for easily-explainable business ventures. It can be very successful, especially with creative marketing.
Great Options for Entrepreneurs
Thanks to alternative lending, the inability to get a big bank loan is no longer a roadblock on the journey to starting your business. Furthermore, with technology making it easier than ever to keep track of your finances, you don’t need a financial degree to be successful.
Begin to brainstorm a business plan. Decide what you will need, and when you will need it, in order to start a successful business. From there you can decide which financing option is best for you. Despite the risks, it’s an exciting time for entrepreneurs and small business owners!
For even more on financing your startup or small business, join us for our live, online Fireside Chat event, “How to Choose the Best Financing for Your Business.” A panel of successful entrepreneurs and small business experts will help you assess your needs and explore your options. Registration is open and free at http://grasshopper.com/firesidechat/.