Four Sources of Alternative Funds

When Sandy Corso launched, a web site that sells products to soothe the mind, body and spirit, in 2002 her friends and family were skeptical. And so, too, were potential lenders. "The banks thought I was crazy, and they would not give me a loan," says Corso, of Madison, Conn.

Now, six years later, Corso's company posts $1.3 million in annual sales (her current best seller is the "neti pot," a container that cleanses sinus cavities), enough to win the respect of her former naysayers. But banks? Still a no-go, which Corso attributes to two factors: the credit crunch, and her company's occasional cash-flow problems. So she turned to a microlender (a not-for-profit that helps female entrepreneurs) and more recently, a private lender called On Deck Capital for some working capital. Alternative funding sources, she says, were "instrumental in helping me get this business off the ground."

It's often difficult for a newly-established business owner to get a conventional bank loan. Many entrepreneurs tend not to have strong enough personal credit or a long enough operating history to meet the five Cs of commercial lending - character, capacity, collateral, capital and conditions. Now, as financial institutions tighten lending practices, many small and mid-sized business owners are finding it even more difficult to get their hands on funding.

But as Corso discovered: even if one lender says "no," another may say "yes." While a non-traditional loan or cash advance might come at a steeper price, the money can be a lifeline for a cash-strapped entrepreneur - and often, it's a better option than relying on a high-interest credit card or local loan shark. Here are alternative places to turn to for funding:


Microloans are small loans (typically, in the range of $5,000 to $25,000) extended to entrepreneurs who can't secure funding elsewhere. Many microlenders are non-profits; for example, Accion USA, part of Accion International, relies on donations from charitable organizations and individuals to provide business loans and training to entrepreneurs.

A relatively new field, microlending has received more attention in recent years since economist Muhammad Yunus won the 2006 Nobel Prize for Grameen Bank. His organization helps Bangladesh's rural poor escape poverty by supplying tiny loans that they can use to start businesses.

In the U.S., microloans generally carry higher interest rates than bank loans, but often are subsidized by federal, state and local grants. The Small Business Administration, for example, provides federal funds to nonprofit, community lenders through its microloan program. One stipulation: typically, the microlender must also provide training or education to the entrepreneurial borrowers. Microloan rates vary, but generally range between 8% and 13%.

Microlenders often focus on a particular interest, such as making small loans to female or minority entrepreneurs. Corso, for instance, received a $5,000 microloan at an 11% rate through Count Me In, the lender helping women entrepreneurs. The loan, secured when her business was still based at home, enabled Corso to move into her first warehouse.

To find a microlender, contact your local SBA office or check the Association for Enterprise Opportunity's searchable database.

Peer-to-peer networks

Business owners might also try tapping peer-to-peer lending networks, such as Prosper, Lending Club and Zopa. Here's how it works: borrowers list the amount they need, details about their business and why they need the loan. Some borrowers claim they need a cash fix (these loans usually cap out at $25,000) to expand product offerings or move into new locations; others are seeking capital to cover start-up expenses, such as advertising or web site costs. Then, individual lenders decide whether or not to offer them funding. In many cases, these lenders are fellow entrepreneurs looking to make a nice return while assisting other business owners.

Thanks to the credit crunch, peer-to-peer loans to businesses are on the rise. As an alternative financing option, these loans offer many benefits, including fast delivery and competitive rates. Prosper currently advertises rates as low as 7.68%, while Lending Club lists 7.88% and Zopa offers 8.49% (Zopa also notes that borrowers can drive rates lower by making a personal appeal to investors).

One drawback: peer-to-peer loans are considered "consumer" debt, so they're reported on the business owner's personal credit report. An entrepreneur who borrows heavily to buy, say, pricey office equipment, could see his or her credit score plummet, making it difficult to secure future financing. Also, peer-to-peer lending sites, similar to credit cards, can make borrowing a little too easy - which could potentially get some business owners in over their heads.

Merchant cash advances

Merchant cash advances or "factoring" has seen a surge in demand since banks retreated from lending. Under this type of financing, a company doles out a cash advance (usually, a lump sum) to a small merchant or entrepreneur. Then, the merchant repays the sum by routing a portion of their future credit-card sales back to the cash-advance company, generally at a hefty premium.

"Yes, it's more expensive," says David Goldin, chief executive of AmeriMerchant, a New York factoring company that plans to advance as much as $100 million to merchants this year. Other players in this field include AdvanceMe, Advance Restaurant Finance, or ARF, and Liquid Capital. But there are advantages, he says: Borrowers get the money with far less paperwork and collateral than a bank would demand. They don't have to take on investors or give up equity. And if they can't pay the advance back, the factoring company absorbs the default.

Unlike a bank, a factoring company isn't considered a creditor if the business goes belly-up - hence the reason for the higher fees, Goldin explains. "You sign up for a bank loan, and you default - guess what, they're taking your house; they're going to sue you personally," Goldin says. "I have no recourse."

Just how expensive is it? Merchant cash advances are often compared to short-term loans that have double-digit or even triple-digit interest rates. Factoring companies typically advance 70% to 90% of the amount they ultimately collect. AmeriMerchant, for instance, might advance $30,000 to a cash-strapped restaurant, but then collect $36,000 over a period of six to nine months. (In the industry vernacular, AmeriMerchant says it purchases a business's future credit-card sales at a 20% "discount.")

Critics say factoring companies charge excessive rates for short-term capital and that terms can be confusing or vague. For tips on factoring, check out SBA-affiliate SCORE's list here. Keep in mind, this type of financing is available to merchants that conduct a lot of credit card transactions, such as restaurants, retailers and hotels.

Private lenders

Private lenders are another option.'s Corso turned to On Deck Capital, which offers loans based on business performance, rather than a borrower's personal credit history.

Mitch Jacobs, On Deck Capital's founder, says many entrepreneurs use up savings and exhaust personal credit cards to launch a business, which results in a personal credit score that banks don't find attractive. His firm, on the other hand, bases lending decisions on a company's cash flow. "We look at electronic reports from the merchant's commercial bank account, as well as reports from their electronic payment processing," he says. "We are able to get much more accurate information from these reports than the traditional process (that banks use.)"

After providing a loan (average size is about $30,000), On Deck Capital debits a small amount each day from the business's bank account. Loans are for one year, at interest rates that are pricey, ranging from 18% to 36%. The company says it's already worked with several hundred small businesses that were previously declined by banks.

Corso says the rate on her loan from On Deck Capital is more than 20%, and she pays back roughly $100 each day, a sum her company finds much easier to manage than a larger monthly payment. "It's not cheap money, but it can help you through a cash crunch," she says. © 2007 SmartMoney. SmartMoney is a joint publishing venture of Dow Jones & Company, Inc. and Hearst SM Partnership. SmartMoney is a registered trademark. All Rights Reserved.

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