Alternative Lending and Other Financing Options for Buying a Business
Beyond traditional bank loans, there are many alternative financing options available for buying a business, starting a new business or growing an existing business. While some may not be for everyone, many offer speed, convenience and more flexible requirements than traditional banks.
What is alternative lending?
After the 2008 financial crisis when traditional banks developed stricter lending guidelines and began turning down many small businesses as risky investments, the alternative lending industry took off. Today, there are a wide variety of alternative options for financing the purchase of a small business.
What alternative lending options are available for buying a business?
1. Peer-to-peer lending.
Prosper and LendingClub were the first peer-to-peer lenders to emerge in the United States. Unlike traditional financial institutions, these online lenders enable borrowers to obtain a loan, while investors purchase notes backed by payments made on the loans. Today peer-to-peer lending is a thriving industry and there are a wide variety of loan products available for small business financing:
- Term loans. Established businesses can borrow a lump sum of cash for a wide variety of business related purposes, such as purchasing equipment or expanding to a new location. Loans are usually repaid over a period of 3 to 5 years in monthly payments of principal plus interest.
- Personal loans. Similar to term loans, a business can use a personal loan to borrow a lump sum of cash for any kind of personal use, such as buying a business or franchise. Loans are repaid over a period of 3 to 10 years in monthly payments of principal plus interest.
- Lines of credit. Established businesses use lines of credit as a flexible means to draw upon capital as needed for unexpected expenses. A business line of credit acts like a credit card, as you only pay interest on the amount you spend.
2. 401(k) business financing.
Also known as ROBS (Rollovers for Business Startups), this type of business financing allows you to use funds from an existing retirement account to buy or start a small business without taking a taxable distribution. Because 401(k) business financing is not an actual loan, there are no monthly payments or interest rates involved.
What are the requirements for 401(k) business financing?
- Corporate sponsorship. Because 401(k) business financing is connected with an employee retirement program, your corporation must first sponsor a 401(k) plan. Your company must also be a C corporation.
- Rollable retirement account. You must have at least $50,000 in a rollable retirement account to be eligible to use ROBS.
3. Angel investors.
These are typically affluent individuals who are willing to provide their own money as capital for a business venture, usually in exchange for a share of the equity ownership. The source of the funds may also be a personal trust, a business, a limited liability company, or an investment fund. Angel investments have helped many businesses in their early stages, such as Google and Costco.
What do angel investors look for in a business?
- Strong management. One of the biggest considerations of any angel investor is the quality of the business’s management team. They expect management to have a clear strategy, a proven track record of achieving success, as well as professionalism and a high level of integrity.
- Growth potential. Angel investors are looking for a business with the ability to grow tenfold over the next three years. They want it to go public in 3 to 5 years. They want to see that there’s a big market for your business. They are not interested in sharing your profits.
- Return on investment (ROI). Most angel investors expect some sort of major financial gain for their investment, one that will be more than investing in the stock market. Surprisingly, many angel investors are looking for something more. They’re taking a risk in the hopes that your business will have a major impact on its industry or solve one of the world’s problems.
Typically accomplished via the Internet, crowdfunding is the practice of funding a business venture or project through raising small amounts of capital from a large number of individuals. The crowd funding model is based on three types of actors: the project initiator, individuals who fund the idea and some sort of moderating organization, such as social media or a website, which brings these parties together. Popular crowdfunding websites include Kickstarter and Indiegogo.
What do investors get in exchange for crowdfunding a business?
- Reward-based crowdfunding. In exchange for funding a project, investors are invited to participate in the launch of a new product or receive some sort of gift, such as a free sample. Friends and family typically represent a large portion of early reward-based crowdfunding.
- Equity-based crowdfunding. Individuals receive an equity position in the company in exchange for providing funds. This also allows businesses to raise funds without giving up control to venture capital investors. Equity-based crowdfunding is regulated by the Securities and Exchange Commission (SEC).
Depending on the type of business you operate, you may be eligible to receive funding through a federal, state or private grant. Many grant programs are for businesses focused on science or research, but some are also for businesses focused on art, education and commerce. There are also grant programs for women, veterans and minority owned businesses.
- Federal grants. The government may want to fund your idea or project in order to provide some sort of public service and stimulate the economy. Your business may support a critical recovery initiative or offer innovative research. Learn more at grants.gov.
- State grants. Many states have grant programs similar to the federal government. Also, each state has a Small Business Administration which is used to offer free educational programs and consulting services through state and local Small Business Development Centers.
- Private grants. Many private organizations, such as philanthropic foundations and non-profits offer grants and awards to support creativity, innovation or the disadvantaged.
There are many types of alternative financing methods that can help fund the purchase of a business, start a new business, or expand an existing business. Whether you’re launching an exciting and innovative product or solving an environmental issue, it’s important to think outside the box, be resourceful and find the best funding method that works for you.