If you are looking to start a business, you are probably looking for funds to bankroll your new venture. You may have heard of crowdfunding, angel investors, P2P loans, SBA loans or alternative business lenders. With all these financing options available, it creates the sense that finding money for a new business should be easy, or at least easier than it was 10 years ago.
One of the most common places for the founders of new businesses to turn for funds is family and friends. As a new business, you don’t have a track record for investors to review. Your investors are essentially making their decision on the business idea and their knowledge of the business owners. Who knows the business owners better than their friends and family? That's why your friends and family are still likely one of your cheapest sources of capital for your new business.
Raising Money From Like-Minded Individuals
The crowdfunding movement is just getting off the ground. Sites like Fundable and RockThePost may be a meaningful source of funds to new businesses in the future, but today not much actual money is being raised. For example, RockThePost claims to have raised a total of $96 million, and Fundable claims $122 million (of commitments) over their entire operating histories. In other words, over several years, two of the leading companies in the equity crowdfunding space have raised less than a quarter billion dollars for companies. This compares to $48.5 billion which venture capitalists invested in US companies in 2013 alone.
The Jobs Act passed by congress was supposed to supercharge the crowdfunding movement by making it easier for small companies to advertise their fundraising efforts and take money from non-accredited investors. Unfortunately, the organization hasn’t yet made all the changes approved by congress. When they do, crowdfunding might become a more important place for new businesses to raise money.
Taking Loans From Strangers
P2P loans are becoming a meaningful source of funds for both individuals and businesses. The majority of P2P borrowers are using the funds for personal means, such as consolidating credit card bills. However, there are tens of thousands of people borrowing money for the purpose of starting or funding their businesses. P2P companies are facilitating lots of loans. The largest US focused P2P company is on track to facilitate over $15 billion in loans in 2014.
While P2P loans are easier to get than a personal loan from a bank, and generally cheaper than borrowing money from sources like credit cards, I wouldn’t describe them as cheap or easy to get. Applying for a P2P loan is easy and online. Getting approval is the hard part. While you don’t need outstanding credit, you do need good credit. Those with credit scores below 660 will not get approved by the largest firm. Even those with higher scores may not be approved. The loans, which can range from 1 to 5 years, generally have double digit interest rates. The rates are cheaper than credit card interest rates by about 2% for borrowers with similar credit scores. The average interest rate on a P2P loan is around 15%. Learn More About P2P Business Loans
Borrowing Money From the SBA
One misconception is that the SBA itself loans money. The SBA doesn’t actually loan money. Instead, they provide banks with was is effectively “insurance” against defaults, making the loan less risky to the bank.
SBA Loans are in fact cheap money. Right now, the highest possible rate on a 7A loan is 8%. (This rate could rise if market interest rates increase.) However, getting an SBA loan is tough. Only 30% of SBA 7A loans go to new businesses. New businesses are generally considered those with less than two years of operating history. In other words, the bulk of the money is going towards businesses with track records. Still three out of 10 loans are going to “new businesses”. The banks that are making these loans want borrowers to be low credit risks, so just like a P2P loan, a good credit score is a must.
The Bottom Line
Crowdfunding is no magic bullet for funding a business. However, P2P lending companies have made applying for a personal loan easier than it was 10 years ago. The loans are not cheap, but will probably cost less than borrowing money through a credit card. The ideal way to borrow money for a new business is through an SBA Loan, which truly is cheap money… but, it's still hard to get.