How to Fund a Business Without a Bank Loan

Approaching a bank is the default idea when a business needs money, and for most small and young businesses it is also the least likely to work. Banks lend against trading history, security, and predictable cash flow, which are precisely what a newer business does not yet have.

Several other routes exist, and they differ enormously in cost. Some are cheaper than a bank loan would have been. Others are far more expensive and are sold in ways that obscure exactly how expensive.

Guaranteed Loan Programs

Government backed lending programs reduce a lender's risk by guaranteeing part of the loan, which allows lenders to approve businesses they would otherwise decline. Rates are regulated and terms are longer than commercial lending, which keeps monthly payments manageable.

Microloan programs within this family lend smaller amounts through community lenders and are considerably more accessible than the larger products. Those lenders frequently provide free advice alongside the loan, which for a first time borrower is worth as much as the money.

The trade off is time. Applications take longer than commercial alternatives and require more documentation. For a business that can plan a few months ahead this is the cheapest borrowing available. For one needing money next week it is not the answer.

Community Lenders

Community development financial institutions lend specifically to businesses that conventional lenders decline, in areas or to groups that are underserved. They assess applications on a broader basis than a credit score alone, which is exactly what a young business needs.

They are non profit, their rates are reasonable, and they generally provide support alongside the lending. They are also almost entirely unknown to the businesses that would benefit most, since they do not advertise.

Where It Gets Expensive

• Merchant cash advances, which take a share of card takings and are extremely costly
• Short term online lenders quoting a factor rate rather than an interest rate
• Invoice factoring, which is useful for cash flow but expensive as ongoing funding
• Equipment finance, which is reasonable but ties the debt to a depreciating asset
• Personal credit cards used for business, which mixes liabilities unhelpfully

The factor rate is the detail that catches people. A quoted figure that looks like a modest percentage frequently translates into an annual cost several times higher once the repayment period is accounted for. Always ask for the equivalent annual rate, and be wary if the answer is evasive.

Merchant cash advances deserve particular caution. They are fast and easy to obtain, which is why struggling businesses use them, and the cost is high enough that they frequently deepen the problem they were taken to solve.

Funding Without Borrowing

Several routes bring money in without creating debt. Customer prepayment, deposits on future work, and selling subscriptions in advance all fund a business from its own demand, which is the cheapest capital there is.

Crowdfunding works for businesses with a product people want before it exists, and functions as marketing as much as funding. Revenue based financing repays as a share of income rather than on a fixed schedule, which suits businesses with uneven months.

Grants, covered elsewhere on this site, are the best of all where a business qualifies, since there is nothing to repay and no ownership given away.

Preparing Before You Apply

Whatever the route, the preparation is similar and doing it once serves every application. Lenders want to understand what the money is for, how it will be repaid, and what happens if trading is slower than expected.

• Separate business and personal finances before applying
• Have two years of financial statements ready, or as much as exists
• Know your own credit position, since personal credit is assessed for small businesses
• Prepare a straightforward explanation of what the funds will do
• Have registration and tax documents in one place

Applying to two or three lenders in a short window is sensible, since terms vary considerably for the same business. Applying to a dozen is not, because repeated enquiries damage the credit position you are being assessed on.

Working Out What You Actually Need

A surprising number of funding applications are for a round number chosen without analysis, and that shows in the application. Lenders respond considerably better to a specific figure tied to a specific purpose than to a general request for capital.

Separating the type of need also determines which product fits. A short term gap between invoicing and payment is a cash flow problem, and borrowing over five years to solve it is expensive and unnecessary. A piece of equipment that will last a decade is properly financed over years rather than months.

• Cash flow gaps, best matched with a facility you draw on and repay quickly
• Equipment, best matched with finance secured on the equipment itself
• Growth investment, best matched with longer term lending
• Working capital during a slow season, best planned before the season rather than during it

Matching the term of the borrowing to the life of what it buys is the principle underneath all of this, and it is where most expensive mistakes originate.

Free Advice Before Committing

Small business development centers, community lenders, and mentoring organizations all provide advice at no charge, and they see funding applications constantly. A conversation before applying frequently changes both the amount requested and the product chosen.

That advice is particularly valuable for identifying which lenders are realistic. Applying to a bank that will not lend to a business of your size and age wastes weeks, and someone who knows the local lending landscape will say so immediately rather than letting you find out.