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When Banks Say No, Entrepreneurs Get Creative With Financing

May 19, 2015
Small Business
When Banks Say No, Entrepreneurs Get Creative With Financing
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We adhere to strict standards of editorial integrity. Some of the products we feature are from our partners. Here’s how we make money.

If your small business fails to qualify for a bank loan — or you’ve already been denied one — you may have to think outside the box and go with creative financing. And there are more than a few nontraditional financing methods you can turn to.

To compare small-business loans, NerdWallet has come up with a list of the best ones to meet your needs and goals. We gauged lender trustworthiness and user experience, among other factors, and arranged them by categories that include your revenue and how long you’ve been in business.

NerdWallet also recently spoke with several entrepreneurs who turned to creative financing to support their small businesses. They share how different kinds of financing helped their companies grow, and offer tips for other small-business owners.

Revenue-based financing tied to cash flow

David Barach is chief executive of Good Done Great, an online platform that helps businesses “engage their employees around philanthropy and volunteerism.” The company recently obtained $500,000 in revenue-based financing from an alternative lender called Lighter Capital in Seattle.

Barach says Good Done Great tried to get bank loans without success. Banks are interested not only in the profitability of a business, but also in its assets and the personal assets of the founder, he notes. Borrowers often have to use these assets, such as real estate or equipment, as collateral to secure a bank loan. The lender can sell the assets to recover losses if the borrower fails to make the payments.

David Barach, CEO of Good Done Great

David Barach

“We’re a software business, so it’s not like I have a ton of machinery that can be used for collateral,” Barach says. “Bank financing is just very hard to get, so we had to be creative about this.”

With revenue-based financing, a company’s loan repayments fluctuate based on its monthly revenue, until a fixed amount is repaid. In this case, Good Done Great borrowed $500,000 upfront and has to repay a total of $950,000, by paying 8% of the company’s monthly revenue until the $950,000 is fully repaid, Barach says. The loans are typically structured to be repaid over five years, but can be paid back much faster if the business grows faster than planned.

“In months we have low revenue, the payment is lower, in months we have higher revenue, our payment is higher,” Barach says. “It helps us better manage our cash flow.”

BJ Lackland, chief executive of Lighter Capital, says this type of financing “aligns the investor’s interests with the entrepreneur the way that equity does, but does not dilute the entrepreneur’s ownership.” This means Good Done Great doesn’t have to give Lighter Capital any equity interest in the company, but Lighter still wants to see the firm succeed.

“We have every incentive to help companies that we fund grow, so we’re like an equity investor, but at the same point in time, we don’t control the company,” says Lackland, who added that companies are typically funded within two to six weeks of applying.

“We will often make introductions to the business, either to new potential customers or other financing sources, and give them advice on how to grow the business,” Lackland says. “We want to help them construct their financial future in a way that’s healthy for them.”

Lighter Capital currently works only with tech companies (software, software as a service, tech services, digital media). A business needs $15,000 per month in revenue and gross margins of at least 50% to qualify, and loan amounts range from $50,000 to $1 million per company, according to the company’s website.

Credit card offers ‘free money’ — for a while

Tim Ryan is the founder and director of TAR Productions, a digital video production company with two full-time employees and several freelancers.

About a year ago, Ryan says, he needed a small-business loan to keep growing his company. But since the business was still very young, he wasn’t eligible for a traditional loan, despite having a “great relationship” with his banker.

“We rent a majority of our production equipment, so we didn’t have collateral to offset the bank’s risk,” Ryan says.

Tim Ryan, founder of TAR Productions

Tim Ryan

Ryan says he found a business credit card that charged 0% interest on purchases over the first nine months. Since his business was so new, he had yet to build a credit history, so he says the credit card company checked his personal credit score instead of his business credit.

“I put about $5,000 per month on the credit card for advertising and marketing,” Ryan says. “We were able to grow enough to pay off the credit card in full and on time, at no interest cost. I felt like I was given free money for nine months.”

To compare business credit cards and find the best one for you, check out:

However, small business owners should be aware of the risks of this strategy. For one, failure to make the minimum monthly payments on a credit card can lead to higher interest costs, late payment penalties and a damaged credit score.

“It’s definitely scary … but when you’re an entrepreneur, failing isn’t an option, and you find a way,” he says.

Also keep in mind that if you can’t repay the entire outstanding balance by the end of the 0% interest promotional period, you’ll end up paying the regular interest rate on the balance, which could be 14% or higher, depending on your card.

Angel investor impressed by track record

Felena Hanson is the founder of Hera Hub, the “first spa-inspired co-working space for female entrepreneurs.” She’s used multiple sources of financing to fund Hera Hub, including a $30,000 loan from her father to open her first location, and equity financing from an angel investor to open her third.

Hanson says she didn’t even try to get a bank loan for financing initially, because she knew she wouldn’t get approved. “I know that banks want safety, a business track record, and two years of tax returns because they are risk-averse,” she says.

Felena Hanson, Founder of HeraHub

Felena Hanson

Instead, Hanson wrote up a detailed business plan and financial projections and showed it to her father, who approved of it and financed the company with a loan.

“It wasn’t until two and a half years into the business and once I had regular income that I could turn around to my bank and say, ‘Hey, I need a line of credit to grow,’” Hanson says. “And that is a very easy conversation to have once I had that track record.”

To open her third location and franchise the business, Hansen projected that she needed about $200,000 in funding. She turned to a woman who is a member of Hera Hub for an angel investment. In exchange for cash upfront, the investor received an equity stake.

“She saw what I was doing and believed in me,” Hanson says. “I laid the numbers out for her, and she said yes, so it wasn’t like I had to do a significant pitch, because I already had a track record and she could see the success we had.”

“My advice for entrepreneurs is to put in your own money first, prove the model, and then go after an equity deal, because, frankly, you’re going to get a lot better of a deal,” Hanson says.

Equity crowdfunding raises money efficiently

Corbin Holt is the director of marketing at Crowdfunder, an equity funding platform launched in 2011 that connects entrepreneurs and investors.

In the past, business executives would have to hit the road and make investment pitches to angel investors and venture capitalists one by one to raise equity, which is not a very scalable way to fundraise, Holt says.

“What an entrepreneur can do now is, they can come onto Crowdfunder and put their deal on the site, and from there, get investors involved in their financing round, basically at the click of a button,” Holt says.

Corbin Holt of Crowdfunder

Corbin Holt

Among businesses that have successfully raised money on Crowdfunder is Bitvore, an Irvine, California, tech company that provides intelligence-gathering and analysis for businesses.

“We looked at venture capital, but we are not in Silicon Valley, so that makes it hard,” says Jeff Curie, president and CEO of Bitvore. “We tried crowdfunding because we saw it as the online version of physically pitching in front of angel groups. We were right: We had great success because we reached so many angel investors all over the country.”

While Bitvore also tried other equity crowdfunding platforms and had some success, Curie says Crowdfunder outperformed the others.

“We raised the most money there by quite a bit, and second, they were very responsive and helpful,” he says. “Great people, good service.”

Businesses on Crowdfunder typically raise $500,000 to $5 million and have 10 to 50 employees, Holt says.

The risk-averse nature of banks can make it difficult for small-business owners and startups to raise capital via a bank loan, Holt says. “Startups and small businesses are very risky investments. Ninety percent of startups and businesses fail, and the leading reason for that is undercapitalization,” he says. “I don’t think banks are willing to take risks, so it’s a very difficult and arduous process to go that route if you’re early-stage.”

Find and compare the best small-business loans

For more information about how to start and run a business, visit Nerdwallet’s comparison of small business loans.

Steve Nicastro is a staff writer covering personal finance for NerdWallet. Follow him on Twitter@StevenNicastro and on Google+.

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Top image via iStock. Ryan photo courtesy of TAR Productions. Hanson photo by Stacey Canfield.