Access to credit facilities in form of loans, overdrafts, and financing is one of the lifeblood of business. Many businesses need to borrow money to get off the ground and other businesses need a cash infusion in order to scale, grow or expand into new markets. For some businesses, getting business funding is hard because the lender wants to examine the creditworthiness of the stakeholders of the business. Others find it hard to raise money because lenders want to see realistic financial projections of the businesses’ ability to grow profitably.
Unfortunately, getting funding is exponentially tougher for small businesses in startup stage. Except for glamor startups that could find ways to go through the VC route to raise funding, most startups usually have very few options to raise funding to get their ideas off the ground. Here’s why it’s hard to raise startup funding from conventional sources.
Here’s why startups find it hard to raise funds from traditional sources
The first reason new small businesses find it hard to raise funding from conventional sources is that they have little proof of creditworthiness. Traditional financial institutions want to be sure that that the business will be able to pay back the loan with interest in good time. However, lenders won’t just take the words of the business owner on the creditworthiness and potential profitability of the business.
Most lenders won’t be comfortable lending money to a business that has not been in operation for at least six months. Some lenders will also be skeptical of lending money to a business that has not shown operations profit. For instance, Australian Sail Business Loans is a brand new Australian lender with lower minimums than some older lenders; yet, it won’t provide credit facilities businesses that are less than 6 months old.
Some business owners might try to bridge the creditworthiness gap by offering assets as collateral. Unfortunately, traditional lenders would still be skeptical about lending money even if the business owner provides a personal guarantee to pledge his personal credit on behalf of the company.
Secondly, it doesn’t always make business sense for a lender to provide credit facilities to new startups. Lenders usually have to consider the cost of regulation surrounding business financing in order to avoid flouting the law. Lenders have to consider the cost of capital in relation to the interest that startups are willing to pay on short-term business loans.
Crowdfunding is not always the best source of funding
Many small businesses now look towards the crowdfunding market to raise the much-needed capital to turn their concepts into tangible realities.
There are about 600 crowdfunding platforms and about $34 billion has been raised globally through such platforms. About $25B of the amount raised was used on peer-to-peer lending platforms. About $5.5 billion were donations aimed at supporting projects, causes, and events. Only $2.5 billion of the money raised was directed towards equity crowdfunding in which small businesses raise money from backers.
Based on the data above, crowdfunding, which appears to be the last hope of funding for small businesses doesn’t necessarily provide guaranteed funding for entrepreneurs. To start with, your story/product might not resonate with potential backers and all the time and energy spent on creating a crowdfunding campaign would end up being lost. Secondly, you could underestimate how much you really need to get your business to the next level, your backers could sue you if the promised growth didn’t materialize after their initial contributions.