Alternative funds for small business

The financial system in the United States is set up to be easily used by large businesses. It's a bit of a self-reinforcing system, because big business also has the political clout to encourage changes that will benefit them.

WHEN SANDY CORSO launched PeacefulCompany.com, a web site that sells products to soothe the mind, body and spirit, in 2002 her friends and family were skeptical. And so, too, were potential lenders. "The banks thought I was crazy, and they would not give me a loan," says Corso, of Madison, Conn.

As the quote shows, small businesses can find it difficult to get capital. Women and racial minorities who may just be breaking into the business world may be especially vulnerable to these additional barriers. They may then miss out on a an opportunity to empower themselves.

However, Smartmoney's Small Business also shows us that the financing world is changing with disruptive Internet technologies. Small businesses in the Global South, many of them owned by women, have been able to access microfinance initiatives like Grameen Bank. The model is starting to spread to the West. Additionally, peer to peer lending networks like Prosper potentially enable people anywhere in the world to lend to other people anywhere in the world.

The article also mentions credit unions. Credit unions have long been available in the US, which has the largest number of credit unions in the world. The model of cooperative banking apparently originated in Western Europe, as this Wikipedia article contends. They apparently exist in as many as 97 countries. Additionally, there are some private lenders that may take time to understand your business, and make you a loan based on that rather than some formulaic credit score.

Merchant cash advances are listed as another option.

Merchant cash advances or "factoring" has seen a surge in demand since banks retreated from lending. Under this type of financing, a company doles out a cash advance (usually, a lump sum) to a small merchant or entrepreneur. Then, the merchant repays the sum by routing a portion of their future credit-card sales back to the cash-advance company, generally at a hefty premium.

"Yes, it's more expensive," says David Goldin, chief executive of AmeriMerchant, a New York factoring company that plans to advance as much as $100 million to merchants this year. Other players in this field include AdvanceMe, Advance Restaurant Finance, or ARF, and Liquid Capital. But there are advantages, he says: Borrowers get the money with far less paperwork and collateral than a bank would demand. They don't have to take on investors or give up equity. And if they can't pay the advance back, the factoring company absorbs the default.

Unlike a bank, a factoring company isn't considered a creditor if the business goes belly-up — hence the reason for the higher fees, Goldin explains. "You sign up for a bank loan, and you default — guess what, they're taking your house; they're going to sue you personally," Goldin says. "I have no recourse."

Just how expensive is it? Merchant cash advances are often compared to short-term loans that have double-digit or even triple-digit interest rates. Factoring companies typically advance 70% to 90% of the amount they ultimately collect. AmeriMerchant, for instance, might advance $30,000 to a cash-strapped restaurant, but then collect $36,000 over a period of six to nine months. (In the industry vernacular, AmeriMerchant says it purchases a business's future credit-card sales at a 20% "discount.")

Critics say factoring companies charge excessive rates for short-term capital and that terms can be confusing or vague. For tips on factoring, check out SBA-affiliate SCORE's list here. Keep in mind, this type of financing is available to merchants that conduct a lot of credit card transactions, such as restaurants, retailers and hotels.

In my opinion these folks are a few steps up from payday lenders. This should have been listed as the last option.