Starting a new business can be daunting, but having the time and money to build one from the ground up is even more challenging. Over the last decade, it has become harder for startups and small businesses to secure a bank loan. Many banks have moved away from loans up to $1 million because of regulations and their old school ways of assessing credit. The difficulty in getting approved is compounded by the fact that lenders can take months to review applications and distribute funds. Moreover, banks often require independent business owners to put up their personal assets as collateral. For many aspiring entrepreneurs, risking their home in order to secure credit is just too risky.
The good news
There are other options such as crowdfunding that are quickly gaining momentum. According to the Crowdfunding Industry Report by Massolution, there was $2.7 billion raised online through crowdfunding in 2012 versus an estimated $5.1 billion crowdfunded in 2013. The concept of crowdfunding has existed since the early 2000s, but only recently emerged as a viable method for raising capital over the past few years. Entrepreneurs, innovators, artists and charities are now regularly taking to sites like Kickstarter and Indiegogo to raise money.
● Kickstarter has funded $480 million to almost 20,000 projects in 2013 through 3 million investors. Companies like Pebble (an early smartwatch), Goldieblox (a construction set and book series introducing girls to engineering) and even Oculus Rift (a virtual reality headset), which was subsequently acquired by Facebook, all got their beginnings in crowdfunding.
● Peer-to-peer lending led by such companies as LendingClub now offer loans citing that businesses can get a loan up to $100k in minutes.
● And, new financial companies like Kabbage provide working capital to small businesses based on their real-time data and social profiles. They claim that in a matter of minutes they can assess whether a company is in good financial health by analyzing their data directly from online accounting software such as Xero, social profiles on Facebook and Twitter, as well as other data from UPS shipping information and ecommerce sites like eBay, Amazon, Etsy, Shopify and Yahoo!
What's on the horizon?
I believe that we are about to start a new era of American capitalism led by the small guys like you and me and not just large investors. With the passage of the JOBS Act in April 2012, equity-based crowdfunding could become a reality. With equity-based crowdfunding, the general public will be able to purchase shares in startups and small businesses outside of exchanges like the NASDAQ and NYSE.
There is still progress to make before equity-based crowdfunding fully becomes a reality in the US. Title III, the portion of the law that makes it legal for non-accredited investors to participate in equity crowdfunding, is still being fleshed out by the SEC. It's taking time because the SEC is assessing the risks and wants to protect investors. Investing is always risky and there is an element of caveat emptor here. Successful investors will tell you that they heavily scrutinize a business before they commit any money to it. Ensuring a company's legitimacy is the first of many steps that should be taken.
There are some good funding alternatives for small businesses and the growth in this area continues to accelerate. It won't be long before you and I can get crowdfunded equity in our favorite startups and businesses. And it's only a matter of time before traditional banks are forced to innovate by offering lending alternatives to better compete with these new funding sources.