Nontraditional Financing Sources Law & Legal Definition


Entrepreneurs can turn to a variety of sources to finance the establishment or expansion of their businesses. Common sources of business capital include personal savings, loans from friends and relatives, loans from financial institutions such as banks or credit unions, loans from commercial finance companies, assistance from venture capital firms or investment clubs, loans from the Small Business Administration and other government agencies, and personal or corporate credit cards. But for some businesspeople, these sources of financing are either unavailable, or available with restrictions or provisions that are either impossible for the company to meet or deemed excessive by the business owner. In such instances, the capital-hungry entrepreneur has the option of pursuing a number of nontraditional financing sources to secure the money that his or her company needs. Some of the more common nontraditional financing sources include selling assets, borrowing against the cash value of a life insurance policy, and taking out a second mortgage on a home or other property.

Selling Assets

Some entrepreneurs choose to sell some of their personal or business assets in order to finance the opening or continued existence of their enterprises. Generally, business owners who have already established the viability of their firms and are looking to expand their operations do not have to take this sometimes dramatic course of action, since their records will often allow them to secure capital from other sources, either private or public. Whether selling personal or business assets, the small business owner should take a rational approach. Some entrepreneurs, desperate to secure money, end up selling business assets that are important to basic business operations. In such instances, the entrepreneur may end up accelerating rather than halting the demise of his or her business. Only nonessential equipment and inventory should be sold. Similarly, care should be taken in the selling of personal assets. Items like boats, antiques, etc. can fetch a decent price. But before embarking on this course of action, the entrepreneur should objectively study whether the resulting income will be sufficient, or whether the enterprise's financial straits are an indication of fundamental flaws.

Borrowing Against the Cash Value of Your Life Insurance

Entrepreneurs who have a whole life policy have the option of borrowing against the policy (this is not an option for holders of term insurance). This can be an effective means of securing capital provided that the owner has held the policy for several years, thus giving it some cash value. Insurers may let policyholders borrow as much as 90 percent of the value of the policy. As long as the policyholder continues to meet his or her premium payment obligations, the policy will remain intact. Interest rates on such loans are generally not outrageous, but if the policyholder dies during the period in which he or she has a loan on the policy, benefits are usually dramatically reduced.

Second Mortgage

Some entrepreneurs secure financing by taking out a second mortgage on their home. This risky alternative does provide the homeowner with a couple of advantages: interest on the mortgage is tax deductible and is usually lower than what he or she would pay with a credit card or an unsecured loan. But if the business ultimately fails, this method of financing could result in the loss of your home. Using a second mortgage as a vehicle for financing a company is very risky and is best for people who want to borrow all the money they need at one time and secure fixed, equal payments.

Other Possible Sources of Financing

Some entrepreneurs obtain financing for growth and expansion through franchising or licensing. Basically, they get money by selling the rights to a unique business or product to other companies. Other small business owners are able to form alliances or partnerships with other firms that have a vested interest in their success, such as customers, suppliers, or distributors. These business owners may obtain funds from their partners through cooperative work agreements, barter arrangements, or trade credit. The Internet provides another potential source of leads for loans from nontraditional sources. For example, America's Business Funding Directory, at http://www.businessfinance.com, includes a searchable database of nontraditional funding sources.

Experts recommend using nontraditional financing to start a business or provide funds during periods of rapid growth, but emphasize that small business owners should consider it a temporary arrangement. The use of nontraditional financing is a last resort move and a business owner should make every effort possible to limit the time frame during which such financing is used.

SEE ALSO Financial Planning

BIBLIOGRAPHY

Caracciolo, Daniel, and Christian Fuccinos. "Non-Traditional Financing Alternatives and Their Tax Incentives." International Tax Review. December 2004.

"Creative Financing." Phoenix Business Journal. 29 September 2000.

"Despite Higher Interest Rates, More Fast Growth CEOs Report New Bank Loans and Increased Credit Lines: Many more considering non-traditional financing in next 12 months." Business Credit. February 2005.

U.S. Small Business Administration. Press Release. "Woman Business Owner Uses Non-traditional Financing for Non-traditional Career." 14 September 2005.

Vanac, Mary. "Alternative Financing Helps Small Businesses Bridge the Lending Gap." Business News. 15 August 1999.

                                  Hillstrom, Northern Lights

                                   updated by Magee, ECDI