In this two-part series, we examine how to start a business without a bank loan or venture capital

Part II: Family and Friends, Peer-to-peer lending, Future customers

By Reed Richardson

Family and friends

Tapping into your network of friends and relatives is a tried-and-true method for raising money-today, roughly one in ten Americans report having an outstanding loan with a relative or friend. Your friends and family are predisposed to care about your success and so are willing to listen to your small business pitch with a friendly ear. Often, just one conversation can lead to getting a hefty check worth thousands of dollars, with few, if any, strings attached. Compared to the increasingly lengthy and rigorous vetting process typically required by traditional banks and venture capital groups, it's easy to see why bootstrappers would be attracted to this easily accessible source of funding.

Still, it's an old adage that money owed among family and friends can greatly complicate relationships and turn once happy get-togethers into awkward, if not downright hostile, situations. As a result, entrepreneurs would be wise not to strike a cavalier tone or presumptuous attitude when asking for cash. For instance, instead of ambushing your rich uncle in front of everyone at a backyard family barbecue, you might want to invite him to lunch to hear your pitch one-on-one. Likewise, you should approach the meeting similar to the way you would a bank loan interview: Be ready to answer serious questions about the business, be detailed in explaining why you want the money, and-yes-be prepared to deal with rejection. In addition, it's a particularly good idea to formalize any family or friend-based loan with a promissory note, which should spell out the principal amount, interest rate (if any), and expected payback schedule. (To download a customizable sample of an unsecured promissory note from the U.S. Chamber of Commerce's Small Business Nation website, go here: http://www.uschambersmallbusinessnation.com/toolkits/tool/instal_m ) Or, if you'd like a neutral, third-party to administer your loans from friends and family, Virgin Money US (http://www.virginmoneyus.com/) can simplify the process by bundling them all together and setting up regular electronic funds transfers to each of them from the bank account of your choice.

 


Peer-to-peer lending

 

Peer-to-peer (P2P) lending involves matching up individuals or small businesses looking to borrow money with private individuals willing to lend it to them. If it sounds a lot like what the friends and family members of entrepreneurs often do to help fund a start-up, it is, except with most online P2P lending sites, the Internet lets lenders and borrowers from almost anywhere in the world join forces.

Most P2P loans are for relatively modest amounts, but as author and entrepreneur Greg Gianforte points out in Bootstrapping Your Business, an NFIB/Wells Fargo survey of business startups found that 70 percent of them were started for less than $20,000. P2P money doesn't come without a cost, however, as almost all online P2P lending sites expect borrowers to pay some kind of interest on their loan. The interest rates are sometimes lower than what your small business might find in normal capital markets, however, because many P2P investors are motivated by the prospect of being socially responsible and doing good. But be aware that posting the specifics of your loan request on an Internet site may require you to open up your small business to more public scrutiny than you're accustomed to. And just as with any normal bank loan application, there's no guarantee you'll get any or all of the funding you seek.

The most popular P2P sites all share the same general characteristics, but there are still important distinctions (including which states they can operate in) worth investigating before posting a loan request. Some, like Lending Club and Accion USA, make their money by charging a one-time loan initiation fee based on a percentage of the principal. P2P site Prosper also charges an annual loan-servicing fee on top of percentage-based closing costs, while non-profit P2P site RSF Social Finance adds an additional 4.0% to its prime interest rate (currently 5.0%) for all loans to cover its administrative costs.

Future customers

 

For small business owners whose start-ups aren't yet full-time endeavors, serial entrepreneur Thomas Frey recommends another, often overlooked, source of financing: future customers. "One good way to supplement your income while you're trying to launch your business full-time is to pick up freelance project work, within your chosen industry if you can," he says. "This is easier to do now since many established businesses are looking for help but want to circumvent the employer-employee relationship to save money."

According to bootstrapping expert Bijoy Goswami, this tactic is an increasingly popular way for bootstrappers to keep their endeavor afloat and learn more about the marketplace at the same time. "As a consultant, you can use your ideas to generate a steady source of income and network with potential customers before launching your business full-time, what I call entering the ‘Valley of Death,'" he explains. Then, when you do eventually take the plunge, Goswami says your business will be better positioned in the long-term. "For bootstrappers, that's when all these self-imposed financial constraints pay off, because they will have forced the business to focus on the customer, rather than some bank or VC firm, to give them the capital they need to succeed."

In case you missed it, be sure to check out Part I in our series Bootstrap Your Business: Part I , which covered personal funds, home equity, and credit cards as potential sources of start-up funding.

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