When raising capital, think outside the bank

The NFIB Small Business Economic Trends Report for June 2010 continues to show that owners complain about lack of access to capital. Despite the challenge, there are still plenty of options for finding the capital you need to start or expand a business. Instead of going to a bank or tapping your family and friends, consider some alternative financing options.

Small businesses can be successful in raising funds if they turn to those who know them best: their customers. Customers who want to see a business continue and grow because they enjoy the business' products or services may be willing to make small loans or investments. Here are some examples:

One chocolatier in the U.K. that was too small for a public offering arranged to borrow needed funds ("chocolate bonds") from its clients and repay them in chocolate. In return for the cash, the chocolatier promised a regular "tasting box" of chocolates delivered to investors' (gourmands'?) homes.

A specialty food market gave its customer-investors a discount each week based on the size of their investment. For a $10,000 investment, the customer-investor was entitled to $125 worth of groceries each week for two years, which amounts to a 30% return over two years.

Note: In the case of public companies, there are now rules governing loans from customers. While privately-owned small businesses don't have to follow these rules, it doesn't hurt to do so. This means, among other things, putting the loan and any modifications in writing.

If you're buying expensive equipment or stocking up on inventory, look to vendors or suppliers for help. A vendor or supplier may be willing to finance your purchase. The benefits:

The loan is easy to arrange. You don't need to present a business plan or complete a lengthy application.

The interest rates are usually more favorable than on other financing options, such as a credit card.

If your vendor can't loan money to you to swing a purchase, the vendor may have contacts with financing companies who can. There are lenders that specialize in financing for medical equipment, heavy machinery and other items. For more, read SCORE's tips on vendor financing here.

Enter a contest

Small businesses can find capital if they can be winners at national and local business-plan competitions. Many competitions are held at universities, such as MIT's 100K Entrepreneurship Competition, a yearlong series of events with three contests that focus on different skill sets, and Rice University's Business Plan Competition, which offers a top prize of $20,000 cash, plus an investment offer and $80,000 in services. These contests usually culminate with a winner announced in the spring; some require a student, faculty or alumni contestant.

Find information about business-plan competitions and their application deadlines at BizPlanCompetitions.com. (See related article about the work involved, "Competitions Might Not Be Worth Effort.")

Business-plan competitions aren't the only types of contests around. A variety of large companies offer contests from time to time that typically pay off in cash and/or prizes, including items or services from the sponsor. For example, Intuit Inc.'s Love a Local Business Contest gave $5,000 to winners around the country and a grand prize of $30,000 is to be awarded soon. Some contests are limited to technology businesses, women-owned companies, businesses in a certain city or other unique entrants.

Note: Contest winnings are fully taxable.

Grants are the best possible source of financing. Unlike contest winnings, they aren't taxable and, unlike a loan, you don't have to pay them back. Keep in mind: Grants typically don't cover all of your capital needs, and you usually have to pony up an equal amount for the project you're trying to finance.

Grants aren't easy to come by, despite what some spam emails may say. Often, grants are made only if they benefit the community. For instance, there may be state or local grants for child-care centers, for certain "green" projects or for a business promising to create jobs in an economically distressed area. To secure a grant, you must go through a rigorous application process and follow submission deadlines.

To find out about grant opportunities at the state level, check with your state's economy development agencies. Also look for federal grant opportunities on the government's site.

Looking ahead, your best banker is yourself. Create your own rainy day account by setting aside small sums on a regular basis. A corporation that doesn't distribute all of its profits in dividends has "retained earnings." But even if you aren't a corporation, you can set up a special savings account to build a reserve that can be tapped when and to the extent you need the funds.