Challenges force innovation. With so many people’s credit messed up thanks to the recession and banks in trouble due to the mortgage crisis, borrowers and lenders have had to seek out new approaches to financing.
Microfinance, which has traditionally been reserved for entrepreneurs in the developing world, has been growing in popularity recently in the West thanks to recent changes in the law that have opened up capital and eased operations for microlenders.
How does the microfinancing model translate to the West? Where that aspiring nonprofit in Asia would just need a small amount of money to rent out an office and hire staff, the American equivalent would require ten times the amount in rent and wages. The loans are larger, but it’s essentially the same concept.
Microlenders see you as more than the sum of your FICO score and assets. You’re an entrepreneur who wants to succeed with your start-up. They evaluate your level of experience, your business opportunity, and your desire in achieving it. It’s more of a personal connection, not just a numbers game.
Microloans can be obtained through Community Development Financial Institutions (CDFIs)—mission-driven financial institutions such as credit unions and community development corporations that operate on a local level. Some of the original CDFIs in the late 1960s formed around efforts to alleviate poverty and improve communities in other ways. Their vision is similar to that of many nonprofits and as a result have an interest in seeing them succeed, making them a fine place to turn for funding.
If you have a great idea to start up a nonprofit, but crappy credit, you still may be considered for a loan. What’s the catch? There always has to be a downside and to microloans, that downside is that interest rates are higher than typical bank loans. For those not willing to pay out the extra interest, however, there are other alternatives.
Peer-to-peer lending
Peer-to-peer (P2P) file sharing forever changed the media world with services like Napster making file transfer easy and effective. It’s a system based on connection between people and sharing of resources. P2P spawned a change of thinking in the finance world as well.
P2P lenders such as SoMoLend advertise borrowing rates as low as 3 percent on their website. SoMoLend was started up by Candace Klein, founder and CEO of nonprofit Bad Girl Ventures, a microfinance organization focused on educating and financing woman-owned startup companies. With the connection to Bad Girl Ventures and the mission statement, “To change the world,” SoMoLend is clearly a P2P lender that wants to support organizations committed to improving the world.
For borrowers, microlending is a great system—gain access to credit despite a low credit rating. For lenders, it’s not necessarily all that good. Some of the sites such as Prosper have been known to suffer from high default rates, and have dashed the hopes of many aspiring microbankers. Though others such as Lending Club have been known to do a better job pre-screening clients, thus reducing risk to lenders.
Merchant cash advance
In this financing arrangement, a merchant cash advance company pays a lump sum to a business then extracts regular payments directly from future debit and credit card sales. Though rates can get quite expensive, from 10 to even 100 percent, they have the benefit of changing with sales volumes—when sales slow, payments slow. Once business picks up, so do the payments. For example, a business asks for $10,000, then pays back five percent from every credit card and debit card transaction until it has paid off the agreed amount of say $12,500. The system works well, but only for those organizations that have goods or services to sell by credit or debit.
Crowdfunding
If you have a creative idea that you think others would like to back, Kickstarter is a great opportunity. As the world’s largest funding platform for creative projects, it can attract a number of small-bucks investors using the all-or-nothing funding approach. If an organization sets a goal of $5,000 and attracts just $4999 by the deadline, they get nothing.
Kickstarter is open to projects that typically deliver something and have a timeline. For example, a band wants to release a record, so they get funding to record, produce, and press 1000 copies. And kickstarters also get something. They receive a gift based on how much they give. In this case a pledge of $25 would likely get them an autographed CD.
With age comes diversity of choice. The world economy has suffered its ups and downs, growth spurts and bursting bubbles. But like any resilient system, it adapts. As we gain the tools to connect to others and the knowledge to want to connect with others, we’re evolving the economy and improving the financial system with it.
image: 401(K) 2012 (CC BY-SA 2.0)
