Instead of borrowing from a bank, can I borrow funds from other sources that offer better terms?

Banks are not the only source of debt capital. Other sources include friends, relatives, independent investors firms and factoring firms that provide cash against receivables and other assets. There are pros and cons to doing business with all of these sources of debt.

Borrowing from friends and relatives can be relatively easy because they are more likely to believe that you’ll repay them, and more likely to forgive you if you can’t. However, if you are not able to repay your friends or relatives, you may find that you have spoiled an important relationship. This loss of a relationship can be much more painful than having a bad credit rating.

Independent investors are often willing to invest, particularly if they like your business model and are able to also get an equity stake. You may want to structure such an investment as convertible preferred stock, which provides both a coupon (interest) as well as the option to convert to common equity at a predefined conversion ration (e.g. one common share for each preferred share).

A non-bank finance company can also be a source of debt for an entrepreneur. Purchase-order financing companies provide funds to companies that sell import goods and distribute them locally. It is a relatively new line of business — about 20 years old — and a variation on the old and much larger business of factoring, in which a company sells an invoice at a discount to get immediate cash.

Purchase-order financing, though similar to factoring, focuses on purchase orders rather than invoices.

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