In addition to crowdfunding, microlending is a possible alternative for small businesses seeking alternative forms of investment. Many entrepreneurs believe that microlending is only a funding option for projects in developing countries. However, microfinance has been proven to work in the U.S.; and, as many microlenders provide pro bono consulting and training along with a loan, microfinancing can be a great option for entrepreneurs just starting out. Here's what you need to know about this financing model.

What is microlending?

Microlending, also known as microcredit, is a type of funding in which small loans are issued by individuals, rather than banks or other credit institutions. These loans can be used by entrepreneurs or business owners to get their idea off the ground or to expand their business with a little extra cash. In that sense, microlending isn't all that different from a small business loan.

Where microlending is unique is in the intent behind the loan. Traditional lenders may seek to earn a profit on their loan by charging interest or fees. Microlenders are interested in investing in the development of an idea or business. The main goal of a microloan is to help a small entrepreneur who may not have access to traditional funding and would not otherwise be able to borrow money.

As such, many microlenders are mission-based: They offer loans from nonprofit organizations or government programs that aim to help disadvantaged communities. Along with loans, microlending bodies will also provide coaching and training to build a strong business foundation. In turn, this helps ensure that the borrower is eventually able to pay back their loan.

Globally, the size of a microloan varies. In the U.S., the Small Business Administration classifies anything under $50,000 a microloan. Microloans can be as small as $25 or $50.

How does a microloan work?

If you have bad credit or no credit, microloans may be an option. They are designed for communities that are often excluded from traditional funding options: minorities, women, veterans, freelancers, consultants, sole proprietors and new startups with only a few employees.

Each microlender will have different requirements and loan terms; but, in general, a microlender will evaluate applicants' credit scores, business revenue, other sources of income, business plan and the duration of time you've been in business to assess whether you're a good candidate for their loan program.

Small businesses can use microloans for a variety of activities -- not just to get started. Some common uses for microloans include:

  • Buying inventory or supplies.
  • Covering payroll or employee training costs.
  • Paying for seasonal expenses.
  • Investing in a new marketing strategy or campaign.

As compared to traditional loans, microloans tend to have low-interest rates and are more flexible in terms of qualification requirements. They come with longer payback periods, sometimes up to six years.

Top microlending sites

Explore some of these microlenders to see if any of their loan options are a good fit for you. Many microlenders are state- or region-specific. The SBA also maintains a list of microlending partners by state.

Alternately, Prosper and LendingClub are peer-to-peer options that mimic crowdfunding sites like GoFundMe. Peer-to-peer microlending is a model where the site connects individuals who provide small-size loans to businesses in need.

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