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Beyond the traditional bank debt (term loan or line of credit), there are a number of alternative debt sources for small businesses. Typically small business owners think about credit lines and other loans that are guaranteed by their personal assets or by their signature when considering financing sources for their businesses. (Signature loans are more difficult to obtain in this somewhat restricted credit environment but they do exist.) However, numerous other options exist.
First, there are asset-based lenders. It is true that banks will lend against your receivables, but only if you have a track record of net income and cash flow (and receivables) that justifies the business credit line. For example, if you generate monthly account receivables of $100,000, have been doing so for 18 months, show a monthly profit of 8% or more, and have financial statements that show this, then your bank will lend you the money. However, if you recently garnered one or more new contracts and jumped from $60,000 per month in account receivables to $100,000, then the bank will only lend against the $60,000.What if your company does not have a profitable history of 12 months or more because it is new or you have had difficulty in the recent past? This is the space where receivables financing providers reside.
For small businesses with little or no history and minimal profit, factoring companies may be the answer. These entities purchase a company’s accounts receivables at a discount (typically 3-14%) and collect the payments directly from the company’s customers. Yes, factoring companies are expensive but may be an excellent source of capital for those businesses just starting out, recovering from losses, or in any number of similar situations. The key is to only use factoring in the SHORT TERM. You must make a PLAN to move to cheaper sources of financing within the next 6-12 months, otherwise you could find yourself in a perpetual cycle of insufficient working capital due to high financing costs.
Another source of accounts receivable financing is accounts receivable credit line providers. These entities provide a line of credit against your accounts receivables. You collect from your customers and pay the credit line provider. The receivables financing firm ensures they collect by placing a UCC lien against your accounts receivables. The typical fee range is 1% – 4% per month. The good thing about this type of financing is that more emphasis is placed on the credit worthiness of your client than on the creditworthiness of your company. Therefore, if you have a mid-sized or large company with a high credit rating as a customer, your monthly interest rate will be lower.
Another source of alternative financing is purchase order financing. The ‘financing” is a bit of a misnomer. Rarely does a financing provider actually lend against the purchase order. In conversations with representatives of over ten companies that purport to offer purchase order financing, when one delves down, what these providers actually offer is a letter of credit or guarantee of payment. For example, you need to manufacture 1,000 items to fulfill the terms of a contract with a large, credit worthy entity such as a government agency or Fortune 1000 company. The purchase order financing company would guarantee payment upon delivery or within 30 days to the manufacturer, using your purchase order as the “collateral”. Thus the financing entity has essentially inserted itself as a high credit-worthy company in order to obtain terms. Otherwise, you would have to pre-pay the manufacturer for the order. Consequently, although not officially ‘financing’, purchase order financing serves a business financing need.
Another debt source for small businesses is equipment loans or lease providers. These are typically industry-specific equipment manufacturers or distributors. Why industry-specific? Because the equipment providers know the industry, market, pressures, and issues that help them determine whether or not a potential customer is credit worthy or not. Third party equipment loan and lease providers often span several different industries. They broaden their understanding of the dynamics in various industries by employing people who may specialize in one or two industries. The others understand how to credit assess small and medium businesses and what the red flag items are. If your company’s credit profile is iffy, consider pursuing a 3rd party equipment financing provider that specializes in two or three industries. These will have the highest risk tolerance because they are highly adept at identifying and mitigating risks in that market sector.
About the Author: Tiffany C. Wright is President of Toca Family Business Services, a strategic advisory firm that provides interim CEO, COO and CFO services. She is the author of Solving the Financial Equation: Financing Solutions for Small Businesses, available at Amazon.com, and HELP! I Need Money for My Business Now!, available at http://www.financeyourcompany.com. In the last five years she has helped companies raise over $31 million in funding. For more regular insights on business financing and management, view/subscribe to her blog at http://www.Cash4Impact.com.
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