Four ways to find financing for your small business.
1. Invoice Factoring
Invoice factoring is a type of alternative financing in which a factoring company, also known as factor, will buy unpaid invoices from you for an advanced cash payment. You receive advanced funding from these outstanding invoices instead of having to wait for the collection period of 30-120 days and you can use the immediate funding for any business-related expenditure. The factor will then collect the invoice amount from your customers and will deduct a percentage as a fee for services and charge interest on the advanced amount. However, total fees and interest may be considerably cheaper than borrowing from a credit card or hard money lenders.
Invoice factoring is intended primarily for businesses that rely on invoices payments from their customers. Due to the many months that it takes for customers to pay invoices, invoice factoring is a great financing option to bridge the funding gap. You can decide to trade having to wait for full payment in exchange for receiving immediate funding with a fee and short-term interest, which is highly beneficial for companies with cash flow shortage problems.
There are two types of invoice factoring: recourse and non-recourse. In recourse factoring, if your customer defaults on the invoice payment, you will be required to pay off the outstanding invoice amount. In non-recourse factoring, the factor will assume most of the risk of non-payment from your customers, and thus, charges a higher factoring fee.
Another thing to be aware of is that factoring companies will look towards the creditworthiness of your customers. Thus, if startups or companies with low credit have creditworthy customers, they are likely to be approved for invoice factoring. Even if your customers are not creditworthy, you can still qualify for recourse factoring.
2. Asset-Based Lending
Asset-based lending is a type of alternative financing which can be structured as a loan or line of credit and is collateralized by the assets you own or intend to buy. If you fail to make payments, then the financing company has the right to seize your pledged assets.
The amount of an asset-based loan will be based on the total appraised value of the collateral, with liquid assets being more highly valued. Accounts receivable is a commonly pledged asset, due to its high liquidity. Less liquid assets such as equipment, inventory, and real estate can also be used as collateral but will offer less appraised value.
Although your company assets are being offered as collateral, your creditworthiness is still considered, which may affect interest rates charged by an asset-based lender. An asset-based loan also has flexibility in terms of how the loan proceeds can be used, provided they are used solely for business expenditures.
The potential risks of asset-based lending include losing pledged assets if the borrower is unable to make payment. Asset-based lending may also have high costs, which can be further exacerbated if a company does not have the kind of assets that the lender requires or prefers.
3. Business Line of Credit
A business line of credit is a fixed amount of money that lenders is set to provide for borrowers to draw down from when the borrowers need money. These funds can often be used for various purposes, from short-term expenses to funding projects. Not only do banks provide a business line of credit, but so do alternative lenders. Alternative lenders provide you a business line of credit based on different criteria and often much quicker and easier than traditional banks can.
It is important to note that it is difficult to get a business line of credit from a bank. Because a line of credit is much more beneficial to borrowers than it is to banks, it is actually against the interests of banks to issue a business line of credit. Borrowers immensely benefit from this financing option because they can withdraw any amount whenever they want and interest will only be charged on the amount withdrawn. This is disadvantageous to banks because they would need to have a set amount of money reserved for your line of credit and they can only charge interest on the amount withdrawn. Banks would rather issue term loans because they can charge interest on the entire loan amount. For these reasons, businesses usually have to turn to alternative lenders to get a business line of credit. Even then, it is still difficult to get a business line of credit from an alternative lender – though it is much easier than getting it from a bank.
4. Merchant Cash Advance
Merchant cash advances are structured similar to a loan despite being a cash advance. After forwarding the borrower the cash, an MCA buys the rights to take a percentage of your future sales.
The benefit of an MCA is that the requirements to qualify are minimal. Your business needs to have sales and credit sales over the past 6 months. MCAs can provide their cash advances within a couple of days.
However, a merchant cash advance will be exponentially more expensive than other options and can cause problems in a company’s future cash flow. This can be further exacerbated if your chosen lender has predatory practices.
Overall, merchant cash advances can solve short-term problems and require little from your company, but this should only be considered as a last resort option.
There are many different kinds of alternative financing options depending on your funding needs. Make sure that you thoroughly research your options so that you can choose the option that works best for your business.
Tristan Kim is an account executive at Accel Business Funding, a company with over 22 years of experience of funding more than $380 million to a variety of businesses. He is often in the middle of a book as he is in front of a computer or hosting a board game group.