A Primer on Alternate Forms of Business Funding

Today’s post will cover a number of forms of financing available to an existing small business.  Traditional bank loans and lines of credit are not always available to all borrowers for a variety of reasons: insufficient operating history, bad credit, lack of collateral, changing lending policies, etc.  That does not mean that businesses in that fall outside of a bank’s sweet spot are un-fundable; in fact, there are thousands of specialized lenders who look for exactly these sorts of borrowers and can oftentimes advance cash quickly and with less documentation than a bank or credit union might.  Many of these lenders are asset-based lenders and below we present four forms of alternate financing for borrowers:

  • Invoice Factoring:  This is a very old form of financing where a third-part, a factor, lends against outstanding accounts receivable balances.  The factor will typically purchase a company’s receivables, advance cash (usually 70-90% of the face value of the receivables), and then take responsibility for collecting the amounts due from customers.  When collections come in, the factor will remit the money back to the company less finance charges and other fees.  The interest rates for this, and most of the other types of financing mentioned in this post, can be expensive, but as a trade-off, the cash can be made available quickly.
  • Purchase Order Financing: Here’s a common scenario: you’ve just sold a job (i.e., have got the signed purchase order in hand), but can’t collect any revenue until some time after the project begins, but you have to pay your suppliers for materials to get the job started.  For many companies, this creates a severe working capital problem.  Recognizing that the likelihood of payment is high in many of these situations, some lenders will provide capital against these purchase orders.  The duration is usually pretty short, but for businesses that are low on cash or growing quickly, this can be an attractive method of raising short-term capital.
  • Inventory Financing:  Simply put, inventory financing is when a business receives a loan and pledges their inventory as the collateral for the loan.  If your business carries a lot of inventory and turns it frequently, you may be a good candidate for this form of financing.  If you hold slow moving inventory, have a poor history of sales or credit, or are a start-up, you may find it more difficult to access this type of capital.
  • Peer-To-Peer Loans: The newest form of loans on this list, peer-to-peer lending uses the Internet to draw together large numbers of potential individual lenders (called “crowd sourcing”) who are looking to earn a respectable return on their capital, but also desire to help a person or business directly.  Prospective borrowers sign-up on the site, create their profile, and make their pitch.  If enough lenders are interested, they all participate and the deal gets funded.  This idea has seen significant growth, particularly for consumers seeking loans, but now businesses are starting to get into the action.  There is also a movement to get Congress to expand some existing financing laws in order to enable business borrowers and start-ups to use this channel with great effectiveness.  This is definitely an area to keep an eye on in the coming years.
There are many ways to raise capital for your business, whether it is to provide working capital, to grow, or even to start a business.  Becoming familiar with the different options and providers of capital is a worthwhile exercise for any small business owner and it is never too early to start.
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Dec 2011