With credit tight and traditional bank loans difficult to obtain, many small business owners are turning to the alternative financing industry to get the funding their business needs. “Alternative” financing can include a wide variety of options, some better suited to certain businesses than others. You should investigate each option to determine which is best for your business.
Accounts Receivable Factoring (Invoice Financing): One common form of alternative financing is accounts receivable factoring. For a business with a large amount of outstanding unpaid invoices, the AR factoring company provides your business with an advance of 70-90% of the value of the invoice and then assumes the responsibility of collecting the outstanding invoice from your customers. When the full payment is received, the factoring company claims their percentage fee and returns any remaining funds to your business.
Asset Based Financing: There are other financing options based on the tangible items in your assets column. In a leaseback (short for “sale-and-leaseback”), you sell fixed assets, such as real estate or vehicles owned by your company, to a buyer for an upfront sum, and then lease the asset back from the new owner at an agreed rate. Depending on the arrangement, you may or may not have the option to repurchase the assets at the end of the lease period.
Purchase Order/Inventory Financing: With purchase order and inventory financing, you borrow specifically to purchase inventory which itself functions as collateral for your loan. Purchase order financing works by providing an advance as a percentage of the full amount of an order. This option is useful for businesses with seasonal cash flow issues; providing capital for the inventory required at the start of the season before revenues have begun to be realized. It can also be helpful if you need to accommodate an increased sales volume, or if your suppliers require prompt payment for their products.
Revenue Based Financing: Some alternative financing options allow a business to repay the borrowed funds based on a percentage of future sales. Revenue based financing involves borrowing capital from an investor and then repaying that capital, plus a fee, or “cap,” with a percentage of future gross revenues. This option is generally best suited to businesses with an ongoing revenue stream and sufficiently high gross margins to allow for repayment.
Merchant Cash Advance: Similar to revenue based financing, a merchant cash advance (sometimes called a business cash advance) allows a business to receive a lump sum payment in exchange for a percentage of future credit card sales. Merchant cash advance companies usually receive payment directly from the credit card companies for each card swipe, instead of collecting from the business. These revenue-dependent forms of financing can be expensive, though, because the “loan” is viewed as a sale of future revenue, not a traditional loan accumulating interest over time, so usury laws limiting interest rates do not apply and cost of the “sale” is generally 20-30% of the upfront amount. Because of this, this should be viewed as a short term financing solution.
For all of these alternative financing options, current regulations are minimal. Be sure to carefully review all the terms and conditions of your financing choice before making an agreement. Many alternative options will cost you more than a traditional bank loan or line of credit, but depending on your business they may be more accessible and more practical than the traditional route, especially if you need fast, short-term funding. It’s certainly worthwhile to know what alternatives are out there for when your business needs a quick infusion of capital.
About the Author
Ked Harley is a writer and researcher for Biz2Credit Business Loans, a leading credit marketplace connecting small- and medium-sized businesses with small business loans , service providers, and complementary business tools. She is also a self-confessed coffee addict working out of New York City. Her interests include business and finance, world news, food, and travel, and she enjoys yoga and running in the park. Follow @Biz2Credit on Twitter for small business news and updates.
Published: May 29, 2013
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