As banks and other financial institutions tighten loan qualification standards, and credit card companies slash limits and cancel accounts, it may seem that small businesses and start-ups are without a means of obtaining the funds they need to survive and expand. The current small business lending situation is quite the contrary; there are options available, and small businesses on the hunt for growth capital should consider the following alternative financing sources.
Merchant Cash Advances
Small businesses with high volumes of credit card sales are prime candidates for accessing funding through one of the more than 50 merchant cash advance providers in the U.S. The industry is a relatively recent development that has seen steady growth over the past few years, largely due to the credit crunch. Through a merchant cash advance, businesses may receive a lump sum as an advance on future sales. A percentage of daily credit card transactions then pay off the advance balance along with the provider's premium, which, depending on the company, could be 30% or more. In order to get an accurate assessment of the costs involved, business owners need to consider the percentage of future sales that will be used to pay back the advance, the premium rate and repayment term, and compute the annual percentage rate (APR) they will absorb.
Asset Based Financing
For a small business that has unencumbered assets, but doesn't qualify for traditional financing due to limited cash flow or other issues, asset based financing may be the answer. Small businesses looking for growth funding can use accounts receivable, real estate, patents, equipment or existing inventory as collateral to back an asset-based loan through a specialized lender or finance company, or even a local bank. This form of small business lending is similar to a revolving line of credit, where a business can make repeated drawn downs and repayments. The approval requirements of an asset-based loan are more flexible and less stringent than a term loan or mortgage, making them an attractive option for small businesses who may be short on credit history and financial documentation. An additional benefit is that interest rates are often relatively competitive with other types of small business loans.
A factor is a specialized lender who advances cash to a business in exchange for their accounts receivable; in essence, the factor purchases a company's A/R at a discounted rate, typically between 1.5% and 5.5% of the invoice's face value. At the time of the sale, a small business receives 70% to 90% of their receivable's value. The remainder, less the factor's percentage, is paid when the amount due on the invoice is collected.
There are two common types of factoring available that can allow a small business to access the cash needed for inventory purchases or other necessities. They can utilize full service factoring by selling all of their receivables to a commercial finance company, and allowing the factor to oversee credit checks and handle invoicing and payments; in this instance, customers are often notified of the sale of their debt. A second option, referred to as spot factoring, lets a business sell selected invoices to a factor, who may or may not notify the debtor. In both cases, individual invoices can be sold as recourse or non-recourse, depending on whether the small business or the factor assumes the risk of default by the customer.
This time-honored method of small business lending is now more readily available, thanks to the advent of the Internet. Peer-to-peer lending, in the form investment clubs, can be a viable source of micro loan funds for small businesses seeking lesser amounts of capital funding. A club's members contribute varying amounts, and the club approves loans from the pooled funds based on an applicant's creditworthiness, using the same criteria as a bank. An approved loan is often structured so that a borrower can repay the debt directly over the Internet.
Small businesses and relatively new start-ups are being drawn towards another new means of accessing capital funding that has become available thanks to the Internet. An extension and expansion of peer-to-peer lending, crowdfunding gives a small business a platform for reaching potential contributors around the world. There are an increasing number of specialized crowdfunding websites that will host a business's description of their project and public plea for funding, in exchange for a percentage of the total contributions. One of the major benefits of raising capital through crowdfunding is that individuals contribute in exchange for a token reward or perk, and repayment isn't required.
Royalty Based Financing
This form of small business financing has a long history in the United States, dating back to the early 1900's and the mining, oil and natural gas industries. With royalty, or revenue, based financing, a small business can access the capital funding needed for a variety of purposes based solely on their monthly revenue, which is ideal for small businesses or young start-ups who don't have the assets or credit history to qualify for traditional financing. All a business needs are a good track record of revenue and a strong customer base; personal guarantees are not necessary. Funds are advanced upon agreed monthly payments that are relatively low percentages of revenue, often 3% to 5%, over a specific time frame. One major benefit for any small business is that the monthly payment amount is directly tied to their revenue; if a dip in income occurs, the amount due for that period would decrease correspondingly.
If you have had difficulty qualifying for traditional loans or lines of credit, one of these six financing methods may be the ideal vehicle to propel your small business to the next level of growth.
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