Are There Better Ways for Small Businesses to Obtain Growth Capital Than Traditional Banks?
There is a lot of lip service touting small businesses as the backbone of the American economy – which they are.
But when small businesses require new capital – especially if it is a new business or one coming out of Chapter 11 bankruptcy – it seems like that backbone has no support.
Who hasn’t put on their best suit for a visit to the bank, only to wilt under the withering gaze of a banker refusing to sign off on a loan?
What small business owners need to know is that the traditional route – going to the bank –is not the only route or even the best way to obtain growth capital.
If you’ve reached the point where you are pulling out your credit card to keep your business afloat, take heart. There are far better options.
- Asset-Based Finance. Troubled businesses large and small have long found the asset-based lending (ABL) industry to be the best source of capital. ABL loans use inventory as collateral rather than relying on a credit score. This translates into more documentation for the borrower, who needs an evaluation company to put a price on the collateral. It also requires more paperwork over the course of the loan. Until recently, the biggest drawback to ABL loans was the time-consuming process, but today’s technology has sped up the timeline considerably.
- Pros: Loans are based on collateral, not credit score
- Cons: The loan amount is limited by the value of the collateral. Depending on the amount needed, a second lien loan may be required as a supplement.
- Factoring. Good King Hammurabi laid down the regulations for factoring in his famous code back in 1800 B.C.E. A factor will purchase your invoices and receive a fee ranging from 2% to 4% of their value. It is a simple transaction, long a staple of the garment industry, but today free-lance writers, psychologist and other independent professionals find factoring is the easiest way to get cash in hand at a reasonable cost. An added bonus: it relieves the business owner from the time-consuming process of billing its customers, since the factor takes on that job along with the debt. Traditional factors now complete with modern fintech factors, who have the funds in your account in as little as 48-hours.
- Pros: These are not loans. This is capital in your pocket for a small percentage.
- Cons: Again, the amount of capital is limited by the amount of your invoices.
- Purchase Order Finance. In many ways, PO finance is factoring in reverse order – instead of purchasing invoices, the PO company pays cash upfront to pay for goods or materials to complete an existing job. For example, if your company receives a large order to produce ski jackets but doesn’t have enough cash on hand to purchase the raw materials, PO financing will pay the supplier to obtain what you need. After the order is complete, your company can repay the PO company by factoring the invoices for the completed product or obtaining asset-based financing based on inventory. The PO company will deduct its fee for the service.
- Pros: PO finance is especially helpful for manufacturers and contractors who need to purchase materials in advance to complete their jobs.
- Cons: It is not applicable to every small business situation
- Fintech. Once the province of peer-to-peer lenders targeting consumer loans, today’s business-oriented fintech companies are receiving large cash infusions from major banks. While the banks themselves continue their snail-like pace for loan approval, these online lenders use proprietary algorithms to determine credit-worthiness instead of that old standby – the FICO score. Borrowers can apply online and have the capital in their accounts in days, rather than weeks.
- Pros: Convenient online application and approvals using algorithms more sensitive to the needs of start-ups and small businesses than FICO scores are.
- Cons: Not all fintech lenders are equal. A few still engage in predatory lending so it pays to check each company carefully. And because of the greater risk, the interest rates are higher than a conventional bank loan.