Tuesday, February 15, 2011

Alternative Debt Sources for Small Businesses

Beyond the traditional bank debt (term loan or line of credit), there are a number of alternative debt sources for small businesses. Typically small business owners think about credit lines and other loans that are guaranteed by their personal assets or by their signature when considering financing sources for their businesses. (Signature loans are more difficult to obtain in this somewhat restricted credit environment but they do exist.) However, numerous other options exist.

First, there are asset-based lenders. It is true that banks will lend against your receivables, but only if you have a track record of net income and cash flow (and receivables) that justifies the business credit line. For example, if you generate monthly account receivables of $100,000, have been doing so for 18 months, show a monthly profit of 8% or more, and have financial statements that show this, then your bank will lend you the money. However, if you recently garnered one or more new contracts and jumped from $60,000 per month in account receivables to $100,000, then the bank will only lend against the $60,000.What if your company does not have a profitable history of 12 months or more because it is new or you have had difficulty in the recent past? This is the space where receivables financing providers reside.

For small businesses with little or no history and minimal profit, factoring companies may be the answer. These entities purchase a company’s accounts receivables at a discount (typically 3-14%) and collect the payments directly from the company’s customers. Yes, factoring companies are expensive but for those starting out, recovering from losses, or in any number of similar situations, may be an excellent source of capital. The key is to only use factoring in the SHORT TERM. You must make a PLAN to move to cheaper sources of financing within the next 6-12 months, otherwise you could find yourself in a perpetual cycle of insufficient working capital due to high financing costs.

Another source of accounts receivable financing is accounts receivable credit line providers. These entities provide a line of credit against your accounts receivables. You collect from your customers and pay the loan provider. The receivables financing firm ensures they collect by placing a UCC lien against your accounts receivables. The typical range is 1% - 4% per month. The good thing about this type of financing is that more emphasis is placed on the credit worthiness of your client than on your company. So if you have a mid-sized or large company with a high credit rating as a customer, then your monthly interest rate will be lower.

Tomorrow I’ll discuss some of the other options.

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