Friday, February 18, 2011

Part II: Alternative Debt Sources for Small Businesses

Continuing from earlier this week, another source is purchase order financing. The ‘financing” is a bit of a misnomer. No company that I know of actually lends against the purchase order. Never say never, but I’ve talked to representatives of over ten companies that purport to offer purchase order financing. When I delve down what they actually offer is a letter of credit or guarantee of payment. For example, you need to manufacture 1,000 items to fulfill the terms of a contract with a large, credit worthy entity such as a government agency or Fortune 1000 company. The purchase order financing company would guarantee payment upon delivery or within 30 days to the manufacturer, using your purchase order as the “collateral”. So the financing entity has essentially inserted itself as a high credit-worthy company in order to get terms. Otherwise, you’d have to pre-pay the manufacturer for the order. Consequently, although it’s not officially ‘financing’, purchase order financing serves a business financing need.

Another debt source for small businesses is equipment loans or lease providers. These are typically industry-specific equipment manufacturers or distributors. Why industry-specific? Because the equipment providers know the industry, market, pressures, issues, etc. that help them determine whether or not a potential customer is credit worthy or not. Third party equipment loan and lease providers often span several different industries. They broaden their understanding of the dynamics in various industries by employing people who may specialize in one or two industries. The others understand how to credit assess small and medium businesses and what the red flag items are. If your company’s credit profile is iffy, I recommend pursuing a 3rd party equipment financing provider that specializes in two or three industries. These will have the highest risk tolerance because they are highly adept at identifying and mitigating risks in that market sector.

Other options include personal, rental, or business property credit lines and business credit or charge cards. These are very self-explanatory so I will not go into them. My only comment on business credit and charge cards is to get them without a personal guarantee, if you can. If you cannot, then make sure that you obtain the business credit card in your company’s name AND under your company’s tax id number and check in every quarter to either reduce or remove the personal guarantee (i.e., any association with your social security number). You will need to build your business credit to do this. That includes obtaining store credit, such as Staple’s or Office Depot, Home Depot or Lowe’s, etc. in your company’s name and tax id.

The next time I’ll cover the last three options I intend to cover in this series on alternative debt sources: supplier/vendor financing, micro lenders, and peer-to-peer lending.

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