There are a myriad of sources of business financing. While the financial crisis has decreased the availability of traditional business financing, many alternative types of financing have increased. There are a variety of reasons businesses seek financing; starting a new business, acquiring an existing business, buying out partners, expansion, working capital, capital expenditures, restructuring debt, marketing and advertising and research and development amongst others. Financing is either traditional debt financing through banks and credit unions or non-traditional financing though many sources such as self-funding, borrowing from family and friends, accounts receivable factoring, equipment financing, personal loans, unsecured lenders, credit cards, crowdfunding, retirement accounts, hard money lenders, bridge loan lenders, private money lenders and angel investors. Here’s an explanation of the many types of financing and their pros and cons.
Traditional financing is typically through banks or credit unions. Typically, they are term loans for a certain period of time, usually 7-10 years, at a certain interest rate, usually the prime rate plus a number of points depending on the loan’s risk with a loan origination fee, usually a couple of points. Banks and credit unions have lowered their risk tolerance, approving less loans, making them harder to get. Usually the loan needs to be significantly collateralized by hard assets such as real estate or equipment. Lenders want to see good business and personal credit scores. They also want a year or two of positive cash flow showing significant coverage to service the loan. They also want to see a fair amount of liquidity. Also, a personal guarantee is usually required. The U.S. Small Business Administration (SBA) offers government assistance to borrowers through a number of programs, helping in obtaining a loan. The loan is done through the bank or credit union and the SBA guarantees most of the lender’s loan, usually 90%, and the loan’s collateral and cash flow requirements are less. This helps lenders make loans that they themselves couldn’t make, helping the borrower get the loan. There are institutions that are preferred SBA lenders whereas they can approve the loan in house as opposed to going through the SBA, expediting the process. Be careful in your ability to repay to loan since lenders can come after your collateral and you personally. Because many businesses can’t qualify for a term loan through a bank or credit union, they’ve turned to the many non-traditional financing sources.
Most start-ups and even existing businesses self-fund with their own money. They borrow from family and friends. That could cause problems for the relationships if the money isn’t repaid. It’s a good idea to have written loan documents with family and friends, even if you’re self-funding to get repaid.
Existing businesses can factor their receivables with companies that specialize in that. They’ll advance money based on the amount of your accounts
receivables. The factor usually buys your receivables and gives you a percentage of their value, such as 80%. The fee is usually 3-5% of the total receivables. Businesses can borrow against their equipment using the equipment as collateral. There are companies that specialize in equipment financing. The amount of the financing depends on the current market value of the equipment and your ability to repay. Businesses can also lease equipment, forgoing large capital expenditures, and hold onto their cash. Most factoring and equipment financing companies will look at your business credit and, sometimes, personal credit.
Business owners can borrow against their personal assets, usually real estate, or get a personal loan based on their income and credit rating, to loan to the business. There’s many unsecured lenders that will lend based on the business’ revenues. They’ll usually lend a small percentage of the revenue, usually 10% of the annual revenues. These loans are typically on a shorter term, usually 6-18 months, at a higher interest rate, usually 20-40%, with higher fees of 5-10%. Credit cards offer cash advances, usually a percentage of the credit line, at also similar higher interest rates and fees. Unsecured creditors don’t require collateral.
Crowdfunding is a newer source of financing. There are numerous crowd funding sites that borrowers can appeal to investors who typically invest smaller amounts. It could take a while to raise the necessary funds, if at all. Credit worthiness and collateral are not factors in crowdfunding.
Businesses can rollover their 401k, IRA or other retirement funds into their business. This isn’t a loan. The business owner forms a C corporation which sponsors a profit sharing retirement plan. From there, the business owner uses the company retirement plan to buy shares in his own company, contributing to the company’s finances.
Hard money, private money and bridge lenders are usually companies or individuals that lend money to higher risk companies, usually at higher interest rates of 10-20%, for shorter terms from 3-5 years at higher fees of 3-5 points. They also want collateral and a personal guarantee.
Angel investors are usually private sources from companies or individuals that invest their capital in start-ups or companies with upside potential. They usually want an equity stake in the company and a share of the profits. They also usually have an exit strategy of 3-5 years to sell their stake back to the business owner. The fees and buy out costs are usually higher. Most angel investors want around a 30% return.
As you can see, there a variety of business financing sources. Before securing any financing, determine your actual financing needs and ability to repay. Sometimes the financing can cause more problems than the problem they were seeking to solve. There’s also disreputable lenders praying on desperate business people that need funding that charge up-front fees and never deliver on the loan or get you into a loan that’s too costly and unsustainable. This could ruin your credit. Use caution and get professional advice. I wish you success in your financing acquisition and business. Let me know if I can help.