How to secure the financing to grow your business in a tight credit market

Eric Fricke, Assistant Professor of Finance, Department of Accounting and Finance, California State University, East Bay

Despite a stabilizing economy and a letup in the banking crisis, small community banks approved approximately 47.5 percent of commercial loan applications in January, while banks with more than $10 billion in assets approved just 11.7 percent, according to Biz2Credit.

In comparison, lenders like community development financial institutions, accounts receivable financers, merchant cash advance companies, micro lenders and others approved more than two-thirds of applications from potential borrowers. The data confirm that executives have to be resourceful and think outside the box to secure the funding they need to expand their small or mid-size business in today’s tight credit market.

“Executives may be forced to restructure, cede market share or relinquish prime opportunities unless they avoid a short-term cash crunch by securing alternative funding,” says Eric Fricke, assistant professor of finance, Department of Accounting and Finance at California State University, East Bay.

Smart Business spoke with Fricke about the ways to finance growth by tapping alternative funding sources.

How can alternative financing help small and mid-size companies grow?

It’s great when a small business consummates a big sale, but it often ends up being a catch-22, because small and mid-size companies may not have the cash to purchase equipment or inventory to fulfill a substantial order. Alternative financing provides up-front capital when traditional commercial loans aren’t available. Best of all, the loans are scalable and may be easier to secure because they’re tied to a specific asset or invoice, so you may not need to submit a full business plan, financial statements and cash flow projections as is normally necessary to comply with today’s strict underwriting requirements.

When is alternative financing appropriate?

Alternative loans are perfect for businesses that have predictable cash conversion cycles. For example, importers and exporters have to advance cash to purchase products, and then wait until  they reach stores and finally sell. And retailers and restaurateurs may have immediate needs for cash but can’t wait for future credit card transactions to finalize. Companies can close the gap in cash conversion cycles by securing a loan tied to a particular transaction, like accounts receivable, inventory, machinery, equipment and/or real estate.

What’s the best way to research and uncover alternative funding sources?

Sometimes traditional banks offer asset-based loans and other forms of alternative financing. But, you can find additional sources by searching the Internet or contacting your industry association and equipment manufacturers, since some vendors offer financing if you purchase their products.

What are the best sources of funding?

These are common sources of alternative funding.

  • Asset-backed loans. Asset-backed loans are secured by collateral like accounts receivable, inventory or equipment and they may be easier to get because the lender may consider the credit worthiness of your customer. So, if you’ve sold a large number of T-shirts to a major retailer, a lender may be willing  to lend you money against that invoice because of the retailer’s ability to pay.
  • Equipment leasing. Equipment leasing is a popular option for companies with limited capital because the bank or equipment manufacturer purchases the equipment and leases it back to them in exchange for a monthly payment.
  • Factoring. Factoring lets you sell your accounts receivable to a third party. The factoring company buys your invoice from you for an amount below the actual invoice amount. You get the up-front cash you need to fulfil the order and the factor collects the invoice once the transaction is complete.
  • Merchant cash advance. This provides a lump sum cash payment in exchange for a percentage of future credit card or debit card sales. It facilitates cash flow because the lender deducts a portion of every credit or debit transaction until the debt is repaid.

What’s the downside to alternative funding?

Alternative loans tend to be more expensive than traditional loans, but the costs may be more easily allocated to certain customers, so you can more easily build the costs into the price of your products and services. Plus, the loan amount is scalable with your sales or a particular transaction instead of being tied to your net worth or cash flows. Some executives view the outsourcing of accounts receivable to a third party as a welcome benefit, while others like to maintain control of the collections process and client communications. But, for most owners, the benefits of accessing funds on an as-needed basis without navigating a grueling underwriting process far outweigh any drawbacks.

What else should owners know before pursuing an alternative loan?

Shop around, because the costs of alternative funding vary among banks and other financial institutions, and if possible  factor the cost of your financing  into your pricing. Finally, read the fine print to make sure you understand not only the costs, but also the process and timeline for distributing funds, since some lenders may collect receivables for you and delay dispersal of funds from risky sales orders.

Eric Fricke is an assistant professor of finance in the Department of Accounting and Finance at California State University, East Bay. Reach him at (510) 885-2064 or [email protected]

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