There are several
potential financing options available to cash-strapped businesses that need a
healthy dose of working capital. A bank loan or line of credit is often the
first option that owners think of - and for businesses that qualify, this may
be the best option.
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In today's uncertain
business, economic and regulatory environment, qualifying for a bank loan can
be difficult - especially for start-up companies and those that have
experienced any type of financial difficulty. Sometimes, owners of businesses
that don't qualify for a bank loan decide that seeking venture capital or
bringing on equity investors are other viable options.
But are they really?
While there are some potential benefits to bringing venture capital and
so-called "angel" investors into your business, there are drawbacks
as well. Unfortunately, owners sometimes don't think about these drawbacks
until the ink has dried on a contract with a venture capitalist or angel
investor - and it's too late to back out of the deal.
Different
Types of Financing
One problem with
bringing in equity investors to help provide a working capital boost is that
working capital and equity are really two different types of financing.
Working capital - or
the money that is used to pay business expenses incurred during the time lag
until cash from sales (or accounts receivable) is collected - is short-term in
nature, so it should be financed via a short-term financing tool. Equity,
however, should generally be used to finance rapid growth, business expansion,
acquisitions or the purchase of long-term assets, which are defined as assets
that are repaid over more than one 12-month business cycle.
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But the biggest
drawback to bringing equity investors into your business is a potential loss of
control. When you sell equity (or shares) in your business to venture
capitalists or angels, you are giving up a percentage of ownership in your
business, and you may be doing so at an inopportune time. With this dilution of
ownership most often comes a loss of control over some or all of the most
important business decisions that must be made.
Sometimes, owners are
enticed to sell equity by the fact that there is little (if any) out-of-pocket
expense. Unlike debt financing, you don't usually pay interest with equity
financing. The equity investor gains its return via the ownership stake gained
in your business. But the long-term "cost" of selling equity is
always much higher than the short-term cost of debt, in terms of both actual
cash cost as well as soft costs like the loss of control and stewardship of
your company and the potential future value of the ownership shares that are
sold.
Alternative
Financing Solutions
But what if your
business needs working capital and you don't qualify for a bank loan or line of
credit? Alternative financing solutions are often appropriate for injecting
working capital into businesses in this situation. Three of the most common
types of alternative financing used by such businesses are:
1.
Full-Service Factoring - Businesses
sell outstanding accounts receivable on an ongoing basis to a commercial
finance (or factoring) company at a discount. The factoring company then
manages the receivable until it is paid. Factoring is a well-established and
accepted method of temporary alternative finance that is especially well-suited
for rapidly growing companies and those with customer concentrations.
2.
Accounts Receivable (A/R) Financing - A/R financing is an ideal solution for companies that are
not yet bankable but have a stable financial condition and a more diverse
customer base. Here, the business provides details on all accounts receivable
and pledges those assets as collateral. The proceeds of those receivables are
sent to a lockbox while the finance company calculates a borrowing base to
determine the amount the company can borrow. When the borrower needs money, it
makes an advance request and the finance company advances money using a
percentage of the accounts receivable.
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3.
Asset-Based Lending (ABL) - This
is a credit facility secured by all of a company's assets, which may include
A/R, equipment and inventory. Unlike with factoring, the business continues to
manage and collect its own receivables and submits collateral reports on an
ongoing basis to the finance company, which will review and periodically audit
the reports.
In addition to
providing working capital and enabling owners to maintain business control,
alternative financing may provide other benefits as well:
·
It's easy to determine
the exact cost of financing and obtain an increase.
·
Professional
collateral management can be included depending on the facility type and the
lender.
·
Real-time, online
interactive reporting is often available.
·
It may provide the
business with access to more capital.
·
It's flexible -
financing ebbs and flows with the business' needs.
It's important to note
that there are some circumstances in which equity is a viable and attractive
financing solution. This is especially true in cases of business expansion and
acquisition and new product launches - these are capital needs that are not
generally well suited to debt financing. However, equity is not usually the
appropriate financing solution to solve a working capital problem or help plug
a cash-flow gap.
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A
Precious Commodity
Remember that business
equity is a precious commodity that should only be considered under the right
circumstances and at the right time. When equity financing is sought, ideally
this should be done at a time when the company has good growth prospects and a
significant cash need for this growth. Ideally, majority ownership (and thus,
absolute control) should remain with the company founder(s).
Alternative financing
solutions like factoring, A/R financing and ABL can provide the working capital
boost many cash-strapped businesses that don't qualify for bank financing need
- without diluting ownership and possibly giving up business control at an
inopportune time for the owner. If and when these companies become bankable
later, it's often an easy transition to a traditional bank line of credit. Your
banker may be able to refer you to a commercial finance company that can offer
the right type of alternative financing solution for your particular situation.
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Taking the time to
understand all the different
financing options available to your business, and the pros and cons of each, is
the best way to make sure you choose the best option for your business. The use
of alternative financing can help your company grow without diluting your
ownership. After all, it's your business - shouldn't you keep as much of it as
possible?
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