Businesses cannot always rely on revenue and profits to fund their operations. They may need to rely on a reputable lender from time to time. Unfortunately, banks are not always open to small and medium sized businesses. Also, they have cumbersome processes that can take weeks to months to acquire capital.
Fortunately, there are several other alternatives to bank loans, such as factoring financing that can help you acquire the short term immediate funds you need to grow your business and scale operations. The most popular options are described in detail in this post.
1. Invoice Factoring
Invoice factoring has been around since ancient Romans and is quite possibly one of the oldest forms of financing. Despite its long and successful history, most businesses are unaware of this form of financing. In factoring financing, a factoring company will purchase your accounts receivables for a small fee.
This is not a loan since you are transferring assets. Instead of waiting 30 or 60 days for the completion of the payment term, you can raise money immediately with a funding partner. This leaves you free to focus on your business. However, you shouldn’t confuse factoring financing with asset based lending that refers to loan generation.
In asset based lending, you use your assets as collateral to raise a loan. This can negatively impact the credit profile of your firm. With factoring financing, you don’t need to worry about increasing your liabilities or debt and the credit profile of your firm stays intact.
Factoring financing is of two main types – recourse and non-recourse. The business owner shares default or nonpayment risk with the factoring company in recourse factor financing. However, in non-recourse factor financing, the factor is required to assume the majority of risk.
Pros of Factoring Financing
- Short processing time
- Funding can be acquired within 3 – 5 days
- Available to business owners with poor or bad credit
- Factor may work as a creditor for the business
Cons of Factoring Financing
- Factor may get involved in business operations
2. Lines of Credit
Businesses need to manage their cash flow responsibly if they want to remain successful. You may experience shortfalls if you extend more credit than you should to customers for attracting more business. This can cause a serious shortage of cash and in severe circumstances can stop the operations machinery.
This is where line of credit (LOC) can come in useful. LOC is a pre-specified amount of cash that a business can use as and when required. This can be both secured and unsecured. Secured LOC requires collateral whereas unsecured LOC doesn’t. You can free up the LOC amount to be used in future when you pay off your current borrowed amount in full.
Typically, businesses only use a part of the LOC which needs to be repaid within a reasonable period. Financial institutions tend to monitor cash application when a business uses LOC and will raise concerns if there are extraordinary situations.
Pros of Lines of Credit
- Helpful with temporary shortages
- Helpful in predicting shortcomings
Cons of Lines of Credit
- High interest may be charged
- Over-dependence can be a problem
3. Merchant Cash Advances
Large companies are less risky to lend than small businesses from a bank’s perspective. Things did not get easier when lending requirements became more stringent after the 2008 banking crisis. Fortunately, small businesses have few alternatives like merchant cash advance (MCA) to finance their operations. Through MCA, a business owner can receive a lump sum amount in exchange for their future credit card sales.
You may find this option highly lucrative if you have a steady stream of customers that pay via credit cards. The provider will take a pre-specified percentage of the credit card sales until the balance gets remitted. You get to make more when sales are high and pay less during slow periods, which means there is no undue financial strain on you.
Pros of Merchant Cash Advances
- Payments are flexible based on sales
- Cash flows can be maintained comfortably
- Quick funding
- No late fee since payments are taken directly from account
Cons of Merchant Cash Advances
- Rates may be high
- Cash advance terms are usually restrictive
4. Working Capital Loan
Working capital loans are used to fund a business’ core operations. Everyday operations without running cash flow can cause financial strains. This is usually the case with seasonal businesses, but can be experienced by any industry. Working capital loans are not supposed to be used for long-term capital expenditures since they are not as cost effective.
They are supposed to be used as a cushion for hard times when cash is expected within a few weeks or days. Working capital loans help businesses meet their short-term operational obligations and can include term loans, factoring financing, and lines of credit. They can either be secured or unsecured depending on the type of loan.
Pros of Working Capital Loans
- Equity can be retained
- Can be without collateral
Cons of Working Capital Loans
- Can affect credit rating
- Secured loans place assets at risk
5. Equipment Loans
There are many businesses that rely on equipment to manufacture the products they sell. Equipment is essentially the lifeline of the business and if they break down, they can derail the entire operations. Replacements can be expensive and not feasible if repairs cannot be carried out.
Businesses can get affected without raising enough capital to replace or fix their equipment. This is where equipment loans come in useful. These are thought to be the best loan options for small to medium sized businesses. They can help firms obtain the necessary funding to repair or replace damaged equipment.
In this class of loans, the equipment serves as collateral. This allows owners to acquire a larger share of the cost since the loan is essentially secured with collateral. Generally, high-end equipment qualifies for an equipment loan, such as vehicles and machinery. Tractors are another example. You can acquire this loan from both banks and alternative lenders.
Pros of Equipment Loans
- Loan is secured
- Easy to obtain
- Attractive rates
Cons of Equipment Loans
- Creditworthiness plays a role
- Down payment may be required
- Equipment may become obsolete but the loan will need to be repaid
6. Professional Practice Loan
This class of specialty loans is designed for professionals in the legal, medical or accounting field. However, these loans are generally used by medical practitioners since their financing needs for purchasing medical equipment is greater than others. This includes veterinarians, doctors, and dentists.
The loans can be used to purchase initial equipment or acquire other practices. Expanding operations with real estate and refinancing existing debt can also be carried out with professional practice loans. In some cases, it may also include malpractice insurance costs for medical practitioners.
Professional practice loans can help a company stay afloat while they spread the word about their services. For instance, they can use the funding towards marketing efforts by hiring a skilled marketing firm. It is important that professionals do not focus entirely on non-core functions. This could leave them looking for more loans when in need of a capital influx.
Pros of Professional Practice Loans
- Attractive rates
- Better terms
- Default risks are understood by the lender
Cons of Professional Practice Loans
- Core business may suffer if the loan is used on marketing and other non-core functions
- Frequent upgrades to keep up with technology can cause higher dependency on loans
7. Franchise Startup Loan
Franchises help businesses open a store, restaurant or another business without starting from scratch and creating brand value. Franchise helps businesses ride on the success of well-known brands and others. Companies (franchisor) that operate on the franchise model lend technical support to those businesses that are accepted in the franchise (franchisee).
However, a franchisee will need to raise capital often in the beginning months or years to cover the cost of franchise fee. Most franchisors have lucrative financing options to help budding franchisees with this problem. But, usually these options are not enough and the franchisee may need to raise capital to fund the entire process.
Traditional banks and alternative lenders will review the FDD or franchisor’s disclosure document before offering a loan. This document is vital since it states a franchisor’s success rate in past endeavors. All franchisees should read this document carefully.
Lending institutions are known to be more open to lending money to franchisees that are part of a big brand. They are comfortable when a franchise has weight. However, a big name doesn’t always guarantee funding. Owners may be required to assess their potential for profit margins and eventual break-even point.
Further, the type of franchise you have will also play a significant role in acquiring funding. Lending institutions understand that a capital-intensive franchise requires interim funding and consider this while offering the loan.
Pros of Franchise Startup Loans
- Established franchise supports quick funding decisions
- Greater lending confidence since odds are in favor of proven business formulas
Cons of Franchise Startup Loans
- Initial funding is not always guaranteed
- Most franchises are capital intensive operations and not easily funded