When most businesses think of raising capital, they think of either taking on an investor or taking out a business loan. While both are viable options, they both take a significant amount of time, a large amount of administrative paperwork, and come with considerable risk.
Finding an investor can be nearly impossible for some businesses outside of possible friends and family. It typically requires detailed financial statements and projections, a sound business plan, lots of meetings and presentations, and usually a significant up-front legal expense. And, in order to secure the funding, the business owner is forced to give up equity in his/her company, many times losing a controlling interest.
Securing a traditional term loan from a bank can take weeks and usually requires financial statements, good credit, collateral, a personal guarantee, and many times the bank will require a “blanket lien” on the business. For those that meet these requirements, a term loan will usually provide the lowest interest rates, but the entire reason for the lower rates is that, by asking for things like collateral, it forces the borrower to share in the risk with the lender. If you default on your bank’s term loan, they can come and take your collateral. This minimizes the risk for the bank.
However, many small businesses are not be able to attract investors and don’t want to give up their hard-earned equity even if they can; and many do not have the credit score, financial history, and collateral to secure a bank loan; and would not want to take the risks if they could.
The good news is that there are alternatives that will allow a business to quickly raise capital without having to deal with the risks and hassles of taking on either an investor or a bank loan.
Revenue Based Loan
The first alternative is a Revenue Based Loan which is not really a loan but a transaction in which a business sells a percentage of its future sales at a discount in exchange for up-front capital. A Merchant Cash Advance is a specific type of Revenue Based Loan where the business sells a percentage of its future credit card sales.
Revenue Based Loans are based almost entirely on business history and not the credit score of the owner; and they require no collateral or personal guarantee from the owner making them both much easier to qualify and much lower risk than a bank loan. There are higher rates associated with a revenue based loan than a term loan, but this is because, since no collateral or personal guarantee is required, the lender is taking much more risk. Revenue based loans also require minimum paperwork, usually just a short application and a few months of bank and credit card processing statements, and borrowers are typically funded in less than a week.
Another nice benefit of the revenue based loan is the variable aspects of the loan payments. With a traditional bank loan, the monthly payment amount is fixed throughout the term of the loan. However, because a revenue based loan is based on a percentage of the monthly sales, the payment amount is lower in months where sales are lower and higher in months where sales are higher. This can be very appealing, especially for seasonal businesses and businesses where it’s difficult to forecast revenue.
Accounts Receivable Factoring
A second option to consider is Accounts Receivable Factoring, also called “Receivables Financing” or “Invoice Factoring”. With receivables factoring, a company can secure quick and ongoing funding by selling its current accounts receivable at a discount in exchange for up-front capital. Receivables factoring is also not a business loan, so no collateral is required and a good credit score is not needed. The capital is made available as a revolving line of credit and typically carries a discount of 10%-30%.
In addition to being a very low risk and easy way to secure quick funding, receivables factoring eliminates the burden of debt collection from the business and is virtually the only source of business funding that increases as the company grows. Also, because receivables factoring is not a loan, neither the owner nor the business incurs any debt so there is no negative impact on the company’s balance sheet which leaves the business open to explore other financing options without having to show debt on the books.
A third option to consider would be an Equipment Sale-Leaseback which allows a company to use the value contained in their existing assets. In a sale-leaseback transaction, a company sells currently owned business equipment to a finance company for up-front capital. The finance company then leases the equipment back to the business who continues to use their same equipment and repays the funding in installments over an extended period. At the end of the lease, the business can negotiate to purchase the equipment back from the leasing company or simply turn the equipment in.
Once again, a sale-leaseback requires minimum paperwork and a high credit score is not needed. Also, because the funding is fully collateralized by the equipment, a sale-leaseback will typically have lower rates and longer payment terms than other forms of financing. There are also flexible buy-out options that include the ability to either purchase the equipment back or, if the equipment is no longer needed, the business can simply turn the equipment in to the leasing company, making it an easy and convenient way to dispose of old and out-dated equipment.
There are also some very nice financial advantages that are possible with a sale-leaseback transaction. First, in the sale of the equipment to the leasing company, the funds are treated as sales proceeds so it will improve the company’s Profit & Loss statement. An equipment sale-leaseback also should have a positive effect on both Return On Asset Ratios and Debt to Equity Ratios; and, depending on how the transaction is structured, it’s possible to be able to take a tax write-off the lease payments entirely!
So, if you own a business that needs funding but don’t want to apply for a bank loan or take on an investor, there are alternatives.