Different sources may be appropriate for different stages of growth. Start-ups often rely on family members, friends, or local associates. As you grow, you may need to turn to alternate sources such as Venture Capital. Once you have achieved a financial track record, you can turn to other sources such as Asset Based Lending or Commercial Loans.
Here are the major business finance solutions available and when to use them.
ne problem many new businesses face is raising sufficient capital. A business in its primary phase will also face a difficult challenge getting a bank loan. One alternative is venture capital.
Venture capital firms offer capital in exchange for equity in a company. This type of financing is ideal for new businesses since venture capital firms focus mainly on the future prospects of a company when banks use past performance as a primary criteria.
Asset Based Financing
In increasingly popular business financing solution is Asset based as a means of financing growth and providing working capital. Asset based financing is a general term whereby a lender accepts as collateral the assets of a company in exchange for a loan.
Most asset based loans are financed against accounts receivable and less often, against inventory since receivables are among the most liquid of a company’s assets followed by inventory. Receivables are favored by lenders since they self-liquidate in a short period of time by themselves and are not susceptible to problems such as shrinkage or physical damage.
Another type of asset based lending is factoring. Factoring is defined as the purchasing of a company’s accounts receivable on a non-recourse basis.
Asset based lending may be the best source of working capital for companies in turnaround where traditional bank loans may not be available or for new and rapidly growing companies where high levels of growth cause the business cycle to outpace the collection of receivables.
Long-term debt is one of the initial financing avenues a company should pursue. Most long-term debt takes on the form of a loan where the interest and part of the principal are paid back in equal installments over the life of the loan. Sources for these business financing solutions include:
- commercial banks
- government sponsored loan programs
- small business investment companies
- private lenders
Lines of Credit
A line of credit loan is designed to provide short-term funds to a company in order to maintain a positive cash flow. Then, as funds are generated later in the business cycle, the loan is repaid.
This is a fairly popular business finance solution. Most commercial banks offer a revolving line of credit, where a fixed amount is available. As funds are used, the “credit line” is reduced and when payments are made, the line is replenished. One advantage of a line of credit is that the no interest is accrued until the funds are withdrawn, but the line is immediately available for the company’s cash flow needs.
Letters of Credit
A letter of credit is a guarantee from a bank that a specific obligation will be honored by the bank if the borrower fails to pay. Letters of credit are useful when dealing with new vendors who may not be assured of a company’s credit worthiness. The bank would offer a letter of credit as an assurance to the vendor of payment. Although no funds are paid by the bank, the credit requirements for a line of credit and a letter of credit are similar.
A loan workout is the process of repaying a problem loan in a fashion that is most agreeable to the lender and the company. Among the steps involved in a successful workout are maintaining communication with the lender, creating a revised payment schedule, and forming a workout team composed of the company’s management, representatives from the lending institution, and legal counsel to manage the process.
Unlike a traditional small business loan, one of the initial steps in workout proceedings is to recognize that repayment of the loan will not occur. The earlier the company recognizes that a problem exists, the greater their flexibility in dealing with the problem. Financial consultants who specialize in loan workouts are also available to coordinate the efforts of the company and the lender. These consultants can direct the workout team’s efforts and suggest solutions to the problem.
Floor planning is another asset based lending approach in which companies can finance their inventories. In floor planning, inventory is financed based on the credit of the vendor as well as the company receiving the financing. The inventory purchased acts as collateral until the sale is made.
Small Company Offering Registration
Another type of equity financing is a small company offering registration or SCOR. Of the various business finance solutions available, this option is not as popular. Since there are laws governing private sales of securities, SCOR’s provide a means of selling common stock to the public. Companies can trade their common stock over the counter rather than deal with the difficulties that initial public offerings face.