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Financing Your Small Business

What Are Your Alternative Financing Options?

You filled out all the forms, provided your tax returns and credit report, gave the bank your business plan or balance sheet and income report, waited for the loan committee to get back to you, and the answer is no. It takes money to make money. Is it time to throw in the towel?

Maybe not.

Taking Partners or Investors

There are several alternative financing options for your business besides conventional business loans. Perhaps the oldest, most time-honored finance method is to approach a family member for help.

Most of us don’t like to complicate our family relationships with money worries, so we approach strangers. Outside investors may provide quicker decisions on less paperwork. But they often demand equity – part ownership – as part of the deal.

Taking partners isn’t necessarily a bad idea. Sometimes they bring not only investment capital to the enterprise, but valuable expertise and connections.

Clubs

Informal groups or “clubs” could be another financing option, they pool their money and take turns disbursing the money to members. This is a risky alternative financing option for group members who aren’t among the first to receive a disbursement. Each member can fail, and each business failure increases the likelihood that no money will be available for the groups’ later recipients.

Even successful recipients may lose their motivation to continue contributing to the fund, because they will receive no further disbursements. These groups usually proceed on the honor system, and that’s a high-risk proposition unless you get your money very early in the process.

Factoring

If you’re already an established business with customers and contracts, you have the option of factoring. This is an arrangement in which an investor, called a “factor,” buys your contracts at discount, advances cash to you, and takes over responsibility to collect the accounts from your customers.

There are two kinds of factoring – account receivable or “invoice” factoring, and purchase order factoring. In the first type, you have already provided your service or product, and have invoiced your customer. In the second type, you have not yet invoiced the customer because you haven’t done the job yet, but you have a binding contract that obligates the customer. What are the benefits of this alternative financing option?

Credit checks

The factor bases the approval decision on the customer’s payment history and credit, not yours. Because of this, factoring is especially beneficial for companies that are too new to establish strong credit, or that have damaged credit. If you’re a small, unproven company that has won a large order from the federal government or a big-box retailer, factoring can provide you with the working capital to pull it off.

Working capital

Factoring can also stabilize the finances of companies that extend 45, 60 or 90-day terms to their customers. With a 70-85 percent advance on accounts receivable, you can plow your revenue back into operations, sales and the next deal instead of waiting for the customer to pay in the fulness of time. The quicker you can move on to the next deal, the more revenue you’ll earn in any given quarter or fiscal year. The less you budget for inhouse collection staff, the more you can commit to sales and operations.

Solutions to cash flow crises

A cash flow problem is a crisis for small businesses, but banks rarely share your sense of urgency. Their salaried employees’ approach is usually “all in due time.” But most factors work on commission, and their incentive is to make good decisions quickly. It’s not unusual for a factor to approve or disapprove within 24 hours after you submit a complete application. Some factoring companies even post their application in .pdf on their website.

SBA 504 Commercial Real Estate Loans

504 SBA Commercial Real Estate Loan

At the other end of the spectrum is government financing. The paperwork is extensive, and the process is even slower than a conventional bank loan, but its terms are usually more generous than bank financing.

For example, an SBA 504 loan is a 10-percent down, fixed-rate, long-term government loan backed by the Small Business Administration. It’s a sensible option for entrepreneurs who want to buy their business premises instead of leasing. It’s also available for other capital purchases, such as machinery.

Banks ordinarily require a 25 or 30 percent down payment for such loans. Getting an SBA 504 loan instead of a conventional bank loan means that less of your money will be tied up. You’ll conserve working capital and avoid cash flow crises. You’ll lock in occupancy costs for the term of the loan, typically 20 years.

SBA 504 loan fees are typically the lowest on the market. Interest rates are based on the debenture rate for the month the loan is funded. SBA 504 loans are funded by monthly bond (debenture) sales on Wall Street.

Don’t underestimate the value of buying your business premises instead of leasing. McDonald’s founder Ray Kroc was one of the first to recognize that his wealth was not based on revenues from cheap hamburgers, but on the value of the real estate that his restaurants paid off.

With an SBA 504 loan, you’ll get tax benefits during the term of your loan, and your property will probably appreciate in value. After you pay off your loan, you could hit the sweet spot in which your revenues continue but your mortgage drops off the books. You might even be able to lease some of your property to other business tenants for increased revenue.

The SBA 504 program permits you to purchase and hold title to a building personally, in the name of your business entity, or via a holding company. This gives you the ability to maximize tax benefits of ownership, or to minimize liability.

Two or more small businesses may receive a single 504 loan by combining to create a real estate holding company. This option works especially well for professionals in the medical, veterinary, legal and accounting fields.

Most businesses worth $15 million or less are eligible to apply for SBA 504 loans for amounts up to $5.5 million. Most American cities will have a Small Business Administration office in the federal building, or in leased premises. Forms and information are available there, as well as on their website.

Minority Owned Small Business Financing

The Small Business Administration’s 8(a) Business Development program isn’t a lender, but it can help minority and other disadvantaged small business owners become more creditworthy through one-to-one counseling, training workshops, and management and technical guidance.

SBA staff and private-sector mentors can also assist minority firms entering the government contracting market, by joint ventures and subcontracting opportunities.

If you are African-American, Hispanic, Native American, Asian or Pacific Islander, you are presumed eligible. If you’re not, you may still be eligible for the 8(a) program, but must provide substantial evidence and documentation that demonstrates that you have been subjected to bias or discrimination, and are economically disadvantaged. Firms owned by Alaska Native Corporations, Indian Tribes, Native Hawaiian Organizations and Community Development Corporations can also apply to the program.

One 8(a) program pairs mentor firms with protégé firms to provide managerial and technical assistance, as well as joint ventures and subcontracting opportunities.

With a government purchase order or invoice in hand, a small business owner can walk into a factor’s office with confidence that the factor will be interested in purchasing the account receivable or purchase order. You might even notice a different attitude at your bank!

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