For many small business owners or solo entrepreneurs, keeping a positive cash flow and securing financing is a top priority. Many small business owners rely on business loans, personal loans or personal savings. Only 10 percent of small business owners received startup funds over $25,000, while a staggering 78 percent did not use external financing at all. For those that did, their finance mainly came from bank loans, friends and family, and SBA loans. However, with the growth of the alternative finance industry, there has been a pronounced shift, showing more businesses willing to consider alternative financing options for their ventures. If they do, it is important to ask all the right questions – and weigh up all the perks and drawbacks before making a choice.
Making The Choice For Alternative Financing
In many cases, small businesses turn to alternative financing when they have either been denied a traditional business loan or are deemed an unsuitable candidate. According to the Biz2Credit Small Business Lending Index, small business loan approval rates at larger banks dropped to 8.9 percent in March this year, illustrating just how difficult it is becoming for some small businesses to access financing at the traditional institutions. For others, they may not satisfy all of the strict criteria set out by these lenders, which ultimately narrows their lending pool. In difficult financial times as we’re seeing now, small businesses can also find their cashf lows and bottom line compromised, giving them poor chances of securing a business loan.
Lines Of Credit
One of the most common alternative finance options for small business owners is to secure a business line of credit. Unsecured lines of credit mean you are not required to offer any collateral as security for your financing. Alternatively, you can opt for a secured lined of credit. For those small businesses seeking better cash flow management or versatility in their financing, this can be a good option since it is not designated for a specific purpose, such as equipment purchases or business expansions. The flexibility of a business line credit often means your business can repay the loan early without any early repayment penalties.
You are also charged interest on the amount you end up drawing. So, although you may be approved for a $200,000 line of credit, you may not necessarily need it all, and therefore only pay interest charges on the amount you use – for instance, to purchase new equipment or additional business vehicles to expand your business fleet. Another bonus of opting for a business line of credit is that its interest rates can be as low as 7 percent for traditional lenders and between 13.99-90 percent for online lenders. More recently, Goldman Sachs and Amazon announced that they will begin offering small businesses line of credit, increasing the options for these ventures.
Merchant Cash Advances
Merchant cash advances can be a great source of financing for small businesses that fall into the $87 billion small business financing gap. Merchant cash advances (MCA) are not necessarily a new concept. Gaining popularity after the Green sheet forum in 2003, MCAs offer small business owners an upfront cash payment in exchange for a percentage of the business’ sales in the future. While they allow you to retain control of your business, MCAs can also come with higher annual interest rates – sometimes rising to triple digits. According to estimates from nav.com, the average interest rates can range between 70 and 200 percent. Therefore, it is always recommended that small business owners consider the pros and cons of an MCA before committing.
Business owners can either get an upfront lump payment in exchange for a percentage of their future credit/debit sales or have their repayments structured into a weekly debit from their business bank account, also known as Automated Clearing House withdrawals. This would reduce your daily/weekly cash flow, and is something every small business owner should consider.
In a recent Small Business Credit Survey by the Federal Bank of New York, almost 67 percent of small businesses admitted they encountered financial hurdles in the last year. For those business owners, the chances are that they will ideally turn their attention to recovering debts owed to them. In this case, an alternative could be the use of invoice factoring, which refers to the selling of your business’ outstanding debt due (receivables) to a company at a discounted rate (normally 90 percent). For small businesses with longer credit collection times, this can be an attractive option for recovering money owed to them rather than chasing overdue invoices. While you do not recover the full cost of your receivables, the forgone 10 percent could be viewed as the transaction cost.
There are also other increasingly popular alternative financing options for small business owners, such as installment loans and equipment financing. For those businesses looking for emergency capital, online installment loans can be an attractive option but often come with the need for collateral. Defaulting would put your business or business assets at risk.