Financing Options—Despite the Credit Crunch
By Tracy Eden
question that the financial crisis and ensuing credit crunch have
made it more difficult than ever to secure small business financing
and raise capital. This is especially true for fast-growth
companies, which tend to consume more resources in order to feed
their growth. If they aren’t careful, they can literally grow
themselves right out of business.
the gloom and doom, however, it’s important to keep one thing in
mind: There are still options available for small business
financing. It’s simply a matter of knowing where to look and
how to prepare.
WHERE TO LOOK:
There are three main sources you can turn to for small
Commercial Banks—These are
the first source most owners think of when they think about small
business financing. Banks loan money that must be repaid with
interest and usually secured by collateral pledged by the business
in case it can’t repay the loan.
positive side, debt is relatively inexpensive, especially in today’s
low-interest-rate environment. Community banks are often a good
place to start your search for small business financing today, since
they are generally in better financial condition than big banks. If
you do visit a big bank, be sure to talk to someone in the area of
the bank that focuses on small business financing and lending.
mind that it takes more diligence and transparency on the part of
small businesses in order to maintain a lending relationship in
today’s credit environment. Most banks have expanded their reporting
and recordkeeping requirements considerably and are looking more
closely at collateral to make sure businesses are capable of
repaying the amount of money requested.
Venture Capital Companies—Unlike banks, which loan money and are paid interest,
venture capital companies are investors who receive shares of
ownership in the companies they invest in. This type of small
business financing is known as equity financing. Private equity
firms and angel investors are specialized types of venture capital
equity financing does not have to be repaid like a bank loan, it can
end up costing much more in the long run. Why? Because each share of
ownership you give to a venture capital company in exchange for
small business financing is an ownership share with an unknown
future value that’s no longer yours. Also, venture capital companies
sometimes place restrictive terms and conditions on financing, and
they expect a very high rate of return on their investments.
Commercial Finance Companies—These non-traditional money lenders provide a
specialized type of small business financing known as asset-based
lending (or ABL). There are two primary types of ABL: factoring and
accounts receivable (A/R) financing.
factoring, companies sell their outstanding receivables to the
finance company at a discount of usually between 2-5%. So if you
sold a $10,000 receivable to a factor, for example, you might
receive between $9,500-$9,800. The benefit is that you would receive
this cash right away, instead of waiting 30, 60 or 90 days (or
longer). Factoring companies also perform credit checks on customers
and analyze credit reports to uncover bad risks and set appropriate
financing, you would borrow money from the finance company and use
your accounts receivable as collateral. Companies that want to
borrow in this way should be able to demonstrate strong financial
reporting capabilities and a diverse customer base without a high
concentration of sales to any one customer.
HOW TO PREPARE:
Regardless of which type of small business financing you
decide to pursue, your preparation before you approach a potential
lender or investor will be critical to your success. Banks, in
particular, are taking a much more critical look at small business
loan applications than many did in the past. They are requesting
more background from potential borrowers in the way of tax returns
(both business and personal), financial statements and business
focusing on what are sometimes referred to as the five Cs of credit:
Character—Does the company have a strong reputation in its
community and industry?
Capital—Lenders usually like to see that owners have invested
some of their personal money in the business, or that they have some
of their own “skin in the game.”
Capacity—Financial ratios help lenders determine how much debt
a company should be able to take on without stressing the finances.
Collateral—This is a secondary source of repayment in case a
borrower defaults on the loan. Most lenders prefer collateral that
is relatively easy to convert to cash, especially equipment and real
Conditions—Conditions in the borrower’s industry and the overall
economy in general will play a big factor in a lender’s decisions.
meet with any type of lender or investor, be prepared to explain to
them specifically why you believe you need financing or capital, as
well as how much capital you need and when and how you will pay it
back (if a loan) or what kind of return on investment a venture
capital company can expect. Also be prepared to discuss specifically
what the money will be used for and what kind of collateral you are
prepared to pledge to support the loan, as well as your sources of
repayment and what measures you will take to ensure repayment if
your finances get tight.
also ensure that your financial statements and records are current
and that your internal control systems are adequate for handling the
level of accounting and bookkeeping lenders and investors expect.
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