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4 min read

12 Ways to Fund Your Business Part 5

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Grants, Assets Based Lending, Factoring, and Credit Cards

By: Shane Bender

As a business owner, have you wanted to improve your cash flow or get additional funding? Over the last five weeks, we have looked at bootstrapping, Accounts Receivable and Account Payable processes, leasing, lines of credit, conventional business loans, SBA loans, and private equity.  This week, we will focus on government funding, mezzanine financing, Asset Based Lending, Factoring, and credit cards.  When do these different options make sense, if at all?

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Government

Depending on your industry, government grants, both federal or state, could be an option. There are many types of grants and funding options. Here are few sites to visit for federal funding

Mezzanine Financing

Mezzanine Financing is a hybrid of debt and equity financing that is used to finance the growth of established businesses.  The interest that a borrower has to pay on this debt can be as high as 15%-20%.  Why would a borrower consider this option if the rate is so high?  If they can’t get cash elsewhere, investors will consider this option because of the attractive return on investment and the opportunity to own equity. The borrower can deduct the interest expense for taxes. It could make sense for a business owner to pursue this option if she is confident that projected growth will successfully deter present cash flow problems. A good explanation of Mezzanine Debt and how is works is at fool.com.

Asset Based Lending

Asset Based Lending is cash funding which is secured based on collateral such as Accounts Receivable, Inventory, or Equipment. How is this different than a traditional loan?  I spoke with Shannon Stetson, Regional VP at Crestmark, to understand the benefits and drawbacks. Asset based lenders are more interested in the “story” and future potential than the historical performance, as is often the case when attempting to secure financing from historical banks. The bank covenants are much less strict. They do require reports such as A/R aging, A/P aging, 2 years of financials, interim financials, and contracts supporting the A/R.  They will ask for more information if it involves inventory or equipment. A fractional CFO can be helpful to get your financials in order so you can get the funding you need. See more about at Crestmark’s Asset Based Lending website.

Crestmark offers an Asset Based Line of Credit in which a customer can submit a batch of invoices or inventory and Crestmark will provide a Line of Credit based on a predetermined formula. This option is appealing because cash is received quickly with no covenants.

Factoring

Factoring is a financing method in which the business sells the Accounts Receivable at a discount to a third party to get funding as soon as possible. The three components to this transaction are the advance, the reserve, and the fee. The advance is the amount of the invoice the factoring company will pay the company needing the cash.  The reserve is the amount of the invoice held back by the factoring company until the customer pays the invoice. The fee is the cost the factoring company charges for the guaranteed cash and interest expense.

Although my opinion is that this funding should be considered almost as a last resort, there certainly are many who disagree.  Some of this is dependent on the agreement and the amount of total interest and fees.  Asset Based Lending agreements and factoring could range from 8% to 24% in interest and fees.  If all customers pay their invoices and there is little risk, then you are only out the fee, which might not be bad, especially if a traditional bank will not lend to you. My concern is that many people who get involved in factoring struggle to get out of it.  If you need to start factoring, work closely with a fractional CFO to build a forecast model that shows how to grow the business so that can get you out of the factoring cycle.

High Interest Credit Cards

As we all know, credit cards are everywhere and fairly easy to obtain. If you have good credit, you probably get credit card offers mailed to you regularly. I would highly recommend not getting into this trap. If you can get a low or zero percent interest rate, this might be a short term fix, but you need to have a strict cash flow plan to pay off the balance with cash or some less risky cash funding method. Do not get in the habit of paying the minimum balance. This cycle will be difficult to get out of.

Conclusion

Over the last 5 weeks, we have visited many different types of funding. My preference is to fund your investments with your own cash, customer and vendor contracts (A/R and A/P management), a line of credit, and possibly a business loan.  The challenge is that this preference just doesn’t work in situations where a large amount of funding is necessary. Also, if the government is willing to give free money, then this is always a consideration as long as there aren’t any strings attached.  Finally, Asset Based Lending, Factoring, and even credit cards may need to be used in some cases. There should be a very strict plan in place in order to successfully exit these higher cost sources of funding so you can be more free to grow your business organically. The less you rely on this kind of funding, the greater your ability will be to withstand the ups and downs of the economy as well as competition within your industry. Remember, cash is king and the lifeblood of your business.