What to Do When the Bank Says NO -- An Overview of Alternative Sources of Capital
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This article will present and briefly describe some potential ways to address the need for capital that many business owners are not aware of. As always, some restrictions and limitations will apply. Subsequent articles will discuss these options -- and others -- in more detail.
Personal Assets. Many business owners have personal assets that can be utilized to provide capital for their businesses:
- A home equity loan or line of credit can provide a low-interest source of capital for your business. In addition, the interest may be deductible on your personal income tax.
- Your personal credit score may qualify you for an unsecured line of credit from a lender. This vehicle will have a higher interest rate and will not provide the potential tax savings but it does not require you to make any of your home equity available.
- Your personal credit cards can be used to pay for items required by your business or you can take cash advances on these cards. It is essential that you monitor interest rates and extra charges carefully, particularly for cash advances. Also be aware that this approach can have an adverse effect on your personal credit score if you let your balances get too high or do not make the required minimum payments.
- Tax-sheltered retirement plans (such as IRA or 401(k) accounts) can be leveraged through loans or transfers to investment plans that allow investment in your business. Avoid early withdrawal of funds from these accounts because of the tax penalties that would result.
Be sure you are fully aware of the risks and tax consequences that are involved. Consult your tax advisor regarding the implications of these strategies for both your business and personal taxes.
Factoring Accounts Receivable. If your business sells its products or services to other businesses or government agencies and extends them credit then factoring might be an option if waiting 30 days (or more) for payment of your invoices causes a cash flow problem. The factoring company purchases one or more of your invoices and immediately advances 75-85% of their value, holding the balance in reserve. The factoring company takes responsibility for collection of the invoice and the reserve is released when your customer pays the invoice. The fee for this service will vary depending on a number of factors but in general terms it is comparable to the merchant service fees you would pay if you accepted payment by credit card.
Factoring is often a good fit for companies that do not qualify for conventional financing. The underwriting decision is based on the customer's credit and not on the business or its owner's credit. If you consider factoring be sure to review the contract carefully so you understand the total cost for the service as well as the commitment you are making.
Business Credit Cards. Most businesses are inundated with offers for business credit cards. One advantage of having a card in the name of your business is that you can keep personal and business spending separate as well as use it to build credit history for the business. Many business cards have extra features such as expense tracking, employee-specific credit limits and centralized billing. You still need to exercise the same cautions as with personal credit cards to keep from damaging your credit and incurring excessive interest costs.
Merchant Cash Advances. If your business accepts credit cards it could qualify for a cash advance based on anticipated future credit card receipts. The advance is repaid by taking a defined percentage of daily proceeds until the full amount is recovered. This solution can appear to be expensive but there is little risk for the business owner and, if the funds are put to good use, there can be a significant return on the investment which justifies the initial investment. Underwriting decisions for merchant cash advances are based on historical credit card receipts and not on the credit of the business or its owners.
Reduce the Need for Capital. Business owners sometimes seek capital to purchase equipment or pay operating expenses. There are strategies to consider that reduce the amount of cash required, potentially eliminating the need to obtain additional capital.
- Consider leasing. Rather than purchase equipment for your business you should investigate leasing. Virtually any asset can be leased and the monthly lease payment may be small enough to fit within your operating cash flow.
- Find low-cost space and services. There are number of business incubators or development centers located throughout Northeast Ohio. These are often affiliated with a college or university, a chamber of commerce or a county Small Business Development Center. Some have an industry focus (such as manufacturing or IT) but most are open to all industries and all of them welcome new tenants. In addition to the cost savings being located in an incubator provides the opportunity to interact with other companies in the same facility.
- Tighten your credit policies. Many small businesses extend credit to their customers and end up waiting far too long to get paid. Consider accepting credit cards for payments rather than invoicing the customer. If applicable to your type of business, require a deposit to be paid up front before commencing work. Finally, turn accounts over to professional collection agencies if you do not have the expertise in house. There are some low-cost services that have impressive success rates when accounts are not seriously past due.
Which of these strategies is appropriate to your business depends on a number of considerations, including the reason you need the capital, your industry, your customer base and how you wish to interact with them. In many cases you will need to consider risks and tax consequences before making a final decision. However, it's important to be aware that there are options available even when the bank says "no".
John Doucette - Liquid Capital of Northeast Ohio - www.lcneo.com
