Exploring Alternative Sources of Business Capital Finance

Small businesses are known to employ almost 50 percent of the entire workforce in the United States. A report by the Small Business Administration showed that some 56 million people representing 48 percent of the total American workforce are employed by small-scale businesses. In total, there are an estimated 28 million small businesses in the United States which account for over 90 percent of the entire businesses in the country. Small businesses, that is one with less than 500 employees, however, often suffer a major setback: difficulty in obtaining business capital finance. Because of this inability to secure funding, starting a small business is not exactly easy. In short, research has shown that while some two-thirds of small businesses will survive the first two years in operation, only a mere one-third makes it past 10 years. Of course, all business people know that it is the first few years of a business that are most crucial to its survival for they are often the hardest.

Some of the challenges facing small-scale businesses

Concerning the major problems facing small businesses in the country, the national association of small business owners in their 2015 profit stated that economic uncertainty was the chief of them all, followed closely by what they described as a decline in customer spending, as well as regulatory burdens. Much of the so-called economic uncertainty that plagues small businesses stems from cash flow problems. This claim has been corroborated in a United States bank study which revealed that around 82 percent of small business in the country which failed did so as a result of cash flow problems. And, of course, cash flow is much more than the amount of money that comes into the business but also encompasses the timing—when cash comes into the business. This is because If, for instance, the business indebted, a delay in repaying the business capital finance might result in consequences which will adversely affect the business.

How are small businesses finding the issue of obtaining business capital finance?

Meanwhile obtaining financing is also a major problem for small firms; this quite ironic considering the immense role they play towards the growth of the nation’s economy. In one survey conducted by the NSBA, 27% of businesses complained that they couldn’t get the funding their business needed. Of this group of business owners, the study also found that a major consequence of their inability to get funding was that they couldn’t grow their businesses. The situation was even worse for minority groups owned businesses such as those owned by women and colored races. There are, however, a number of reasons why small firms often do not get business capital finance from traditional financial institutions like commercial banks.

Inconsistency of cash flow and collateral as major obstacles to receiving business capital finance

One of the common reasons adduced by banks for refusing to grant the loan request of small business has to with inconsistency in cash flow. It is quite natural for banks to be inclined to view loan requests from small businesses with a steady revenue stream and consistent monthly cash flow positively. Once a small business is unable to demonstrate steady revenue and consistent cash flow, chances are that any application it makes for a loan will be rejected. Lack of or insufficient collateral is another factor which results in commercial banks declining loan applications. Commercial banks make it core requirement for a business provide a viable piece of collateral as a security against the funds it is to be issued. Of course, this won’t pose a problem for large businesses which typically own large property or huge assets; but for small businesses just struggling to stay afloat, this can prove to be much of a challenge in obtaining a business capital.
Read More: How Merchant Cash Advance can Help You With Small Business Finance

The Issue of Debt to Income Ratio and Customer Concentration

Other factors such as debt to income ratio, which is a measure of how much the business owes in relation to how much it earns also play a major role in deciding whether or not a business is granted a loan or not. For instance, commercial banks have been known to be cautious of lending money to businesses that are already indebted. In short, they often disqualify a business once it is found that it has obtained some sort of financing in the past. And small businesses are quite notorious for seeking funding options from multiple sources especially at the outset of the business. Customer concentration also forms part of what banks consider before issuing business capital. Most banks usually have second thoughts about lending money to businesses which report that the vast majority of their sales come from some selected customers. Banks often expect that a business should have a fairly distributed customer base and not one that is lumped as in the case of a hypothetical restaurant which relies on a group of regulars to make sales.

Personal guarantee and sufficient operating history

Because of the risky nature—at least from the perspective of banks—of lending money to small businesses banks often go a step further to demand a personal guarantee from the business owners. This demand is of a serious nature because by making the business owners personally responsible for the payment of the loans, they stand in a position of losing personal belongings such as homes if the business fails and they are unable to repay the business capital. And this is a position most business owners won’t want to be in. Above all, banks prefer to issue loans to businesses with a sufficient operating history. This essentially means that businesses that have been in operation for less than five years might not be favored. Since obtaining loans from commercial banks has become this difficult (one study showed that 57 percent of small business owners either get their loan application rejected or never applied at all), small businesses have no choice than to turn to alternative sources such as merchant cash advance.

Understanding what a merchant advance is all about and why it is a great way to obtain business capital finance

A merchant cash advance is one the easiest ways of obtaining business funding. It is not a loan per se but a mere commercial transaction involving a merchant and a merchant cash advance provider. The business which is in need of the business capital finance sells a portion of its future receivables in exchange for a cash advance so to speak. Interest is not charged on this cash advance the way it is done for a conventional bank loan. A cash advance is a form of business funding that is obtained at no risk whatsoever to the business owner. All such things as collateral and personal guarantee that are integral to loans from traditional financial institutions are lacking in merchant cash advance transactions. A merchant, having agreed to sell its future receivables to the cash advance provider, commits to sending a fraction of its credit sales to the provider on a daily basis in a bid to repay the advance. This daily remittance continues until the advance is repaid—which in most cases takes about 18 months or less. Yes, unlike commercial loans a merchant cash advance expects to recoup his funds quickly since the business is quite a risky one.

How the whole process of obtaining a merchant advance works plus the basic requirements

To obtain business capital finance, a merchant signs the merchant agreement which contains all the usual terms of the advance after verifications have been made. For instance, in order to be eligible for a merchant cash advance, a business is expected to meet certain requirements. The major thing merchant cash advance providers look for is whether the business generates enough cash flow that will enable it to pay back the advance. For this, they consider firms which rake at least $10,000 in credit card sales on a monthly basis. The business also has to have a physical location as online businesses are not allowed. And although, merchant cash advance providers do not base much of their decisions on the credit score of the business, a certain minimum score before an advance can be issued. Once all these requirements are met by the merchant, the holdback percentage, and the factor rate are determined. The factor rate determines how much the merchant pays back. A $10000 advance with a factor rate of 1.5 attracts a total payment of $1500; while the same amount at a holdback percentage of 10% means that 10% of the daily credit sales of the business will be transferred to the merchant provider until the business capital finance is repaid. It is that simple.

Conclusion

Although there are concerns about the relatively high cost of a merchant cash advance, its benefits cannot be overestimated. One often finds oneself wondering if there can be anything more important to the small business owner than knowing that urgent business funding can be obtained almost instantly and with so much ease.  If one adds the unsecured nature of the advance it is easy to see that the benefits of obtaining a business capital finance through merchant cash advance more than justify the cost.

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