How Small Businesses Can Obtain Alternative Financing
Getting alternative financing is fast becoming the leading concern of small businesses in several parts of the world. The reason for this is not far fetched: the overall bank lending to small businesses has been on a steady decline since the economic recession of 2008—but not like there was a time when banks were particularly liberal in issuing loans to small businesses. For instance, recent studies have revealed that commercial bank loans to small businesses have dropped by as much 20 percent; while another report showed that more than 50 percent of loan applications from small business owners were turned down, leaving them with no other option but to seek alternative sources of business funding. And there are quite a number of options when it comes to the issue of alternative financing, so much so that business often find it a challenge making the right choice—one that suits their business needs.
Alternative business finance is an all-encompassing term that covers different options that extend beyond conventional bank loans which are hitherto not forthcoming. The term covers everything from working capital advances to equipment financing, and to long-term commercial real estate loans. In general, working capital from alternative sources are more flexible and are much easier to process. In addition, the funds are disbursed more quickly as compared to traditional bank loans. As has been said earlier, the options for alternative financing quite many and we shall take a look at some of the most popular ones before delving into merchant cash advance which has proven to be a veritable source of alternative funding for small businesses.
Account Receivables Financing Option
There are a number of options when a business is looking for an alternative financing option and each of them has its own unique features that differentiate it from the others. The first option that we shall look at is account receivable financing commonly known as factoring. Factoring entails a business using its receivables, that is, money it is owed by customers to serve as collateral for a business advance agreement. The lender in this scenario is known as a factoring company and it offers the business an amount which is equal to a reduced value of the unpaid voices or account receivables. The most significant thing about this method of obtaining alternative financing is that it enables the business to utilize its working capital that had been trapped in unpaid debts. One more benefit of this source of alternative business funding is that the risks inherently associated with those debts that have been used as collateral are immediately shifted to the financing company.
In the actual sense, the factoring firm offers about 70 to 90 percent of the worth of the unpaid debts and invoices of the small business. It then takes responsibility for collecting the debt and if it succeeds in retrieving the debt, it returns the agreed percentage to the business and thereafter keeps the remainder as profit. Such lending firms often take into consideration some salient factors before deciding on how much it is to price the debts and unpaid invoices. For example, factoring firms are known to prefer debts owed the business by large corporations to those owned by smaller firms which they believe are more likely to default on payments. In addition, more recent debts are often preferred to older ones. But, in general, whenever the factoring firm judges that it would be easier to collect a particular debt, it assigns more value to such debt and the bidding price for it becomes higher. The same is also true when it foresees difficulty in collecting the debt, in which case it prices the debts and unpaid invoices much lower Even though account receivables financing seems like a good option in getting alternative financing, it is much more difficult to obtain as compared to something like merchant cash advance.
Short term loans
A short-term business loan is one other way businesses get around small financial hindrances to the smooth running of their businesses. In most cases short-term loans are used to buy inventories, to boost working capital, and to cover payroll expenses. One good thing about short terms loans is that it can be obtained from a number of different sources including commercial banks, mutual banks, credit unions and other nontraditional financial institutions. The requirement for short terms loans should include among others a record of payment history for previous loans which the business had obtained, business cash flow history for a previous couple of years, as well as the income statement for the period the loan is expected to last. Short-term business loans are not alternative financing that businesses can obtain from non-banking institutions such as credit unions.
Business line of credit
Small businesses can also obtain working capital through a business line of credit. A business line of credit can be viewed as an arrangement between a business and a financial institution often a bank, in which the bank provides the partnering business with a maximum amount of loan which it can draw upon at any time. The business is permitted to withdraw funds whenever the need for cash arises provided the limit set by the bank is not exceeded. A business line of credit helps a business to handle certain everyday operations such as making a purchase and buying of additional inventory. Because a business can suddenly be plunged into cash flow problems, alternative financing such as a business line of credit which is always readily available can serve as buffer for the business —once the need for funding arises that cannot be met by the business quickly on its own, it draws cash from the line of credit within the limit. After the business must have drawn on the line of credit, the amount available to it for withdrawal on a future date reduces. However, the business does not have to wait for the limit to be exceeded; it can repay what it has used on interest so it can borrow any other time the need arises.
Merchant Cash Advance – Brief Description of the Best Alternative Financing
Merchant cash advance is another significant source of an alternative finance but is not a loan per se—at least from the legal perspective. It is a commercial transaction in which a business (henceforth referred to as the merchant), and a financial institution (henceforth referred to as the merchant cash advance provider or merchant cash provider for short) agrees to sell a portion of its future receivables to the merchant cash provider in exchange for a lump sum of cash. That is, the merchant sells its future credit card sales to the merchant provider in exchange for a lump sum of cash.
Alternative financing through merchant cash advance is unsecured. This means that there is no personal guarantee on the part of the merchant that the advance is to be repaid at some particular time, and in short, if the business happens to fall into difficult times and eventually fails as a result of dwindling sales, the merchant cash advance provider loses his investment in the business. Simply put, collateral is not required for a business to obtain a merchant cash advance transaction. Merchant cash advance also differs from a traditional loan in that it does not attract interest and there are no penalties for late payments nor there rewards for early payments.
How Merchant Cash Advance Actually Works
Let us take a particular scenario where a merchant requires a specific amount of alternative financing in order to purchase new equipment that will enable it to boost its production levels. The merchant would be normally required to sign a merchant cash advance agreement after which the said cash will be obtained from the merchant provider. If this amount is, say, $10000, the merchant provider scales it by a certain factor of about 1.5 to account for the discounted sale of the future credit card sale of the business against which the advance is to be recovered. If this factor is 1.5 then the total amount the merchant is expected to pay back is $15000. The merchant then determines what the retrieval rate should be. The retrieval rate determines what fraction of the daily credit card sales goes to the business. This is might be in the form of a percentage of the daily credit sales that often falls below 25 or a fixed sum that is also to be paid daily to the alternative finance provider. Once an agreement has been reached on this rate, the agreed amount is remitted to the lender on a daily basis until the advance has been fully repaid.
Benefits of using merchant cash advance as an alternative financing
There are quite a number of benefits that come with merchant cash advance. The first is that cash is obtained quickly from a completely stress-free process. There is also no risk of a personal loss in a merchant cash advance as the merchant cash provider bears all the risks and suffers loss if the business happens to fail. Meanwhile, a low credit score does not disqualify a business from getting a cash advance. It is therefore not surprising that small business has particularly embraced merchant cash advance as a good source of alternative financing.
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