Businesses that are cash-strapped and require a significant amount of working capital have access to a number of different potential financing options.Owners frequently consider a bank loan or line of credit first, which may be the best option for businesses that meet the requirements.
It can be challenging to qualify for a bank loan in today’s uncertain business, economic, and regulatory environment, particularly for new businesses and those that have previously faced financial difficulties.Owners of businesses that aren’t eligible for a bank loan may choose to look for venture capital or equity investors as alternatives.
But are they truly that?Including venture capital and so-called “angel” investors in your business may have some advantages, but there are also disadvantages.Unfortunately, owners frequently fail to consider these disadvantages until after a contract with an angel investor or venture capitalist has been signed, at which point it is too late to withdraw from the agreement.
Working capital and equity are really two different kinds of financing, so bringing in equity investors to assist in providing a boost to working capital presents a challenge.
Because working capital, or the money used to pay business expenses while waiting for cash from sales (or accounts receivable), is short-term, it should be financed with a short-term financing instrument.However, equity should typically be used to finance acquisitions, rapid growth, business expansion, long-term asset purchases, or assets that are repaid over more than a 12-month business cycle.
However, the most significant disadvantage of involving equity investors in your business is the possibility of losing control.You may be giving up a portion of your company’s ownership when you sell equity (also known as shares) to angel investors or venture capitalists at the wrong time.Most of the time, this diluting of ownership results in losing control over some or all of the most crucial business decisions that need to be made.
When there are few or no out-of-pocket costs, owners may be tempted to sell equity.Equity financing typically does not require you to pay interest, unlike debt financing.The ownership stake in your business gives the equity investor its return.However, in terms of both actual cash cost and soft costs like the loss of control and stewardship of your business and the potential future value of the ownership shares that are sold, the long-term “cost” of selling equity is always significantly higher than the short-term “cost” of debt.
Alternative Options for Financing But what if your company requires working capital but isn’t eligible for a bank loan or credit line?Elective funding arrangements are frequently fitting for infusing working capital into organizations in this present circumstance.These companies typically employ three of the most common alternatives to conventional financing:
1.Full-Service Factoring: Businesses sell their outstanding accounts receivable to a commercial finance (or factoring) firm at a discount on an ongoing basis.The receivable is then managed by the factoring company until it is paid in full.Factoring is a well-known and accepted method of temporary alternative financing that works especially well for businesses that are expanding rapidly and those that have a concentrated customer base.
2.A/R Financing: Accounts receivable (A/R) financing is a great option for businesses that aren’t yet bankable but have a stable financial situation and a wider range of customers.Here, the company pledges assets as collateral and provides information on all accounts receivable.While the finance company calculates a borrowing base to determine the amount the business can borrow, the proceeds from those receivables are sent to a lockbox.At the point when the borrower needs cash, it makes a development demand and the money organization progresses cash utilizing a level of the records receivable.
3.Asset-Based Lending (ABL) is a credit facility that is backed by a company’s entire inventory, equipment, and assets.In contrast to factoring, the company continues to manage and collect its own receivables and regularly submits collateral reports to the finance company, which will examine and audit the reports on a regular basis.
Alternative financing may also offer additional advantages, such as the ability for owners to maintain control over the business and the provision of working capital.
It is simple to ascertain the exact financing cost and request an increase.
The kind of facility and the lender can include professional collateral management.
Online interactive reporting in real time is frequently available.
It might give the company access to more capital.
It is adaptable; financing fluctuates in accordance with the requirements of the company.
It’s important to remember that equity can be a viable and appealing method of financing in certain situations.This is especially true in situations involving business acquisition, expansion, and the introduction of new products; these are capital requirements that typically do not lend themselves well to debt financing.Equity, on the other hand, is rarely the best option for financing a cash flow or working capital shortfall.
A Precious Good Keep in mind that business equity is a scarce resource that should only be considered in the appropriate context and at the appropriate time.Ideally, equity financing should be sought when the business has significant cash requirements for growth and favorable growth prospects.In an ideal world, the company’s founders should retain majority ownership and, as a result, complete control.
Without diluting ownership or possibly giving up business control at an inopportune time for the owner, alternative financing options like factoring, A/R financing, and ABL can provide the working capital boost that many cash-strapped businesses that do not qualify for bank financing require.It is frequently simple to move these businesses to a standard bank line of credit if and when they become bankable in the future.Your banker might be able to direct you to a commercial finance company that might be able to provide you with the kind of alternative financing that is best suited to your particular circumstance.
The best way to ensure that you select the most suitable option for your company is to invest some time learning about each of the various financing options available to your company, as well as the benefits and drawbacks of each.Your business can expand with the help of alternative financing without diluting your ownership.Since it is your company, shouldn’t you keep as much of it as you can?
