If you are looking to raise capital to grow your business, it’s a good idea to explore all options before jumping into a business loan offered by a traditional bank. This blog will discuss the alternatives to traditional financing but first let’s look at the advantages and disadvantages of traditional bank financing.
Traditional bank financing typically offers lower interest rates than alternative financing options. Banks offer full relationships with many additional services to cover all of your banking needs. Traditional banks also allow you to keep full control of your company without giving up a percentage of ownership. Small businesses may benefit from government backed financing through SBA loans offered at traditional banks.
The disadvantages include eligibility criteria which is usually stringent. As the saying goes, “The best time to ask for a bank loan is when you don’t need one!” Banks offer lower rates because they are typically willing to accept less risk than other capital raising alternatives. Traditional bank financing also comes with a long application process and a significant amount of documentation. Please visit our Commercial Banking Documentation Checklist blog for more information about the documentation required.
There are several alternatives to traditional bank loans. Each one has their own advantages and disadvantages.
- Reputable Online Lenders
- Merchant Cash Advances
- Asset Based Lending
- Invoice Factoring
- Equipment Financing
- Mezzanine Debt
- Equity Financing
- Issuing Bonds
Reputable Online Lenders typically offer fast, flexible and secure financing for small businesses. These online vendors typically base credit decisions on your personal credit score and they require at least one year of business operating history and may require minimum revenue. Decisions are quick and the funds are typically deposited same day. They often come with no prepayment penalties and no collateral requirements. Disadvantages include higher interest rates and the short term nature of the loans.
Crowdfunding offers equity and debt financing solutions. Crowdfunding is a popular way for start-ups and small businesses to raise capital. According to a Forbes article, the average crowdfunding campaign is $7,000. Given the small dollar amount, this type of capital may only be sufficient for small businesses and start-ups. Equity crowdfunding is much like venture capital and angel investing only on a smaller scale. A business owner gives up a portion of ownership in the business in exchange for capital. Reward based crowdfunding allows you to offer incentives or rewards for their small donation.
Merchant Cash Advances are a small business solution for those businesses that need cash quickly. A merchant cash advance is not technically a loan but you are given a lump sum of money upfront in exchange for your future debit and credit card sales. Like many other cash advance alternatives, MCAs carry high fees and should be used in only the most problematic and dire situations.
Asset Based Lending (ABL) is essentially a business loan secured by the company’s assets. This business loan typically comes in the form of a revolving line of credit. If your business has AR, Inventory and Equipment, this might be the best solution for you. While many traditional banks have ABL departments and specialists, a business can also source an ABL line of credit from private companies that work in specialized finance and factoring. These private companies may be more costly but credit decisions and funding are typically faster.
Invoice Factoring is an alternative to a bank working capital line of credit. Invoice Factoring is not a loan therefore collateral is not required. It allows you to sell your invoices (accounts receivable) to a third party at a discount. It provides immediate working capital rather than waiting for your customer to pay you. This is best for B-to-B businesses. Factoring fees can be expensive as they run from 1% to 5% of the invoice amount. There may also be hidden fees. Some of the same non-traditional finance companies that provide ABL lending may also provide factoring services.
Equipment Financing is much like ABL lending in that it is a business loan secured by the company’s assets. In particular, equipment financing is secured by collateral such as equipment. While traditional banks offer equipment financing in a streamlined fashion, there are alternatives to traditional banks. Equipment Finance companies typically have less stringent requirements than traditional banks and funding is fast for both small and large companies.
Mezzanine Debt is a hybrid between debt and capital. It is the riskiest form of debt because it is unsecured and subordinated to senior debt. Mezzanine debt does have priority over common and preferred stock. This debt often includes warrant options which provide lenders with the right to convert the debt into an equity interest in the company. Interest on mezzanine debt is tax-deductible. Mezzanine financing is used by PE firms and venture capital companies to help fund buyouts, mergers and acquisitions. It’s also used by companies looking to fund large projects. Given that mezzanine debt has the highest form of risk, it also provides opportunities for substantial returns. Mezzanine debt is best suited for established companies.
Equity Financing provides a great way to raise capital and fund the growth of your business. Unlike debt, equity capital does not have to be repaid. The owner of the business does have to give up a percentage of ownership in the company. Equity financing can be achieved by taking the company public or via private investors. Venture Capitalists, Private Equity Firms and Angel Investors are the most common type of equity investors of private companies. While small businesses may raise capital via equity from friends and family, large established businesses should consider PE, venture capital or even the possibility of an IPO if the business is experiencing rapid growth. Raising capital via equity can often take a lot of time, energy and requires a lot of out-of-pocket costs.
Issuing Corporate Bonds may provide a flexible way for a company to raise capital. Corporate bonds are sold to investors; the original investment is returned to the lender/investor when the bond reaches maturity. The company pays interest payments to the bondholders. The interest rate is typically higher than debt financing because the bondholders/investors are taking on more risk. Corporate bonds are a form of debt capital that must be repaid but does not dilute the value of existing shareholders. Issuing bonds is also much cheaper than issuing equity shares. There are also tax benefits to issuing bonds as the interest is an expense that reduces taxable income.
This blog was written to inform business owners and executives of the options available to raise business capital. As you can see, there are several alternatives to traditional financing. If you have any questions or need further guidance, feel free to reach out to us today.
To learn more about LonaRock, LLC and our business finance consulting services, please visit our website at www.lonarock.com or contact us directly at 234-217-9033. We look forward to helping you become an ideal business client and helping you obtain the best possible financing for your company!