6 Alternative Financing Methods for Your Private Business

 

Working with private business owners, I find it increasingly apparent that securing financing for growth is becoming a critical challenge. To see why this is, let’s briefly review the nature of how private businesses have changed.

Private Business Has Changed

As businesses have transitioned from being producers of things to producers of services, they have a greater reliance on intellectual and human capital to generate revenue. For example, I currently have a client who is an IT solutions provider to mid-size businesses, and human capital is her greatest production asset. The firm’s margins are great, and the business is growing at a consistent and controlled rate. However, finding traditional financing has continued to be a challenge, because two traditional sources of financing — collateralized loans and raw material trade payables — generally are not viable.

Financing growth is difficult for the owner because she generates her revenue with very little physical collateral, so traditional banks aren’t too keen on advancing funds. And trade payables are not a source of funds or float since there are virtually none. Her greatest single “raw material” cost is labor, and experience tells us that workers like to be paid on time and in a routine manner. So let’s explore the sources of funds that private businesses can use to leverage growth in the 21st century.

Alternative Financing Sources for Private Businesses

1) Leverage what you can from physical assets. Take advantage of same-as-cash offers and extended terms. With record loan interest rates, leverage what you can. Be certain to pay within the terms but don’t be in a hurry to pay these items off.

2) For organizations who do project based work that may require a number of months to complete, ask the client for initial deposits and progress billing options. Determine project scope, duration, and value, then establish completion metrics to drive progress payments.

3) Consider pre-pay discounts for clients. With the low cost of money in recent times, pre-pay discounts have lost their importance because a pre-pay discount is considered to be an “expensive” way to generate capital. While this may be true from a strict dollars and cents standpoint, cash flow is king when funding growth.

4) Leverage accounts receivable factor sources. On the day you invoice your client, you “sell” the receivable to a factoring company and generate cash. This source of funds has become more popular in recent times. Lower interest rates and more competition in the marketplace has made this a more attractive source of funds by driving down fees. Two things to be mindful of with this source. 1. You need to stay on top of timely payments by clients since you will be assessed fees as the receivable increases in time outstanding and 2. If a client does not pay by a pre-set time, most firms will charge back the entire receivable to you — so now you are out the fees and you are left holding a delinquent receivable.

5) Private investments are an alternative to lenders. Friends or family members can probably gain added return on their invested dollars verses traditional interest-bearing products. But draw up formalized agreements with specific interest rates and terms. Do not take funding on a hand shake.

6) Working capital lenders offer short-term loans that don’t come with the same requirements for credit score, time in business, and use of funds that bank loans carry. It’s another funding method in which collateral usually doesn’t matter. As long as a business has a healthy cash flow, it can often secure a working capital loan to meet immediate needs and opportunities. However, it is important to note that often interest rates are higher and payback terms are accelerated compared to other funding sources.

In summary, business owners have a number of alternatives for funding as they grow. Experience tells us that most business owners do not set funding as a priority until near-term needs arise. The key is to plan ahead and stay vigilant to maintain adequate funding to support growth.