By P2Binvestor Staff
Finding financing for your business is tricky. Finding the right financing for your business? That’s downright tough. Based on industry, profitability, and age, the right funding option should match the needs and growth stage of your business. Businesses also may not be eligible for certain types of funding, so why waste time and resources if rejection is in the imminent future?
We put together a high-level summary that outlines five common types of business financing methods to help you decide how to finance your business. Some of the details include risk, pricing, and eligibility, which will hopefully put you on the finance-seeking path that is right for your business.
Ready? Let’s get funded!
1. Bank Loan
While most business owners would choose a bank loan as their preferred method of financing, the reality is that most businesses won’t qualify for one (including growing and profitable ones). Since the economic downturn, most banks tightened rules for lending, and many bigger banks consider small business loans not worth the hassle. A major reason for this is because small business loans yield a very small profit margin for banks. If their loans are doing well, they will get a return on assets of between 1-2%. If just one loan goes bad, however, it can often impact the profitability of the bank. For this reason and because of pressure from regulators, banks don’t want to (or simply can’t) approve a loan for a business that doesn’t meet all of their requirements.
Some of the top reasons that businesses are denied a bank loan are:
- They have been in business less than 2-3 years
- A business owner has bad personal credit
- There is no tangible collateral
- The business is not yet profitable
- Numerous industry-specific risks
The story about how your business got started, the rave reviews by your customers, or an unusually high web presence have no weight when it comes to a bank loan. Don’t feel bad though…most small businesses are getting the same stamp of disapproval from banks today.
2. Asset-based lending (ABL)
A common type of asset-based lending for individuals is a mortgage, or home loan, that is secured by the property itself. In business, an asset-based line of credit is typically collateralized by accounts receivable and inventory. A small business will find it difficult to obtain an asset-based loan unless they have a need for $1M or more in financing, as this type of financing is more involved and costly than a traditional bank line. Lenders often aren’t interested in small asset-based deals because of the expense and trouble involved in monitoring them, as well as the small profit margin. Similar to a bank loan, asset-based lending usually comes with restrictive covenants.
3. Purchase Order Financing
Purchase order financing, commonly referred to as PO financing, is for companies that need financing to order raw materials or goods to fulfill their own orders from other businesses, but don’t have collateral through receivables or inventory. Many of the businesses using this kind of financing are growing businesses (often manufacturers or wholesalers/distributers) that don’t have access to working capital and may also have poor cash flow because proceeds come in only after an order is fulfilled. PO financing can fairly expensive with typical rates being anywhere from 3-5% per month. It can, however, in the short-term, be the best path to order fulfilment, growth, and profit.
For a small business, equity is a good option for those that can’t afford to take on more debt. It is very difficult to obtain, however, and can be the most expensive financing available in the long run. Giving up more ownership and control than originally desired is common with equity financing, but having access to an investor’s network is a great way to build credibility and develop relationships. Profits don’t go toward paying back loans, and investors usually take a long-term approach when it comes to a return. And while difficult to obtain equity, it is equally difficult to get rid of once an investor has ownership in the company.
For B2B businesses, factoring is one of the easiest types of financing to obtain. To solve common cash flow problems, companies use their receivables to get working capital. There are no restrictive covenants—as is common with bank financing, and there are no penalties for being an early-stage company. Factoring is more expensive than banks, but qualifications for business owners are also much less stringent, and often, an owner’s personal credit score matters less than the company’s roster of customers. Wrongly perceived as a last resort for financially distressed companies in the past, factoring is actually a thriving $136-billion industry in the United States with a majority of factoring contracts between large, old-line factors, many of which are bank-owned or affiliated, and creditworthy client companies. Factoring can be a good strategy for any company that has receivables as leverage.
The Bottom Line
The bottom line is that most successful companies utilize many if not all of these methods at some point or another depending on their company’s stage of growth. Equity may be appropriate at the end of year one or in year two. In the first two years, companies generally are not bankable yet, so factoring, purchase order financing, or an ABL may be your best bet if you do not wish to raise equity (or if you’ve raised some already). When you are finally bankable, you may not find a bank line with terms that work for your business. Additionally, you may find that a bank’s line of credit, while perfect in the early part of year three of your company’s growth, no longer works in year four when your growth has outpaced your cash flow and your bank says “no” to a line increase. In that case, purchase-order financing for short terms or factoring for longer terms may make sense if you can get a decent rate. If you are a less-risky company and have solid financials, alternative lenders will often be willing to negotiate rate. Some alternative lenders, such as P2Binvestor, are popping up with new ways of pricing risk differently (our crowd and technology help us lower the effective cost of capital, and we pass the savings onto our customers) in order to offer more flexible and affordable rates.
Most lenders, including banks and SBA lenders, often build in a multitude of hidden fees to increase their margins that greatly inflate the effective rate you’ll receive when preparing to borrow, so do your homework and read the fine print when shopping around for any financing solution. We always advise discussing any looming borrowing situation with a financial professional, business attorney, or trusted advisor so you don’t find yourself in a 72% APR situation when 35% APR was originally quoted because of excessive, hidden fees (this just happened to a business we know).
Whatever financing method you choose, good luck! Drop us a line at firstname.lastname@example.org if you have questions about financing options available to you at your stage of growth, we are happy to provide some information and direct you to a professional who can advise you further.
P2Binvestor is a crowdfunding platform for working capital financing and a leader in crowdfunding receivables. P2Binvestor utilizes the power of technology and its crowd of accredited investors to simplify lending and provide working capital to growing businesses faster and at more affordable rates. The company offers three flexible products: A receivables-purchase product, an asset-backed line of credit, and a credit line secured by future revenue (designed for SaaS companies). P2Binvestor lends to companies in all 50 U.S. states in various industries including staffing, natural foods, manufacturing, technology, and more. P2Binvestor has been providing businesses’ receivables financing since December 2012. For more information, like us on Facebook and follow us on Twitter @P2Binvestor.