Latest posts by Tristan Kim
- 5 Alternative Financing Options That Help Startups Access Funding Quickly - January 10, 2021
Securing funding can be difficult for new entrepreneurs, especially given how stringent banks are when qualifying potential borrowers. However, numerous alternative financing lenders offer a wide array of potential financing options that are accessible to startup founders. In this article, we explain what some of those funding options are.
Business line of credit
Business lines of credit are fixed amounts of money that lenders provide for borrowers to withdraw from. Lines of credit are a flexible form of financing and can fund many business expenditures, from short-term costs to long-term projects. Alternative lenders provide you a business line of credit based on different criteria and usually do so much quicker and easier than traditional banks can.
Note that it is exceedingly difficult to get a business line of credit from a bank. Since a line of credit is much more advantageous to borrowers than it is to banks, banks have little incentive to issue a business line of credit. Borrowers immensely benefit from this financing option because they can withdraw any amount whenever they want, and interest will only be charged on the amount withdrawn. This is disadvantageous to banks because they would need to have a set amount of money reserved for the entirety of a line of credit, but they can only charge interest on the amount withdrawn. Banks would prefer to issue term loans given that they can charge interest on the entire loan amount.
For these reasons, businesses typically seek alternative lenders to get a business line of credit, and even then, business lines of credit can still be difficult to obtain.
A short-term loan is another option available for startups that are not eligible for traditional bank loans. Short-term loans can range from $100 to $100,000 and must be paid back within a year. While banks do not offer short-term loans, they are commonly issued by alternative lenders.
Short-term loans are best used for temporary and unexpected financial problems, and both the application process as well as the funding is quick. One potential downside of short-term loans is that they do not offer much funding. Since most short-term loans must be repaid within a year, the loan amount is smaller than other typical financing options.
Asset-based lending is a financing option that can be structured as a loan or line of credit and is collateralized by the assets you own. The lender has the right to seize your pledged assets if you default on your payments.
The amount of an asset-based loan is based on the total appraised value of the assets pledged as collateral, with higher liquidity being more highly valued. This is why liquid assets, such as accounts receivable, are commonly pledged as collateral. Less liquid assets such as inventory, equipment and real estate can also be used as collateral, but will offer less appraised value.
Although asset-based lending heavily focuses on the assets pledged as collateral to determine qualification standards, your creditworthiness is still considered, which could potentially affect interest rates. An asset-based loan also has flexibility in terms of how the loan proceeds can be used as long as they are used for business expenditures.
The biggest risk to asset-based lending is that you will lose your pledged assets if you are unable to make a payment. Asset-based lending may also come with high costs, which can be further exacerbated if your company does not have the kind of assets that the lender requires or prefers.
Invoice factoring entails a factoring company purchasing your unpaid invoices for an immediate advance payment. You receive advance funding from these outstanding invoices instead of having to wait for the collection period of 30 to 120 days. Since this payment is not a loan, you can use the funding for any business-related expenditure, from hiring new employees to paying taxes. The factoring company will then collect the invoice amount from your customers and will deduct a percentage as a fee for services and charge interest on the advanced amount. Total fees and interest may be considerably cheaper than borrowing from hard money lenders or a credit card.
Invoice factoring is best suited for businesses that primarily rely on invoice payments for their cash cycle. Given that it usually takes months for customers to pay invoices and that some may end up paying late, invoice factoring is a great financing option to bridge a company’s funding gap. You trade having to wait for full payment in exchange for receiving immediate funding that deducts a fee and short-term interest, which is highly beneficial for companies with cash flow problems.
There are two types of invoice factoring: recourse and non-recourse. In recourse factoring, if your customer defaults on the invoice payment, you are required to pay the remaining invoice amount. In non-recourse factoring, the factor will assume most of the risk of non-payment from your customers but will instead charge a higher factoring fee.
Factoring companies will also look at the creditworthiness of your customers. Even if your startup has low credit, you are still likely to be approved for invoice factoring if you have creditworthy customers.
Merchant cash advance
Merchant cash advances are structured like a loan, despite being a cash advance. After forwarding cash to a borrower, an MCA company buys the rights to take a percentage of your future sales, which include your future credit card and debit card sales.
The appeal of an MCA is that the requirements to qualify are minimal. For example, your business needs to have sales and credit sales over the past six months. An additional benefit of MCAs is that it can provide cash advances within a couple of days.
The biggest downside of merchant cash advance is that it will be considerably more expensive than other financing options and will likely disrupt future cash flow. You will need to exercise an extra level of precaution to safeguard your business if you choose this route.
Merchant cash advances can solve short-term problems and require little from your company. However, this should only be considered as a last resort option.
Alternative financing summary
Startup founders may consider working with alternative lenders given that most alternative financing options are faster than traditional financing and there are a myriad of alternative financing options that can be tailored to your funding needs. As always, before working with any lender, make sure to thoroughly research your options so that you can choose the option that works best for your business.