Large commercial banks who used to actively court small business lending retreated from the marketplace in recent years, only to sit on the capital that has been given to them by the government until “times get better”. When that fuzzy “time” may be reached is anyone's guess, but meanwhile, businesses need capital to survive.
Luckily, there are many alternatives that are out there for small and medium businesses. Usually this capital can be obtained fairly quickly, even if business and personal credit is tough. However, no business should be under the illusion that business working capital loans are cheap in the post-economic crash world. With business failures still tracking at an all time high, it is incredibly risky for those lenders who choose to make this their livelihood. Because of this, they must be compensated accordingly, or risk becoming victims of bankruptcy themselves.
SBA Loans –
Pros – The best terms available for small business. Loans are made by private banks and are partially (up to 90%) guaranteed by the government against default.
Cons – Reams of paperwork are required from audited financials, P & L statements, etc. Processing times can run up to 4 months, and approval ratios are low. Only the best credit applicants need apply and even then, certain industries, like restaurants, are potentially impossible to approve in this credit environment.
Funding Times- 2-4 months
Commercial Mortgages –
Pros – If you have equity in your commercial property and it does not have any major problems or environmental concerns, this is a very good options with rates ranging from 6-14% depending on credit quality and other factors.
Cons -It's difficult to have equity in your commercial property when values have plummeted to rock bottom in the past 5 years. Additionally, you will have to pay out of pocket up to $ 3000 for a commercial appraisal and you may still not be approved, depending on what the appraiser comes back with. Look for processing times of 4-8 weeks before you know the arrival of your application.
Funding Times – 4-8 weeks or more
Equipment Secured Loans / Leaseback
Pros – This can be an attractive option for those companies that own, or have significant equity in, capital equipment that they use in the everyday operation of their business. Depending on credit quality, rates can be anywhere from 10-40% depending on the file and equipment being securitized.
Cons – As a hedge against default, all lenders in this arena will only lend on a percentage of the estimated value of the equipment. Keep in mind that in almost all cases, the equipment is used, and the loan will be against the depreciated value of the equipment or it's anticipated sale price at auction, minus any money owed on the loans used to purchase it. Therefore, a $ 100,000 dollar piece of equipment bought 8 years ago may be only worth $ 60,000 dollars today, and the lender is only going to lend against a portion of this anticipated value, usually as low as 50% of the auction price. Expect to take a further hit on the lending percentage if the credit is tough or the cashflow of the company is weak. On the example above, a $ 30,000 loan would have considered good.
Funding Times – 10-14 days
Pros – This is not technically a loan, but purchasing anticipated receivables at a discount. This method is great for a company that primarily operates on a “net 30” model and receives most of it's income via cash or cash equivalents. Essentially a factoring company will advance you up to 90% of the face amount of your anticipated receivables in a lump sum. Then, the payments due from your client are redirected to the factoring company via a legal agreement. The difference between the amount advanced and the amount paid to the factoring company represents their profit margin on the deal. This method is fairly quick, and no repayment of the advance is required because your clients send their payments previously owed to you to the factoring company.
Cons – Your clients by law must be informed of this change and where to send the payment previously due to your company. Some companies are not comfortable having their clients know this level of detail about their company finances. Additionally, if the credit of the company following the receipt to your company is bad, or you company's credit is bad, the deal may be returned by the factoring company or be purchased at a steep discount that can run as high as 40%. of the original amount owed. In this case, a $ 100,000 dollar bill owed to your company would only net and advance of $ 60,000.
Funding Times – 7-10 business days
Merchant Cash Advance
Pros – Think of this as the “little brother” to receivables factoring. Companies that accept credit cards as a primary means of payment are advanced an amount guaranteed against their future credit card receivables. This method works great for businesses with high credit card transaction volumes and low average tickets and is ideal for those companies that may have difficult credit circumstances. Usually, owner credit scores down to 500 are OK as long as the business processes at least $ 10,000 per month. Usually the paperwork associated with this type of advance is minimal, with no financials required and a short one page application.
Cons – Because these are risky advances, the capital is expensive. The upside is that payments are made daily out of the existing credit card processing stream at least 5 times per week. This means that, while these advances are expensive, they are usually paid off within 6-12 months. Payments typically do not equate to more than 11% of a companies monthly gross income. A company may also be required to switch credit card processors as a requirement of funding the deal. Usually this is a fairly painless process, but some companies can make it difficult or require you to buy new swipe equipment.
Funding Times – 5-7 business days
Bank Only Cash Advance
Pros – Similar to a merchant cash advance but designed for those companies that do not accept credit cards or do not have significant credit card volumes. This type of advance is based solely on the strength of the business bank account and the average balance within it. Funding amounts fluctuating between 2 and 4 times the average monthly balance are common. This type of advance also does not require a lot of paperwork or audited financials and is usually short term (6-12 months max)
Cons – Your business bank account must be in good shape with a healthy average monthly balance (over $ 4k) and very few “negative balance” days and few NSF's in your account. Additionally, owner credit must be in the 600-650 range minimum, depending on the size of the deal. Because the capital is very risky, it is also expensive.
Funding Times – 5-7 Business days.
Credit Card Receivable Loan
Pros – Also similar to a merchant cash advance, but regulated as a true business loan, not a cash advance. This means the on-time payments help your business credit. Typically, rates are 30-50% less than a comparable merchant cash advance, but are still expensive compared to a bank loan. Because payments are ACH'd out of business bank account, not a credit card processing stream, there is no requirement to switch credit card processors. Owner credit down to 550 is acceptable, but anticipate tighter underwriting requirements than a merchant cash advance. Terms are short, between 6-12 months and payments are made daily, 5 times per week in most cases.
Cons – Not quite as flexible as merchant cash advance because the capital is significantly cheaper, undercutting the ability of the lender to accept the same level of default risk as a merchant cash advance.
Funding Times – 5-7 business days
Hopefully you have learned a little bit more about what is possible in the post-credit crunch world when it comes to financing and working capital loans for your business. Understanding the types of working capital, how they are priced and what that means for your business is critical before making any move. All of the above sources of working capital have there place in today's economy, especially given the dearth of options at your local bank or credit union, so knowing the differences and how this fits into your range of options will help when trying to make your next business move.