Where to Go When Your Bank Says No

It takes money to make money, as any business owner knows. But many small businesses also know what it’s like to be turned down by a bank for a loan or line of credit, not get as much as they need, or simply not get the cash quickly enough to take advantage of an opportunity.

It’s not just start-ups that run into financing difficulties. Even an established company that is growing rapidly will frequently have financial challenges. To make matters worse, owners of small businesses have an especially difficult time getting business credit without relying on their own personal credit and assets as guarantees. But there are alternative financing methods that business owners should know about: accounts receivable financing (also called “factoring”), purchase order financing and merchant card (or credit card) receivables financing. These are all alternatives to traditional asset-based lending or bank financing. They are frequently used as “bridge,” or short-term, financing until companies can qualify for bank financing, although some companies choose to use these techniques on a longer-term basis. Because these tend to be higher-cost ways to raise funds, they’re best used by firms that operate with good profit margins.

For many business owners, these alternatives help them avoid taking the route that strapped business owners take: selling a share of the business to an investor or partner. With alternative financing, an owner doesn’t dilute his or her ownership stake or control of the business.

Unlike in traditional lending, where the company’s financial strength is a determining factor in getting a loan, in these alternative financing methods, invoices, purchase orders, credit card receivables and the quality of the client’s debtors or suppliers are the determining factors in providing financing. These methods can provide financing quickly and simply.

The most familiar method of alternative financing is “accounts receivable” financing, often referred to as factoring. Factoring, which accounts for about $4 trillion a year in lending in the U.S., uses the assets of the business — namely a business’s accounts receivable — to secure financing by a financial organization. The financing company examines an aging report of the client’s debtors, looks at their creditworthiness and does a search of the client’s business and its owner’s past history. Funding can be provided in as little as three to seven days after application. Factoring is the most commonly used method of alternative financing, and we’ll examine it in more detail below.
Purchase order financing (sometimes called purchase order factoring) involves financing before a company has accounts receivable to factor; at this earlier stage, a business has received a purchase order. Often it’s used if a company gets an order that is much larger than the orders it typically receives, and doesn’t have a sufficient line of credit with a bank or sufficient terms with a supplier to cover such an order. Usually purchase order financing is used in conjunction with accounts receivable financing. A purchase order financing company provides the cash to complete production of an order, and when it’s finished (and an invoice has been generated), the invoice is sold to an accounts receivable financing company, which finishes the transaction.

Typically purchase order financing companies charge about 2.5% to 4% in fees per 30 day period. (For a case study on how one New York area food processing company has successfully used purchase order financing click here.) Another alternative funding source is merchant card receivables financing (also called credit card factoring or merchant advances). This is a newer form of alternative financing. Credit card factoring companies focus on the restaurant, catalog and other merchant categories where credit card payments account for a large percentage of total sales but cash flow is irregular. Basically, the company sells future credit card receivables. The financing company will typically advance a business owner up to one month’s average credit card receivables. Typically loans are in the $10,000 to $30,000 range. Fees are steep, often about 35% of the amount borrowed. To qualify for this type of financing, a business generally needs at least $5,000 a month in credit card receivables and must have been in business for at least six months. According to Dean Landis, president of Credit Cash, a Manhattan financing company, there are other types of credit card receivables financing, with lower rates, available for companies with higher levels of monthly credit card receivables.

By far the most common type of alternative financing used is accounts receivable financing or factoring. Accounts receivable financing is often referred to as “transaction financing.” Combined with purchase order financing, it is a useful way to increase sales volume without the obligation of a loan or the need to pursue venture capital when the size of the orders that a company receives grows more rapidly than does the company’s available traditional financing.