Short of Cash? 8 Alternative Sources of Business Financing
By Lyman Gardiner, CPA, CA, LPA, CBV
It’s a rare business that doesn’t experience the occasional financial slump.
There can be many reasons for a downturn: From an unexpected dip in the national economy to something relatively simple and short term, such as a major customer who doesn’t pay on time.
Whatever the reason, downturns often have business owners scrambling for loans or lines of credit to carry them through tough times.
But the loans officer willing to lend at a reasonable rate during good times won’t be so willing if he or she thinks the bank’s money is at risk. The response to a regular customer might not be an outright ‘no’ but at the very least, the interest rate will increase. And likely they will add conditions.
When conventional funding sources are either unavailable or too restrictive, it’s time to look for alternatives.
Much depends on the size and type of business, and whether your need is short or longer term, but here are some alternatives to consider.
- For both, short term, or longer term requirements, consider your non-cash assets and see if they can be used as collateral. For example, land or a building currently under financed. Re-financing real estate can be cheaper than loans without “hard asset” security .
- To fulfill a short term need, think about accounts receivable. Who owes you money? You could be in a position to factor some, or all of your accounts receivable. Factoring is selling your accounts receivable to a financing company for a fee or a discount on the invoice amount. The result is conversion of accounts receivable to immediate cash. The cost of factoring depends on the quality and terms of your accounts receivable. It gets trickier if, for example, you’re in the import-export business and you’re waiting for payment from an international customer or supplier. The conventional lender won’t be so confident and, quite reasonably, will ask: ‘If they don’t pay you, how can we make them pay us?
- Related to that international customer scenario, it’s possible to insure foreign accounts receivable through Export Development Canada. It offers some added security and peace of mind for the business owner and the lenders.
- So called ‘Bulge Financing’ is another short term alternative. For example, if a business has a $1-million line of credit, your lender might be willing to offer a temporary $300,000 ‘bulge’ for six months. But two caveats: You will need a specific, detailed plan that shows the downturn or cash requirement is temporary, and you will need to be prepared for additional interest costs.
- For longer term financing, perhaps you can sell and lease back a piece of equipment or real estate. For example, a business might own equipment or real estate asset worth $ 2 million, with little financing against it. Some financial institutions will buy assets and lease back to the former owner.
- Mezzanine financing is typically used when a business with little remaining security needs significant funds to expand or for succession to new owners. This type of financing often has flexible repayment terms. Mezzanine financing can be considered a hybrid between debt and equity financing, which costs more than conventional debt but less than equity. The Business Development Bank of Canada can be good place to start for businesses in this situation.
- Private equity is a well-known alternative, especially in Ottawa’s high-tech sector. Pension funds and wealthy individuals are regular investors in start-ups and high-tech firms experiencing growth spurts. Although private equity partners might be involved for relatively long terms, they also consider their exit strategy. Their focus is normally to fund growth, before selling their piece of a company.
- Some small business owners seeking an unsecured loan will turn to friends and family who will hopefully understand the risks and who might, for example, be willing to finance a second mortgage on a property owned by the company.
Finally, there are two extremely important points to remember.
- It’s significantly easier for a business owner to arrange loans and lines of credit on agreeable terms when the business is doing well and profits are healthy. You don’t have to spend it, but it’s already there if you need to. It becomes increasingly difficult to ask for the same amount when profits are down or there’s no money left in your business account.
- Successfully financing a business is about continual planning, continual reviewing, and keeping up-to-date business plans. It’s also about knowing, in detail, what financing options are available before you need them because the easiest and/or cheapest options you might find in a last-minute scramble might not be the best.
Lyman Gardiner is a GGFL Associate Partner