Alternative Financing

Delivering alternative sources of money

To many, alternative financing carries a bad connotation. Some identify the term with loan sharks or other high priced sources of money. Although there are some out there that feed on the weaknesses of companies, there are many sources of money that charge reasonable rates. Most of those sources use a method of lending called factoring.

Factoring Companies buy accounts receivable and assume the risks of collection. Factoring agreements come in two basic forms: they either include or exclude recourse. In those that include recourse, the seller is required to take back receivables that are determined to be uncollectible and in those that exclude recourse the buyer of the receivables assumes the entire risk of collection. Naturally, those without recourse are a more expensive type of factoring but, in either case, the funds are advanced to the seller against purchased receivables, less a percentage.

Commercial Finance Companies often advance funds upon assignment of receivables and warehouse shipping/receiving receipts and will also consider short-term equipment financing.

Approaching Trade Creditors, Factors and Commercial Finance Companies:

Sales finance companies, in cooperation with the product suppliers commonly offer sales finance or factoring programs and leaseback options on their equipment. The onus is on you to ask your vendor if they have access to any such finance programs, or if the vendor will finance the purchase directly, through a factor or floor-planner scheme. Small office equipment may often be purchased on a lease-to-buy arrangement. Generally, these will expect a less detailed business plan, but will be particularly interested in the parts that relate to sales projections, stock movement and replenishment, and monthly cash flow information.

Suppliers Inventory Buying Plans

An alternate way of realizing working capital is through supplier financing. Suppliers may be willing to extend payment terms to 60, 90, or even 120 days. Some suppliers offer 2% discounts for early payment (within 10 working days) and penalize slow paying dealers with monthly interest charges. Other aggressive suppliers may offer floor planning or factoring options to assist dealers in financing stock purchases. Occasionally, such a supplier promotion plan will enable a dealer to pay for specific items only as they are sold (the supplier retains ownership of goods until paid for.)

These plans entail your empowering a representative of the supplier to enter your premises and take spot-counts of their merchandise in your stock. The supplier then invoices you for what has been sold according to the representative’s report, and replenishes your stock to the original agreed level. This system also permits the supplier to constantly alter the mix of his/her merchandise on your shelves, quickly replacing slow-moving items with those that seem to sell more quickly in your particular market.

Renting and Leasing vs. Buying

In aggressively competitive equipment markets, most leasing companies will be pleased to arrange lengthy leases on equipment and computers with an option to purchase in order to close the sale for the supplier. Renting or leasing can free up equity capital for investment in other areas of greater return; free up borrowing power (improves cash leverage) for more critical borrowing; requires no down payment; fixes the rate for a set term; allows you to deduct the full expense from your taxable income; and still allows you the flexibility to exercise purchase options at a later date and at a predetermined price.

Leasehold Improvements

When you are negotiating a lease for a rented premise, remember that a substantial amount in leasehold improvements will be going into that location. The person in the best position to oversee the leasehold improvements as a security for the loan is the landlord. Moreover, the landlord or property manager will often agree to provide a portion (a dollar amount per square foot allowance) or all of your leasehold improvements against a longer-term lease. A three- or five-year lease gives you a reasonable negotiating position for including leasehold improvements in the deal and paying for these through your rent over the course of the lease. This may represent $30,000-$60,000 of start-up expenditure for retail locations, for example, and off-laying that can significantly reduce the start-up cash and equity required. In addition, it can make a balance sheet appear healthier when its ratios are examined. A skilled lease (contract) lawyer, acting on your behalf, can perform a great service in this kind of negotiation.

Advance Payment from Customers

You might consider negotiating a full or partial advance payment from customers to help finance the preparation costs related to taking on their business. In some project-oriented industries, it is customary to receive stepped (partial) payments payable at defined stages of progress prior to the completion of the project.

Consider requiring a deposit for all work (normally deposits are held in trust pending completion.) This will reduce the need for a line of credit. Deposits collected for work that involves special orders for goods or services will serve to prove the customer was committed to the order and will prevent the business from having to absorb costs resulting from non-payment.

Factoring Accounts Receivables

An effective way to grow a business with limited working capital is by utilizing a factoring company to discount your accounts receivable. In fact, with good supplier credit and a professional factoring company, you may need a lot less capital than you think. The factoring company can also provide you with credit management expertise.

What happens is basically the same thing that happens when a retailer accepts a credit card; you receive the money right away while it is the factoring company who waits for payment. By having the use of your money right away, you can begin to concentrate on making the next sale.

Factoring is more expensive (typically 3 – 5% of your invoice) than most other forms of finance, therefore, it is important to find ways to build it in (pricing) and earn it back (suppliers.) There are also savings realized by not having to perform necessary credit functions yourself. If you can use the factoring monies to add new business, then the costs of factoring are fairly easy to justify.

By factoring your receivables, you do not increase debt or dilute equity. You are simply given access to your own money when you want it rather than when your customer chooses to pay. As you build your own working capital, you can reduce the amount that you factor and carry more of your own accounts receivable. Eventually you can become completely self-financed.

Factoring is a means of purchasing a company’s receivables, exchanging cash for ownership of the receivables and right of collection. Two types of factoring exist, with recourse and without recourse. Factoring with recourse means that in the event that the Factoring Company (“the Factor”) fails to be successful at collection, ownership of the receivable reverts back to the original source. Lending without recourse indicates that the Factor will suffer the consequences in the event that a receivable becomes un-collectible. The latter is the preferred choice for obvious reasons yet bears more risk and is therefore more costly.