Creative financing for small businesses
By Pat Curry
Every small-business owner needs credit at some point. Unfortunately, traditional bank loans can be tough to obtain. But there are alternative financing solutions -- from new crowdsourcing options to receivables loans -- that could help when traditional credit isn't an option.
According to the Biz2Credit Small Business Lending Index, big banks approved slightly less than 15 percent of the small-business loan applications received in December 2012 -- and even that small amount is a huge increase from December 2011, when only 9.7 percent of small-business loan applications were approved.
Small, regional bankers are much more receptive to financing small businesses; they OK'd approximately half of the small-business loans that came across their desks in December 2012, according to the index.
Entrepreneurs who didn't make the cut have to look elsewhere for capital. The most obvious choice may be business credit cards, which essentially act as a small line of credit from a bank. The nice part is that they can amount to interest-free money if the balances are paid off each month. Plus, responsible use helps a business build a credit profile.
"For a small business that is bootstrapping it, the credit card is important," says Mitchell D. Weiss, an adjunct faculty member at the University of Hartford (Conn.) Barney School of Business. Weiss spent more than 30 years in commercial lending, and recommends having two credit cards for a business. One is for budgeted expenses that are paid off in full each month. For those, go for a no-fee card with a reward of some kind, such as cash back on common expenses such as office supplies and fuel. The second card, he says, should be for emergencies that you can't pay off right away.
"You don't use that except for expenses you know you can't retire in a single month -- a computer blows up or a transmission goes out in a delivery truck," he says. "Do it that way because when you carry a balance, all your charges wind up incurring interest. Why do that on everything you know you can pay off?"
Business credit card issuers also regularly send out cash advance checks with interest-free payment offers. As long as they're paid off in the prescribed time period (often 12 months), they can be a good deal. Compare fees on cash advances, which usually run about 3 percent to 4 percent of the amount borrowed.
Many small-business owners may find that they need more funds than are available on a credit card, but less than the amount that conventional bankers are interested in funding. If you're fall into this category, an unsecured Small Business Administration loan may be right for you.
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Superior Financial Group out of Walnut Creek, Calif., has a partnership with Sam's Club to provide such loans (Sam's Club members get a discount on the processing fee, but the loan is open to virtually any small business owner). The loans, which require a personal guarantee, are usually for $5,000 to $25,000 at a lower interest rate than a business credit card.
Vice President of Operations Tamara Declerq says that Superior Financial Group has made about 1,200 working capital loans to Sam's Club members. "We've funded all sorts of businesses, from pizza to pet shops to personal trainers," Declerq says.
One benefit of the program is that, unlike many bank loans, it's open to startups. "These are more like incubator loans," she says.Most people apply for the $25,000 maximum; the average loan size winds up being about $12,500. It's a simple interest loan with an eight-year term; the payment is $71 per month per $5,000 financed. The application is much shorter and simpler than the application for larger SBA loans, and funding often is within five to 20 days. If there's a drawback, it's that the monthly payments are automatically debited from your checking account.
Another new option for startups is crowdfunding, which leverages the power of the Internet and social media to get funding from a wide group of people. In the past, crowdfunding sites such as Kickstarter, Indiegogo and RockthePost have focused on donations, with small rewards given to donors. Startups interested in using the medium to secure equity financing have been shut out because the Securities and Exchange Commission only allows accredited investors to provide backing.
Once the regulations are issued, we'll explore the possibility of becoming a funding portal for the average Joe.
That was poised to change when President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act in 2012. The law allows for the creation of online funding portals for startup companies that are open to small investors; it limits their investments based on their income so they can't lose their shirts -- and gives them the opportunity to get in on the ground floor of the next big thing. Thousands of Web addresses have been snapped up and are parked, waiting on the SEC to write the required regulations. (They were supposed to be done by January 2013; they're not out as of March 2013.)
RockthePost, which works specifically with entrepreneurs, recommends that small businesses looking for $5,000 to $35,000 take the donation route. It's much less expensive and involved -- and doesn't require you to give up any equity in your company.
For those who are looking for serious dollars -- up to $5 million -- the site is launching a new platform March 5 to connect with accredited investors who will end up owning part of the company.
"Right now, a funding portal can't operate for investors, period," says RockthePost CEO Alejandro Cremades. "We're operating under the license of a broker/dealer. This is only for accredited investors. Once the regulations are issued, we'll explore the possibility of becoming a funding portal for the average Joe."
Whether a company is looking to use crowdfunding for donations or equity investors, Cremades says it's important to understand that it's not an easy route to fast cash.
"People who think they can put up a project and the money will roll in aren't going to be successful," he says. "It's easier than real-life fundraising because you're not knocking on doors and making lots of phone calls, but it takes a lot of work and a lot of time. You need to have a plan."
You also need to understand that any income to the business comes with tax implications. "Uncle Sam never forgets you," Cremades says. "You need to have a good accountant."
If your business has stable business customers that typically pay in 30 days or more, take a look at accounts receivable financing, more commonly known as factoring. It works like a cash advance on your receivables.
After you sell a product or service to a customer, you sell the invoice to a company called a "factor," which advances you a portion of the amount due -- usually 75 percent to 85 percent. The factor bills the customer the full amount. When the customer pays the bill, the factor sends you the balance, minus its fee, which is a percentage of the bill.
Because the product or service has already been provided, the factor is more concerned with the creditworthiness of your customer than your own business, says Tom Stamborski, president of Liquid Capital of Illinois. As a result, the factor is likely to agree to working with companies that generally don't qualify for bank financing, including startups and those with maxed-out credit cards.
"We don't create debt; we're leveraging a current asset," Stamborski explains. "We can deal with folks who are credit-stressed. As long as their customers qualify, we can increase their credit and grow with the company."
Some factoring companies require small businesses to assign all of their invoices or sign a contract for a certain period of time. Others like Liquid Capital allow customers to sell as many -- or as few -- of its invoices as they want. Pricing varies based on the size of the invoice and the creditworthiness of the customer.
Steve Shriver, CEO of organic lip balm manufacturer Eco Lips in Cedar Rapids, Iowa, used factoring after starting his company in 2003, and often recommends it today. "It was a really easy way to get money as a startup," Shriver says. "We had the sales, but in terms of bridging cash flow, there weren't many other options for us. They made it amazingly easy to get paid on invoices that we had."
The drawback, he says, was that it was hard to wean off factoring. At one point, the company was assigning 80 percent of its invoices. "It took months and months longer than we thought it would to be stable and patient enough to wait for our customers to pay for us," he says.
We can deal with folks who are credit-stressed. As long as their customers qualify, we can increase their credit and grow with the company.
|-- Tom Stamborski
Liquid Capital of Ohio
His advice to anyone considering using factoring is to do a formal cash-flow forecast on how factoring will impact your business and have an exit plan.
Most financial planners will tell you that it's an extraordinarily bad idea to pull money out of a retirement fund for anything other than its intended purpose. Taking an early distribution typically results in a hefty penalty and a big tax bite. But not always. Through a carefully constructed process called a self-directed 401(k), you can have your retirement funds invest in your own company.
It's a funding mechanism that can be attractive for startups, which rarely get bank financing, and especially for franchisees. The process works like this: You set up a corporation, which then establishes a 401(k) for its employees. You then roll over as much of your retirement account as you want into the 401(k). The 401(k) buys stock in your company, which can use the funds to buy a franchise, build a store, purchase equipment, etc.
"It's essentially like operating a stock market," says David Nilssen, CEO of Guidant Financial Group, which has set up plans for more than 3,000 companies.
Linda Tyler worked with Guidant Financial when her SBA loan wasn't enough to start up her first Red Mango frozen yogurt franchise in Little Rock, Ark. Even with a background in managing employee 401 (k) plans and a husband who is a CPA, Tyler had not heard of this option. Neither had her accountant, who was justifiably wary. "It's an area of the law that has existed for a very long time, but it is a niche," Nilssen says. "It's fairly common to talk to a tax professional and have them not be familiar with it."
The benefit of using a self-directed 401(k) is that it's a way to access a significant amount of money quickly. (Nilssen says the entire process often is done in less than a month.) It's an investment, not a loan, so theoretically, it doesn't have to be paid back. Plus, there's no bank approval needed. "It gives you a financing vehicle you would not have otherwise," Tyler says. "I'm not sure we'd have been able to do it otherwise."
The drawback is easy to see. For many people, a retirement fund is the sum total of their life savings. If the business fails, they've lost their retirement income. Tyler chose to leave some of her retirement funds where they were, and she is paying back the funds she borrowed.
Her advice to anyone considering taking this route is to be prepared to follow the steps precisely. If you don't have the experience or background to understand what you're committing to, make sure you have qualified accountants or attorneys to help you. "I think it's doable for the average investor," says Tyler.
With her first location doing well, Tyler is planning to open another. "Now that we have a track record, we have a strong relationship with our bank," she says. "We'll pursue another SBA loan for our second store."See related: Financing your small business with plastic: A capital idea?, Business owners turn to bank loans, not business cards, for financing, 8 steps to boost your business's commercial credit score
Published: March 4, 2013
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