Large companies have always had a number of options that
they could depend on to raise capital for their businesses. The have always had
access to a number of alternatives such as selling stock, issuing bonds, bank
loans and accounts receivable financing among others. Looking at the other side
of the coin, smaller companies, those that have between $20,000 and $500,000 of
yearly revenues, have always had a challenge trying to find capital to operate
their businesses.
The lack of access to capital has prevented many small
businesses from growing and capitalizing on the many opportunities that are
available to them. It is not uncommon for small companies to reject large deals
or opportunities because they do not have the necessary capital to obtain the
resources to service the account. However, even when small businesses do take
on large contracts, they find that they are never paid immediately upon
delivery of services. Most contract terms demand that the supplier provide 30
to 60 days for the customer to pay their invoice - in effect, forcing them to
extend them with supplier credit. The lack of adequate capital resources, along
with the necessity to offer commercial credit to clients, creates a
"perfect storm" that prevents small businesses from growing and that
is very difficult to avoid.
A number of these issues could be sidestepped if the company
had immediate access to working capital. Working capital could enable the
business to add employees and resources to serve new clients and larger
contracts. It also enhances a company's ability to extend 30 to 60 day payment
terms to their customers.
This paper outlines the most common sources for working
capital and provides an evaluation of each source. Each source has also been
assigned a score, which summarizes the availability and flexibility of the
source.
Scoring System
Each working capital source that has been evaluated has been
given a score from 1 to 10. The following features where considered when
assigning a score:
Accessibility to small businesses
Requirement complexity (e.g. do they require significant
financial reporting?)
Flexibility
Payment terms
A higher score indicates that the source of capital has a
positive outlook on a number of these criteria and is available to small
businesses. A lower score indicates that a particular source of capital may not
be best suited for most small businesses.
Financial Options
Venture Capital - Score: 1
Many books and publications tout the benefits of obtaining
venture capital to finance a new or ongoing operation. Venture capital is an
option for small companies that have a seasoned management team and very aggressive
growth plans, however, venture capitalists will rarely invest in small
businesses that have no intention of going public. The venture capitalist
objective is to invest in a company for a short period of time - say 5 years -
and then cash out of the business while making a significant return on their
investment.
Angel Investors - Score: 2
An Angel investor is a wealthy individual or group of
individuals that typically invest in pre-venture capital companies. That is,
companies that don't meet the current requirements of a venture capitalist but
that could meet their requirements with a capital and management influx.
However, you should not rule out angel investors completely since there are
angel investment groups who focus on the growth of certain communities and will
invest in small businesses. The best way to find an angel investment group near
to you is to search them on the Internet using a search engine such as Google
(www.google.com).
Banking Institutions - Score: 4.5
Most small businesses owners will first approach their bank
to try and obtain a loan or line of working capital. However, unless the
business has been in operation for a number of years, has substantial assets
and all the appropriate financial records, their chances of obtaining any
financing are minimal. Banks, however, can provide lines of credit if the
business owner personally guarantees them. This means that the business owner
will be personally liable for the repayment of these loans. These lines of
credit can provide the business with the needed working capital; however they
can be very risky, especially if the business does not produce the expected
results and the owner is unable to repay the bank. Business owners should use
this method of financing very cautiously.
Credit Cards - Score: 5
Much like bank lines of credit, many business owners use
their credit cards to fund their businesses. Credit cards offer the ability to
make purchases or obtain cash advances and pay them at a later time. It should
be noted that credit cards can be a very expensive source of funding. Although
most credit cards have reasonably low interest rates for purchases, their cash
advance rates can be as high as 17% to 19% due to greater delinquency rates.
Furthermore, most credit cards will charge you 2% to 4% of the face value of a
cash advance as a "fee". Much like bank lines of credit, the business
owner personally guarantees payment of a credit card. Thus, this method of
financing can be very risky if the business does not produce the expected results
and the business owner cannot repay the credit card company. Business owners
should use this method of financing very cautiously.
Home Equity Lines of Credit- Score: 5.5
Business owners who are also homeowners have the option of
tapping into their home equity to finance their ongoing business operations.
Home equity loans and lines of credit have many advantages, such as low
interest rates and the possibility of having some portion of it deducted from
taxes . This method of financing gained a lot of momentum between the years
2000 and 2004 when interest rates where at their lowest point in decades and
real estate was appreciating in value. A major disadvantage if this financing
method is that it directly places the business owner's home at risk. In fact,
the business owner is placing a bet - with their home as the potential wager -
that the business will succeed and will be able to repay the loan. Much like
lines of credit, business owners should use this method of financing very
cautiously.
Small Business Administration - Score: 7.5
The US Small Business Administration (www.sba.gov) provides
a number of very viable options to finance business operations. Although the
whole scope of SBA services is beyond the scope of this paper, the SBA provides
a "Microloan" program. The program objective is to stimulate
micro-enterprises and provides loans of up to $30,000 to small businesses.
These loans are usually provided through a financial institution or a bank.
They have higher interest rates than traditional loans, but their requirements
are more flexible, making them more accessible to small business owners.
Founders, Friends and Family - Score: 7
Friends and family are one of the most conventional ways of
financing small businesses. Many entrepreneurs have been able to leverage
existing relationships and obtain funding, either as a loan or as a capital
investment, for their businesses. Although this source of funding can be easier
to obtain that others, it does have some inherent problems. First, the business
owner runs the risk of placing the relationship in jeopardy if things do not go
as expected and the business defaults. Furthermore, these transactions are
usually done with little formality and without written agreements, further
complicating matters. If you elect to use this funding option, you should
consult an attorney and draw some formal documents that describe the intent and
responsibilities of each party.
Accounts Receivable factoring- Score: 8
Accounts receivable factoring, also known as invoice factoring,
has been a source of working capital for large companies for many decades. It
is now becoming mainstream and available to mid-size and small businesses.
Factoring enables a company to sell their slow paying accounts receivable to a
financial company, who in turn pays for the invoices within a day or two. After
the sale, the financial company waits to be paid for the invoices. A key
feature of factoring is that the factor will take the credit strength of the
business' customers, as it's main consideration. Until recently, accounts
receivable financing was out of the reach of the small business owner. However,
enhancements in technology have now turned this method of financing into a
viable alternative for small businesses. This means that a small company with
little or no credit can leverage a strong roster of clients, sell their
invoices and get funding very quickly. Factoring should be considered as an
option for businesses that sell products or services to other businesses,
rather than to consumers.
Conclusion
Obtaining working capital for their businesses is one of the
most important decisions that a business owner can make. Like all important
decisions, it should be carefully thought out and deliberately executed. The
old adage that "the best time to look for capital is when you don't need
it" is still true. You should spend some time researching the all
available options for your business ahead of time, so that you can be ready to
"tap" your war chest when the right opportunity arrives.
DISCLAIMER
This paper is written to provide small business owners with
an overview of the financial options that are available for their businesses.
However, this paper does not intend to provide financial or legal advice as
only qualified professionals can do so. The author and Commercial Capital LLC
disclaim all liabilities arising from the use of the information on this paper.
Please consult a professional before making an important decision about your
personal or business finances