Securing Funding in a Bad Economy

Written by admin on April 25th, 2011

Acquiring financing for a company is tough when the economy is doing well and close to impossible when the economy is suffering. This is especially true when considering traditional borrowing avenues such as bank financing. Compounded with the fact that the present time is considered the worst economic credit crisis since the Great Depression and the chances of business owner locating money for his/her growing company is slim-to-none. Or is it? Needless to say, entrepreneurs need to take a more creative approach when it comes to securing business financing during these bad economic times. This article will help jump-start the process, sharing information about three alternative cash flow sources worth considering in these cash-strapped times.

Banking with Family and Friends

Although it might have an unconventional connotation, borrowing from friends and family has helped well-known companies fund their growth. Richard Branson borrowed money from his aunt when he founded Virgin Records. Sam Walton, used a ,000 loan from his father-in-law to start Wal-Mart, and Ahmet Ertgeun borrowed ,000 from his family dentist to help him launch Atlantic Records. 

Unlike borrowing from a bank, friends and family may offer lower interest rates, more flexible terms and a much simpler approval process. The lending criteria are mostly based on the personal relationship the lender has with the borrower. With that said, experts warn that it’s important to treat the loan arrangement in a professional manner to avoid damaging personal relationships. This means, much like a business owner would explain his/her borrowing intentions to a bank or an investor, it’s very beneficial for the business owner to put together a short presentation for family and friends. Even if friends and family aren’t interested in the same nitty-gritty details as professional investors, giving them the basics (goals, potential risks and a repayment plan) will squash any investing worries they might have.

Once a family member or friend has agreed to front money for a business venture, experts suggest drawing up the loan’s terms and its repayment plan to avoid potential problems on down the road. Of course, once the formal documents have been created and agreed upon, business owners should stick to the terms indicated within the documents. In the event that the business is unable to make a payment, it’s important to communicate this situation with the party who loaned the money. Because it’s a family member or a long-time friend who loaned the money, he/she might be more forgiving than a traditional bank; therefore, they might be able to work around the cash flow difficulties.

Peer-to-Peer Lending

Similar to borrowing from friends and family, peer-to-peer lending is exactly what it sounds like—people lending other people money. Categorized in the same tier as borrowing from friends and family, peer-to-peer lending is a much more structured financing relationship, because it provides a buffer between the borrower and the lender. Formalizing the process helps create distance between emotions and the business in need, easing what can sometimes be a tense situation for both parties involved. The loan process usually starts in an online social networking site. For example, the owner of a medical transcription service would create a borrower profile, upload a photo, list a requested loan amount and add specific details for why he/she needs the loan. Lenders have the ability to peruse the borrower profiles and select someone to assist. It’s important for business owners to note that some peer-lending sites will not accept borrowers with less-than perfect credit, and other sites have a borrower-rating system in place to help prospective lenders assess the risk involved. Once a lender has chosen a borrower, the website handles the formalities of the arrangement.

Borrowers are asked to provide personal information similar to what a bank would need when signing a loan. Contracts are then drawn up, exchanged and signed. If the borrower is unable to pay back the loan according to the agreed upon terms, he/she will be sent to a collections agency and reported to a credit bureau. 

There are a number of websites dedicated to peer-to-peer lending, most notably Prosper, Lending Club and Virgin Money.

Exchanging Invoices for Cash

If an entrepreneur doesn’t want the hassle of paying back a loan and muddying up his/her balance sheet in the process, there is one more alternative financing option to consider — accounts receivable factoring. Selling invoices to a factoring firm is a very common, yet understated way of keeping a company’s cash flow going throughout an economic downturn.

As opposed to accepting a loan from a bank, a family member or a peer, accounts receivable financing is not a loan at all. In this type of funding arrangement, the factoring firm purchases the rights to an invoice, advances cash immediately on that invoice and then collects on it. Credit decisions are based on the creditworthiness of the company’s customers rather than the business itself, allowing the factor to leverage the higher quality of their customers’ credit in securing funds. In addition, many factoring companies are willing to work with start-up companies, as well as those who are in a rapid growth phase. Many factoring firms are also willing to fund receivables without requiring a personal guarantee of the business owner, allowing the owner to protect his/her personal assets. Accounts receivable factoring agreements also generally provide generous lines of credit because factors are able to increase their funding as their clients’ businesses grow.

For example, let’s say that a company provided services to a doctor’s office and then billed the physician for those services. Also affected by the current economic conditions, the physician tells the business owner that he is not able to pay the bill until next month. If the business owner is working with a factoring company, he/she can sell the invoice to the factor and receive the majority of his/her funds right away. The factor charges a fee for the aged invoice once it receives full payment, releasing the difference back to the company’s owner. As a result, factoring allows the entrepreneur to continue its basic business operations as usual while also maintaining a good vendor-relationship with the physician.

Factoring firms come in all different shapes and sizes, and they are spread out all over the world, and each offers their own twist to the invoice funding model. Therefore, it’s important for entrepreneurs to take the time to research factoring companies and select the best one to meet their company’s financing needs. Some more pertinent qualities to consider when choosing a factoring company is to find one who is a member of the International Factoring Association. The IFA, understands the uniqueness of your business and offers flexibility with its funding.

In a time when more and more banks are saying “no,” business owners can and should take advantage of some or all of the alternative financing options shared within this article. When researching any kind of funding source, it’s important for business owners to remain professional and be upfront about his/her company’s financial needs and goals in order to secure the best funding solution for his/her company.

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