Unlike what most small business owners believe, funding a business is not brain surgery. In point of fact, there are only three major ways to do it: via debt, equity or what I call “do it yourself” finance.
Every technique comes with benefits and drawbacks you should be aware of. At various stages in your business’s life cycle, one or more of these methods may be appropriate. For that reason, a complete understanding of each method is essential if you think you may ever have to secure funding for your business.
Debt and Equity: Pros and Cons
Debt and equity are what many people think about when you ask them about business financing. Traditional debt financing is typically provided by banks, which loan money that must be repaid with interest within a certain period. These loans typically must be secured by collateral in case they can not be repaid.
The cost of debt is relatively low, especially in today’s low-interest-rate setting. However, business loans have become more challenging to come by in the current tight credit environment.
Equity financing is provided by investors who receive shares of ownership in the company, as opposed to interest, in exchange for their money. These are typically venture capitalists, private equity firms and angel investors. Even though equity financing does not need to be repaid like a bank loan does, the cost over time might be much higher than debt.
This is because each share of ownership you divest to an investor is an ownership share out of your pocket that has an unknown future value. Equity investors often place terms and conditions on funding that can handcuff owners, and they count on a very high rate of return on the companies they invest in.
My preferred kind of financing is the do-it-yourself, or DIY, variety. And one of the best ways to DIY is by using a financing technique called invoice discounting. With factoring products, companies sell their outstanding receivables to a commercial finance company (sometimes referred to as a ” invoice factoring company”) at a discount. There are two key advantages of factoring:.
Significantly improved cash flow Instead of standing by to get payment, the business gets most of the accounts receivable when the invoice is produced. This reduction in the receivables delay can mean the difference between success and failure for companies operating on long cash flow cycles.
Say goodbye credit analysis, risk or collections The finance company performs credit checks on customers and evaluates credit reports to uncover bad risks and set appropriate credit limits essentially becoming the businesss full-time credit manager. It also performs all the services of a full-fledged accounts receivable (A/R) department, including folding, stuffing, mailing and documenting invoices and payments in an accounting system.
Invoice Factoring is not as widely known as debt and equity, but it’s often more useful as a business financing instrument. One reason many owners don’t consider factoring first is because it takes a while and energy to make invoice discounting work. Many people today are looking for immediate answers and immediate results, but stopgaps are not always offered or advisable.
Making It Work.
For factoring to work, the business must accomplish one very important thing: deliver a top-notch product or service to a creditworthy customer. Undoubtedly, this is something the business was created to accomplish to begin with, but it serves as a built-in incentive so the business owner does not forget what he or she should be doing anyway.
Once the customer is satisfied, the business will be paid immediately by the factor it doesn’t have to wait 30, 60 or 90 days or longer to get payment. The business can then immediately pay its suppliers and reinvest the profits back into the company. It can use these profits to pay any past-due items, obtain discounts from suppliers or increase sales. These benefits will typically more than offset the fees paid to the invoice factoring company.
By factoring, a business can grow http://www.accountsreceivablefinance.org its sales, develop strong supplier relationships and enhance its financial statements. And by relying upon the factoring company’s A/R management programs, the business owner can concentrate on expanding sales and increasing profitability. All of this can take place without increasing debt or diluting equity.
The average business factors for about 18 months, which is the period of time it usually takes to attain growth objectives, pay off past-due amounts and boost the balance sheet. Then the business will likely find themselves in a better position to search for debt and equity opportunities if it still has to.