Northeast HVAC News Guest Column
Alternative Sources of
Small Business Capital.
By Dan Hawthorne.
Last month’s article mentioned the
contraction in credit card limits and the resulting need to
ensure that you have access to other sources of credit. Putting
a great big exclamation point on the magnitude of the
contraction in credit card limits, a recent article in Barron’s
reported the biggest-ever drop on record in consumer credit in
the third quarter of 2009.
This was the 10th straight month of contraction yet the rate of
contraction accelerated (a very concerning trend). Evidently,
consumer credit contracted by 8.5% (or $17.5 billion – WAY more
than the $5 billion contraction expected!). The vast bulk of
that came in the form of reduced revolving credit lines, mostly
credit cards, which dropped 18.5%.
Make no mistake, you can no longer
rely on your business or personal credit cards as a key source
of financing – you must have alternative sources of credit in
place should your limits be cut or eliminated. Let’s take a look
at some of the various sources and types of financing available
to small businesses. For the purpose of this article, I will not
discuss angel and venture capital or any other source that
requires an “exit” event and expects exceptionally high returns
on investment. If you need information or advice on those types
of capital sources, let me know.
For the average business looking for capital, here are some of
the more important sources to consider:
• Government (federal, state and local): The government provides
a wide array of financial support to small businesses –
especially during economic downturns such as today if you can
show that the funding will help to keep or create jobs. The
government also provides guarantees that can help you get loans
or bonding as well as other incentives and credits for business
investment, workforce training, etc. Typically, the amounts are
on the smaller end and are designed to help a business rather
than be its sole source of capital.
• Quasi-governmental entities (e.g., MassDevelopment): Depending
on the mission of the entity, it may provide equity, debt, tax
incentives, access to public bond offerings, and/or guarantees.
The amounts they will lend or invest can be large or small
depending on the size of the entity and the use of the proceeds.
• Banks (national, regional, & local banks, investment banks,
and credit unions): Depending on the size and sophistication of
the bank, it may provide just simple residential loans and
HELOCs or it may provide the entire gamut of credit products
including large commercial real estate loans, financing for
acquisitions and equipment purchases, long-term syndicated term
loans, trade financing, asset based loans, etc. The amounts can
range from very small to very large.
• Commercial finance companies (e.g., CIT or GE Capital):
Commercial finance companies range in size from small shops to
massive national corporations and provide almost all of the
credit products and services provided by the big national banks
and investment banks. Again, the amounts can range from very
small to very large. • Factoring companies: A factor doesn’t
loan you money, he buys your accounts receivable from you for
75-80% of the face value. If the factor collects the more than
the 75-80% he paid to you upfront, he will give you the excess
collected less the his fee (typically in the 1-5% range
depending on the quality of the A/R and how long it takes to
collect). For instance, if you sell a $1,000 receivable to the
factor he would give you $800 up front. Let’s assume the factor
eventually collects $900 and has to write off $100. In that case
he would forward you an additional $80, which is equal to the
excess $100 ($900 collected less the $800 already paid to you)
minus his fee of $20 (we are assuming 2% of the original $1,000
A/R sold to the factor).
• Vendors & strategic alliances: Vendors will often provide you
credit to purchase their products and services if you can
establish a record of timely payment or otherwise demonstrate
the creditworthiness of your company. However, there are times
when your vendor (especially if it is a large company) may
consider providing you with a longer term loan or even an equity
investment. For instance, if you are trying to expand into a new
territory where your vendor doesn’t have a great customer then
the vendor may be willing to help you finance your expansion of
territory. Alternatively, if you are unable to pay your bills
and might have to close shop then your vendor might be willing
to work with you to ensure you stay in business.
• Business development corporations (e.g., MA BDC): In 1980, the
U.S. Congress created a class of corporation called business
development corporations to encourage the flow of public equity
capital to private businesses. A BDC must invest at least 70% of
its assets in private U.S. corporations. BDCs must also make
available significant managerial assistance to their client
companies. BDCs often, but not always, take an equity interest
in their client companies.
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• Peer-to-peer lending
networks: This is a relatively new (in the last 3-5 years) source of
capital. Sites such as prosper.com or lendingclub.com match business
and personal borrowers with investors looking to put their money to
work by lending it to others. The site will assign your or your
business a creditworthiness “grade” which will set the range of the
interest rate you are likely to receive. As with most other sources
of capital, it is highly competitive – according to one of the
sites, only 10% of loans requested were funded.
• Family and friends: A tried and true source of capital for small
businesses. If the money will come in the form of a loan, one thing
to consider is using a service such as VirginMoney to formalize the
loan terms and repayment schedule.
• Personal assets (e.g., savings, retirement accounts, real estate,
life insurance policies): Another tried and true source of capital.
While this is not an exhaustive list, it may help you to open up
your thinking to sources you haven’t considered in the past.
If you talked to the bank you have been doing business with for
years and didn’t get anywhere, that doesn’t mean you can’t get new
financing – it just means you have to expand your search. Assuming
you have a reasonable plan to repay the loan or provide a return on
any equity investment, there are multiple sources of capital that
you can and should explore. However, as always, the key is to
identify the right match.
To do that, consider exactly what type of financing you need, how
long you will need it, and the types of terms under which you would
accept a deal. Identify the capital providers that provide that kind
of financing and then figure out if your company fits the profile of
their target clients (i.e., various entities tend to have somewhat
well defined profiles in terms of size, industry, location, etc.).
Consider their typical rates, terms and fees and what it would be
like to work with them (after all, once you take their money you are
most likely going to have work closely with them). How you finance
your business is an important decision with significant consequences
and should be the result of a well-considered strategy developed
with the help and input of your key advisors (attorney, accountant,
As you begin down this path, it may merit calling me or someone like
me (a person who offers financial analysis / CFO level thinking) to
discuss your situation in detail to make sure you are on the right
track. In future articles, we will delve more deeply into the
various types of credit products available, how underwriters decide
whether or not to extend credit, and how you can improve cash flow
and minimize how much external capital you need. As always, don’t
hesitate to call or email if you have a specific finance or business
question you would like addressed.
Dan Hawthorne, MBA provides an array of services including financial
consulting, on-demand/retained CFO services, and residential
mortgages to small business owners, non-profits managers and
individuals. Dan can be reached at danhawthorne@ yahoo.com or (617)