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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 or 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, consultant, etc.).

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@ or (617) 648- 6570.



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