Business Financing Myths Debunked
After years working with companies of all shapes and sizes in many industries, I have seen a variety of creative ways to finance a business. Entrepreneurs have told me which financing products worked best and which ones were complete busts. After talking with prospects, clients, business advisors, and lenders, I decided to assemble a list of the top financing myths that can impact an entrepreneur in deciding which solution is best for their business. There are many more myths out there, but I wanted to share the ones I have heard most often.
Myth: Bank loans are the cheapest and least restrictive way to finance your business.
Reality: Bank loans, when attainable, are one of the cheaper ways companies can finance their business. Banks have a lower cost of funds than most lending sources, thus their ability to charge less. The caveat to cheap funds is more restriction, not less. The idea of banks closing your loan and letting you go about your business is not the case. Most bank loans have multiple financial covenants, require conservative growth forecasts, and force you to have a lot of your own capital in the business to essentially de-risk their transaction so they can charge less.
Myth: Factoring is too expensive and should only be considered as a last resort.
Reality: Factoring does cost more than a traditional bank line but if used properly, it can actually be a low-cost financing source. Factoring fees are attached to individual invoices that are financed. There are no upfront commitment fees, audit fees, or exit fees involved in a factoring facility, which can dramatically increase the cost of financing depending on the amount financed. In my experience, I have seen many high-growth companies use factoring to launch their business. A startup staffing company client of ours grew from $100k in annual sales to $15 million in five years using factoring, proving that it is the ideal use of factoring.
Myth: Asset-based loans are too cumbersome and used only by companies who are struggling.
Reality: ABL loans do require more reporting to your lender: weekly or monthly collateral tracking, submission of results from monthly aging and financial statements, as well as periodic audits of the underlying collateral base. All of the above helps lenders advance more cash to the business because they better understand the company’s financial position. ABL lenders typically work with companies who are growing out of a story, such as a new contract, prior year loss, leveraged balance sheet, etc. The key word is ‘growing.’ Companies who use ABL do so because their current position is not reflective of the past. Traditional lenders look back in time to grant loans, whereas ABL lenders look at the present and the future. Leveraging an ABL lender to maximize value in each asset class provides more access to cash than a cash flow loan to the same company.
Myth: Merchant cash advance loans are easy to get, cheap, and do not tie up your assets.
Reality: Easy to get, yes. Cheap and unsecured, no. Most companies can produce multiple months of bank statements and credit reports, so access to funds is easy. Depending on how long you take out the loan and the amount, the cost could be a bit higher than expected. Some merchant cash advance or online lenders claim they don’t file a UCC (security interest) against business assets, so check your contracts. I have run across many companies who could not finance their accounts receivable or inventory because the online lender has a first security interest in those assets. When obtaining any type of loan, make sure you ask detailed questions and read the contract.
Myth: Credit cards are an easy way to fund the startup of a business.
Reality: The answer is yes, but what most people don’t realize is that the credit card is often in the owner’s name and tied to their personal credit, not the businesses’ credit. Situations come about where credit card limits are maxed out with the intention to pay them off once the business is producing positive cash flow. In a young, growing business, cash needs always arise and when credit card payments are missed, the delinquency is then reflective on the owner’s personal credit. Personal credit is looked at by most banks when applying for a business loan, so a history of delinquent payments and poor credit score can impact your ability to get a bank loan.
Myth: Obtaining a venture capital investment is the ultimate way to finance a business.
Reality: Venture capital funding is used by many companies to fund the future expansion of their business. What business owners don’t know is that venture capital is not easy to obtain for most traditional businesses. VCs are looking for companies with substantial growth opportunities or niche businesses and are willing to take on more risk and therefore expect higher returns on their investment. Due to the level of capital invested by VCs, they often require a board seat or significant control of the business. To some business owners, this can be an issue so proceed with your questions in hand.
Most Importantly, Find A Trustworthy Advisor
To summarize, there are many ways a company can finance its business. Usually it takes multiple solutions and not just a one-size-fits-all approach. Ask questions and more follow-up questions. Confide in your trusted advisors: CPA, attorney, consultant, and fellow business owners who have experience in the financing arena. All the solutions listed above have a place in the lifecycle of a business. Some solutions are more appropriate for your business than others, so do your homework on both the product and lender. There are more capital providers today than ever and more products in all shapes and sizes. A solution that meets your needs today may not be the right fit for you next year. Be open minded and have a game plan. Good luck!