As we all work hard to grow our businesses we are offered opportunities to grow and take a bit more risk that would have a great upside. Even though there may be great opportunities available, we might not have the available cash flow to make it happen.
So I began exploring all of the creative ways to finance your small business. In the first part of this four part series, I covered alternative sources such as ARC Loans, Retirement Fund Lending and Credit Cards. Next up are Peer-to-Peer Lending, Asset-Based Loans, and Accounts Receivable Factoring.
Peer-to-Peer Lending and Microcredit
Peer-to-Peer Lending is built around the concept of community lending. The concept has been around for a long time and I am sure you have heard the term of borrowing money from 'friends or family.' Many people are uncomfortable with that because of the strains it can place on a personal relationship. These new types of 'social investing' models allow you to diversify your investment portfolio and invest in people and projects you feel are worthy.
Companies that engage in peer-to-peer lending are the Lending Club and Prosper. They are mostly focused on projects in the United States and offer a pooled investment model (they handle the loans) or a directed model where you as an investor can review the loan requests and direct your loan investments.
A related type of peer-to-peer lending worth mentioning is Microcredit. Microcredit has become focused as a tool for socio-economic development in empoverished nations. Wikipedia defines it as 'building capacity of a micro-entrepreneur, employment generation, trust building, and help to the micro-entrepreneur on initiation and during difficult times. Companies that do this include Kiva and Lend for Peace.
Asset-based loans are just as you might think. Trusty old Wikipedia defines an asset-based loan as 'a loan, often for a short term, secured by a company's assets.' These assets can include but are not limited to real estate, inventory and physical equipment. You see this type of loan often in real estate deals because of the value of the property and building. Loans like these can be collateralized on a single asset or a combination of them depending on the loan. Other types of assets included in these loan include accounts receivable (A/R) as part of the loan. This is different from accounts receivable factoring which we will talk about next.
Accounts Receivable Factoring
One of the first things I learned getting an accounting degree was what the terms 'accounts receivable' (what people owe you) and 'accounts payable' (what you owe people) meant. If you are running a small business you are quite familiar with what accounts receivable are but if you aren't, it is the running balance of what customers owe you. This directly relates to the terms you set for clients paying you - Immediate, Net 15, Net 30, etc. However, many clients don't pay on time and this can put a real crunch in your cash flow when you have real billable work to do and need to pay the bills.
It is different from asset-based loans mentioned above since you are selling the receivable right there on the spot and receiving cash for it. This means that factoring is not a loan and that is important to remember. The emphasis here is on the value of the receivables and not your credit worthiness because it transfers ownership of the receivables. You see this type of financing with large long term contracts that have long payment terms (e.g. Net 60) which means that a client could take 90-120 days and not be in jeopardy of collections. That can be disastrous to a small business with payroll to fund and a 30-60 day cashflow window.
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