Growing small businesses with capital
“There is an $87 billion gap in financing for small businesses,” said Marina Linhart, CEO at Next Street. The firm advises cities, foundations, large institutions, lenders, and nonprofits that serve small businesses on how to do it better.
Undercapitalized companies have lower sales and profits, generate fewer jobs, and are more likely to fail. Evidence finds that women entrepreneurs are dissuaded from applying for credit, ask for less financing than men do, are approved less often, and pay more for credit. Key to closing the gap “is having access to the right form of capital in the appropriate amount that is needed.” noted Linhart. “Alternative finance provides a very useful product for very specific circumstances for businesses.”
The good news is that there is an array of not just new financing options that are now available but also ones that have been around for years. The bad news is that the abundance of options can be overwhelming to the entrepreneur. Even if you have consulted with a professional, understanding why some options are expensive but maybe still right for your situation is essential.
Factors such as being a startup, having an inconsistent cash flow, needing money fast, not having a good credit score, not having collateral, and wanting a simple application process should weigh into your decision. As the clothing retailer, Sy Syms said, “An educated consumer is our best customer.” What is valid for shopping for clothing is even more true for financing.
A tiny percentage of growth companies will raise angel or venture capital, but even they should know about non-dilutive financing options, so they do not give away too much of their company. When investors own a share of your company, you may need to consult them on how you run your business. And finding the right investors can be time consuming. Lenders and most alternative funders do not take an ownership stake in your business. They have no say in the way you run your company. However, you must pay the money back within a set time frame, so having cash flow is critical.
“Merchant cash advance has been around for decades,” said Christine Chang, CEO, 6th Avenue Capital. She has spent her 25-year career in the alternative credit sector at companies such as Charles River, Credit Suisse, and New York Private Bank & Trust. Merchant cash advance (MCA) is not technically a loan; it gives you an upfront sum of cash in exchange for a slice of your future sales, such as credit card / debit card sales. Or, Automated Clearing House (ACH) advance, which uses a small business’s bank account deposits and bank statement cash-flow to determine funding and repayment. Money is repaid on a daily or weekly fixed schedule. It’s a good source of short-term (12 months or less) financing. 6th Avenue Capital uses technology to help its underwriters be more efficient in its due diligence process, but it also interviews entrepreneurs to understand their personal story.
MCA and ACH advance are expensive. They are a form of capital that has been associated with predatory lending, are unregulated, and unsecured financing, commented Chang. “We have a policy of radical transparency about the total cost of capital. Our average factor rate is between 1.25 and 1.5, with an average of 1.32.” For every $100 a small business receives, it pays $32 for the use of the money over the prescribed period of time.
Because the industry is not regulated, “we really do a lot of self-regulation,” she said. While 6th Avenue Capital would welcome regulation to eliminate the bad actors, it also recognizes that sometimes regulation can hurt those constituents it is trying to help. The Dodd-Frank Act enacted in 2010 had the unintended consequence of making small business lending less profitable. However, even before then small business lending was in decline. Big banks have been moving their focus to lend to mid- and large-size businesses, and some small banks shuttered. As a result, the company is a member of the Independent Lending Platform Association and the Small Business Financial Association. Both organizations are active lobbyists on Capitol Hill, advocating for both small business and lender interests.
When you are not a bank, marketing to small businesses looking for financing is a costly endeavor. It may sound counter intuitive, but 6th Avenue Capital has strategic partnerships with other small business financiers. When a small business is not a good match for a bank or credit union loan, they make referrals to other reputable funders. For that reason, other alternative financing options make referrals to each other. Industry specialists and associations make referrals, too. And, finally, mission-based organizations, such as Next Street, make referrals.
When entrepreneurs need short-term financing fast — 24 to 48 hours — an MCA or ACH advance may be worth the cost. A variety of companies use this type of funding to fill the gap:
- During the federal government shutdown, when SBA loans stopped flowing.
- When a fleeting opportunity to buy expensive kitchen equipment at a deep discount presented itself to a restaurant.
- When a skincare startup received a big order from an impressive retailer and did not qualify for traditional invoice factoring.
- After Hurricane Harvey left Houston decimated, a construction company needed equipment fast to help the city rebuild.
- When a home-based e-commerce business needed to stock up for the holiday season and did not qualify for traditional factoring.
Importantly, once your company has grown and established its ability to repay, it can move up the credit stack to cheaper sources of capital.
When seeking financing, be prepared. You need to decide if you must raise capital (and how much), what you will use it for, and during what period you will spend it. How fast do you need the money? Determine your funding needs by estimating the related costs for this particular phase of your business. Estimate the revenue as well. Do a monthly cash flow analysis. This analysis will highlight the period for which you need outside financing. Find out what all your financing options are.
What types of financing are you considering?