different Financing Vs. Venture Capital: Which Option Is Best for Bo…
There are several possible financing options obtainable to cash-strapped businesses that need a healthy measure of working capital. A bank loan or line of credit is often the first option that owners think of – and for businesses that qualify, this may be the best option.
In today’s uncertain business, economic and regulatory ecosystem, qualifying for a bank loan can be difficult – especially for start-up companies and those that have experienced any kind of financial difficulty. Sometimes, owners of businesses that don’t qualify for a bank loan decide that seeking venture capital or bringing on equity investors are other viable options.
But are they really? While there are some possible benefits to bringing venture capital and so-called “angel” investors into your business, there are drawbacks in addition. Unfortunately, owners sometimes don’t think about these drawbacks until the ink has dried on a contract with a venture capitalist or angel investor – and it’s too late to back out of the deal.
Different Types of Financing
One problem with bringing in equity investors to help provide a working capital raise is that working capital and equity are really two different types of financing.
Working capital – or the money that is used to pay business expenses incurred during the time lag until cash from sales (or accounts receivable) is collected – is short-term in character, so it should be financed via a short-term financing tool. Equity, however, should generally be used to finance rapid growth, business expansion, acquisitions or the buy of long-term assets, which are defined as assets that are repaid over more than one 12-month business cycle.
But the biggest drawback to bringing equity investors into your business is a possible loss of control. When you sell equity (or shares) in your business to venture capitalists or angels, you are giving up a percentage of ownership in your business, and you may be doing so at an inopportune time. With this dilution of ownership most often comes a loss of control over some or all of the most important business decisions that must be made.
Sometimes, owners are enticed to sell equity by the fact that there is little (if any) out-of-pocket expense. Unlike debt financing, you don’t usually pay interest with equity financing. The equity investor gains its return via the ownership stake attained in your business. But the long-term “cost” of selling equity is always much higher than the short-term cost of debt, in terms of both actual cash cost in addition as soft costs like the loss of control and stewardship of your company and the possible future value of the ownership shares that are sold.
different Financing Solutions
But what if your business needs working capital and you don’t qualify for a bank loan or line of credit? different financing solutions are often appropriate for injecting working capital into businesses in this situation. Three of the most shared types of different financing used by such businesses are:
1. complete-Service Factoring – Businesses sell noticeable accounts receivable on an current basis to a commercial finance (or factoring) company at a discount. The factoring company then manages the receivable until it is paid. Factoring is a well-established and accepted method of permanent different finance that is especially well-suited for rapidly growing companies and those with customer concentrations.
2. Accounts Receivable (A/R) Financing – A/R financing is an ideal solution for companies that are not in addition bankable but have a stable financial condition and a more different customer base. Here, the business provides details on all accounts receivable and pledges those assets as collateral. The proceeds of those receivables are sent to a lockbox while the finance company calculates a borrowing base to determine the amount the company can borrow. When the borrower needs money, it makes an improvement request and the finance company advances money using a percentage of the accounts receivable.
3. Asset-Based Lending (ABL) – This is a credit facility secured by all of a company’s assets, which may include A/R, equipment and inventory. Unlike with factoring, the business continues to manage and collect its own receivables and submits collateral reports on an current basis to the finance company, which will review and regularly audit the reports.
In addition to providing working capital and enabling owners to continue business control, different financing may provide other benefits in addition:
- It’s easy to determine the exact cost of financing and acquire an increase.
- specialized collateral management can be included depending on the facility kind and the lender.
- Real-time, online interactive reporting is often obtainable.
- It may provide the business with access to more capital.
- It’s flexible – financing ebbs and flows with the business’ needs.
It’s important to observe that there are some circumstances in which equity is a viable and attractive financing solution. This is especially true in situations of business expansion and acquisition and new product launches – these are capital needs that are not generally well appropriate to debt financing. However, equity is not usually the appropriate financing solution to solve a working capital problem or help plug a cash-flow gap.
A Precious Commodity
Remember that business equity is a precious commodity that should only be considered under the right circumstances and at the right time. When equity financing is sought, ideally this should be done at a time when the company has good growth prospects and a meaningful cash need for this growth. Ideally, majority ownership (and consequently, absolute control) should keep with the company founder(s).
different financing solutions like factoring, A/R financing and ABL can provide the working capital raise many cash-strapped businesses that don’t qualify for bank financing need – without diluting ownership and possibly giving up business control at an inopportune time for the owner. If and when these companies become bankable later, it’s often an easy change to a traditional bank line of credit. Your banker may be able to refer you to a commercial finance company that can offer the right kind of different financing solution for your particular situation.
Taking the time to understand all the different financing options obtainable to your business, and the pros and cons of each, is the best way to make sure you choose the best option for your business. The use of different financing can help your company grow without diluting your ownership. After all, it’s your business – shouldn’t you keep as much of it as possible?