Although we offer several financing solutions through our Chamber, sometimes you are going to need a little more. However, in this tight market, venture capitalists are being careful, so perhaps some of the options in this article will help . . . (orginally posted here):
by Dileep Rao, PhD
Your small company isn’t sexy enough to entice venture capital nor does your collateral give skittish banks enough comfort. Bootstrapping aside, here are five often overlooked alternative sources of funding in this tough environment.
This hodgepodge includes a host of intermediaries under the auspices of the Small Business Administration. Gaining prominence are Community Development Financial Institutions (previously known as Community Development Corporations); these entities have more resources to throw around thanks to sponsorship in recent years by the U.S. Treasury. Development programs tend to offer larger loans at lower rates than banks do, though you’ll be expected to create jobs (or at least maintain them) in the community.
A great source of working capital for companies that market to other businesses and to governments–but beware the hefty tolls. One method, called factoring, involves selling your receivables at a discount, up to 3%. That means if you offer 30-day payment terms, you will pay 3% for the privilege of getting your money 30 days before it’s due. Even without compounding, the annual cost of that capital is 36%. Some factors tack on penalties if the receivables don’t pay out.
Asset-based lenders use your receivables as collateral. They often charge 200 to 600 basis points above rates that banks offer small businesses (typically prime plus two percentage points). Unlike term loans, asset loans are lines of credit, so you pay interest only on the amount you use. Asset-based lenders prefer loans of decent size ($500,000 and up), while factors might buy just $20,000 in monthly receivables.
Say you need a loan for a new project and you’re confident you can repay within 24 months. These notes have properties of equity and debt. Reasonable terms: a 12% annual rate (payable quarterly), with the principal due in two years and maybe an extra incentive to let lenders know you mean business. Example: If you repay the loan in 12 months, lenders get warrants to buy a slice of your company; repay in 18 months and they get a bit more. Miss the two-year deadline and the toughest financiers might take your company.
You need $200,000 to build a prototype. You could form a limited partnership in which a subsidiary of your company is the general partner and the limited partners are individual investors. LPs put up cash in return for a majority interest in the partnership; your company handles the R&D while the LP books the costs. Limited partners get paid a royalty (or perhaps a cut of the profits) when the product generates revenue, and often the payments ebb after a prenegotiated level of return. LPs also get the right to convert their interest in the LP to equity in your company. These arrangements were a popular (and tarnished) tax shelter for high-net-worth investors in the 1980s, but the concept remains sound.
Employee Stock Ownership Trust
Your company can raise cash by selling shares to an ESOT, which borrows money to pay for them. The company makes periodic contributions to this employee-owned trust to repay the loan. Advantages: All contributions (principal payments, too) are tax-deductible, and your employees are motivated by having more skin in the game. With private-equity firms on the sidelines, this is an option for baby boomer business owners looking to cash out. Disadvantage: If no market emerges for the stock when employees are ready to retire, the company may be forced to buy back its stock.
Read more from Dileep Rao at Forbes.com. Have a particularly gnawing question about running a small business? Send it to email@example.com.