A look at various ways to raise capital when faced with cash-flow emergencies. Methods include contract financing, factoring, and microloans. Plus: a list of four key rules for raising capital.
Inc. Query
Q--"I started my company in June 1998 to provide answering services, bookkeeping, transcriptions, and other services to business and government clients. Sales have been increasing by 150% each month. But our problem is cash flow. My customers take from 45 to 90 days to pay. My personal credit is worse than awful after a divorce. I don't own anything to offer as collateral, and the banks won't talk to me because I haven't been in business for three years. Bottom line, we need money for cash flow, payroll, advertising, etc. Any suggestions?" --Janie Montgomery, general manager, ASAP Answering & Personnel, Soldotna, Alaska
A.--It's sad but true: Montgomery's problem is far from unique. Start-up entrepreneurs have traditionally been forced to rely on their personal resources--savings, credit cards, homeequity loans, help from family or friends--when it comes to raising early-stage financing. But with growing numbers of people experiencing some type of personal financial problems (which run the gamut from high debt loads to personal bankruptcies), that's a strategy that sometimes won't work. Combine that with today's volatile capital markets and many business owners are finding themselves in a real bind.
But that's not to say that cash-strapped entrepreneurs like Montgomery have no options. Jesus Arguelles, a financial consultant based in La Quinta, Calif., suggests a two-pronged approach to raising capital: solve the immediate cash crunch while taking concrete steps to improve the long-term personal financial picture. "The first stage is, What does she need to support her cash flow for the next three to six months?" asks Arguelles. "If she needs, say, $30,000, and she has work orders or contracts in place from her existing customers, she should be able to raise it through a method called contract financing."
Contract financing allows you to borrow money from a financing company against a percentage of your outstanding contracts. It's one of three costly--but effective--ways to raise cash when your company is too young (or your personal financial records are too spotty) to help you qualify elsewhere. In Montgomery's case, Arguelles expects that contract-financing costs will run about 3% to 5% per month--pricey but preferable to closing up shop if there's no other way to support current operations at a fast-growth clip.
The other two methods, which are slightly cheaper than contract financing, involve accounts receivable rather than contracts. They include factoring, in which a company sells receivables for a discounted price to bring in cash sooner rather than later; and accounts-receivable financing, in which the company uses receivables as collateral for a short-term loan from a bank or other financier.
The main point to keep in mind is that these three options should be viewed strictly as short-term, last-ditch financing methods, since they can eat a big hole in your profit margin. "The reason to do this is to give your company a chance to build up a slightly longer track record, which will then hopefully allow you to move to other, somewhat cheaper financing options," notes Arguelles.
Two cheaper options worth trying: the Small Business Administration's SBAExpress program, and microloans, which are offered on a regional basis by some banks and other financial institutions, according to Hedy M. Ratner, copresident of the Women's Business Development Center, in Chicago. "What's possible is to qualify for loans of up to $25,000, providing you've got a strong business plan and good business fundamentals," she explains. The way to find out what's offered in your region is by contacting your state department of commerce, as well as regional SBA offices and local economic-development agencies. In some regions, nonprofit groups like Ratner's will work with entrepreneurs to improve their applications and chances of financing success.
Of course, in cases like ASAP's, it can only help to pursue all possible lending sources. That includes vendor financing if you're doing enough business with any company to make it worthwhile for it to support your business's growth activities; customer financing, so long as you position your request as one that will support expansion efforts (rather than simple survival); and cosigned loans. While the way this third option tends to work involves family members or friends, Arguelles notes that entrepreneurs can sometimes pay independent outsiders to cosign loans, typically for a onetime, up-front fee of 3% to 5% of the loan's face value. "In some cases, assuming that the outsider has enough confidence in the business venture, you can expect him or her to make the introduction to a willing banker," he says.
For business owners in Montgomery's bind, it's important to remember that there are two sets of financial goals that must be pursued simultaneously: raising short-term capital for the company (for roughly six months to a year) and improving the personal financial picture. "Until she, or any business owner, builds up a personal credit history that looks good, she won't be able to convince most bankers or other investors that she truly understands financial controls--and that will hamper her ability to raise capital," says Gayle Ehrlich, a partner at the Boston law firm Sullivan & Worcester. "The problem is, that's not something she can achieve in three months."
The best way to start is by working with a local credit-counseling service to set up a plan to pay off credit-card debts and clean up any other outstanding personal financial problems. It won't be easy at first. As Montgomery herself explains, she doesn't even pay herself a salary yet, since, like many start-up entrepreneurs, she is reinvesting all her company's spare cash in supporting its growth.
