Alternative bank financing has increased significantly since 2008. Unlike bank lenders, alternative lenders tend to place more emphasis on a company’s growth potential, future earnings and assets than on its historical profitability, balance sheet strength or creditworthiness.
Alternative lending rates may be higher than traditional bank loans. However, the higher cost of financing can often be an acceptable or only alternative if there is no traditional financing. The following is a rough outline of the alternative credit landscape.
Factoring is the financing of trade receivables. The factors focus more on the receivables/securities than on the strength of the balance sheet. The factors lend funds up to a maximum of 80% of the receivable value. Foreign receivables are generally excluded, as are sold receivables. Receivables older than 30 days and any concentrations of receivables are generally discounted at more than 80%. Factors generally govern accounting and the collection of receivables. Factors usually charge a fee plus interest.
Asset-based lending is the financing of assets such as inventories, equipment, machinery, real estate and certain intangible assets. Asset-based lenders usually lend no more than 70% of the value of assets. Asset-based loans may be temporary or bridge loans. Asset-based lenders typically charge a closing fee and interest. Estimation fees are required to determine the value of the asset(s).
Sale & Lease-Back Financing. With this form of financing, real estate or equipment is sold simultaneously at a market value that is usually determined by an expert opinion and the asset is leased back for 10 to 25 years at a market price. The financing is offset by a lease payment. In addition, it may occur that a tax liability has to be recognized on the sales transaction.
The Trade Financing order is a short-term loan with costs. If the manufacturer’s credit balance is acceptable, the order lender (PO) issues a letter of credit to the manufacturer guaranteeing payment for products that meet pre-defined standards. Once the products have been tested, they are sent to the customer (often the production sites are abroad) and an invoice is issued. At this point, the bank or other source of funds pays the PO lender for the funds disbursed. Once the PO lender receives the payment, he deducts his fee and transfers the balance to the company. Order financing can be a cost-effective alternative to inventory management.
Cash flow financing is typically used by very small businesses that do not accept credit cards. Lenders use software to check online sales, banking, bidding stories, shipping information, social media comments/ratings, and even restaurant health ratings, if applicable. These metrics provide data that demonstrates consistent sales volumes, revenue, and quality. Loans are usually short-term and for small amounts. The annual effective interest rates can be high. However, loans can be financed within one to two days.
Merchant cash advances are based on credit/debit cards and electronic payment-related revenue sources. Advances can be secured against cash payment or future credit card sales and generally do not require personal guarantees, liens or sureties. Advances do not have a fixed payment schedule and no restrictions on use. The funds may be used to purchase new equipment, inventory, expansion, conversion, debt or tax repayment and emergency financing. In general, restaurants and other retailers that do not have sales invoices use this form of financing. Annual interest rates can be onerous.
Non-bank loans can be offered by financial companies or private lenders. Repayment terms may be based on a fixed amount and a percentage of cash flows, as well as a share of equity in the form of warrants. As a rule, all conditions are negotiated. Annual interest rates are generally significantly higher than for traditional bank financing.