Is borrowing through factoring or asset based lending cost competitive to diluting through equity?
As a business grows, working capital is a crucial factor in the success of a business. Business owners seek the most beneficial and cost-effective options to obtain working capital, but as they become focused on growing the business, time constraints and preconceptions of financing options result in choosing the less-than-best financing option. Banks may not take the risk on your business, but there are other financing options to choose from, such as venture capital, angel capital, mezzanine financing and asset-based lending. When it comes to choosing the best option for your business, do you choose to borrow or dilute? When is asset-based lending or factoring more beneficial than equity financing?
Equity or mezzanine financing is appropriate when the business is trying to expand significantly and has a need for funding over and above what borrowing on the assets of the business will allow. Equity financing and mezzanine lending provides the working capital needed while receiving ownership rights from the business in return. Questions for an entrepreneur to answer when deciding whether to dilute or not are: Can I do this on my own without giving up ownership rights in my blood, sweat and tears? What are my goals as an entrepreneur and can they be accomplished without selling part of my dream? The answers to the questions, as with any venture, depend on the goals of the entrepreneur and the particular situation of your business. However, if you can utilize the assets of your business to accomplish your goals with bank debt, do so, but if bank debt is not appropriate, look to an asset-based lender or factor who may be slightly more “expensive,” but is generally less costly than selling part of your dream or not growing your company.
If you are having a hard time figuring out whether or not asset-based lending will get the job done, prepare a cash flow statement and find out where the hole comes in. If the hole can be plugged by accelerating your accounts receivable turn to one day and/or leveraging 50% of your inventory, you are probably a good candidate for asset-based lending or factoring. If not, you are probably best suited to take on another form of financing with your given level of profitability.
Once you have made that determination and you are considering factoring or asset-based lending as a vehicle for your growth, here are some questions to answer about the asset-based lender or factor.
- Can they finance your receivables on a non-notification basis? In other words, will they factor or lend on your invoices without your customers being involved?
- Will they make your company a loan that is similar to a revolving line of credit in a bank?
- Can they customize the relationship to meet the needs of your particular business or do they have a “fit in our box” mentality?
- Do they have an entrepreneurial mindset or a sales mindset?
- Have they been in your shoes and understand what you’re going through?
Not all asset-based lenders and factors are the same. We recommend getting to know the ownership group and top management very well before entering this type of relationship to find the right fit for your business. Most importantly, consider how the company will react if things don’t go exactly as planned. Will they help you or only watch out for themselves?
If you have more questions, visit www.farwestcap.com or call (512) 527-1100. We can help you evaluate the best option for your company.