Entrepreneurs often face the need for alternative sources of business capital to traditional bank financing but are often unable to find them. Similarly, they can find themselves at a loss to understand how this form of capital differs from traditional bank financing. Banks make loans and extend lines of credit to a business based on its underlying assets and other assets available to the business owner to collateralize or guarantee the financing. It’s important to note that traditional banks are subject to federal regulation which restricts how much a business can borrow or leverage. For example, in a high growth business the assets available to support traditional bank financing often cannot keep pace with its need for capital. This is when an alternative source of business capital may become necessary.
Alternative business capital comes in many forms
It may include any or a combination of the following:
• Small Business Loans and Guarantees – where the Federal Government backs financing which may not meet the bank’s requirements.
• Peer-to-Peer Lenders – where investors pool their cash and make loans directly to entrepreneurs for a fixed period of time. Although relatively new in the United States, this form of crowdfunding is becoming more popular.
• Bank and Vendor Leasing – where the business may find attractive lease rates which improves its cash flow.
• Asset Based Lending – where the business uses its current assets to secure a loan and the lender is not regulated by the federal government. Typically these assets included Accounts Receivable and Inventory. ABL’s fully collateralize their loans and lines of credit, whereas a bank uses a borrowing base formula, personal guarantees and covenants in its agreements.
• Factoring – where the business sells its Accounts Receivable at a discount. The credit worthiness of the business and its owner is not considered. Instead, it’s the credit worthiness of the customer that matters.
• Mezzanine Instruments – where the debt is subordinate to the business’s primary borrowing instruments. It is often used in periods of transition. Equity mezzanine offers the investor an opportunity to participate in future capital appreciation.
• Venture Capital or Private Equity – where a group of investors lend and/or offer cash for a portion of the business’s equity, typically early stage or startups.
• Angel Investing – where a single, wealthy investor offers the business cash for a portion of its equity.