Alternative Financing Vs. Venture Capital: Which Option Is Best for Boosting Working Capital?

There are many potential financing options available to cash-strapped businesses that need a proper dose of working capital. A bank loan or line of credit is usually the first option that owners think of - and for companies that qualify, this may be the best option.

In today's uncertain business, financial and regulatory environment, qualifying for a bank loan can be difficult -- especially for start-up companies and those that have experienced any type of monetary difficulty. Sometimes, owners of businesses that don't qualify for any bank loan decide that seeking venture capital or bringing upon equity investors are other viable options.

But are they truly? While there are some potential benefits to bringing venture capital plus so-called "angel" investors into your business, there are drawbacks too. Unfortunately, owners sometimes don't think about these drawbacks until the printer ink has dried on a contract with a venture capitalist or even angel investor - and it's too late to back out from the deal.

Different Types of Financing

One problem with bringing in equity traders to help provide a working capital boost is that working capital and value are really two different types of financing.

Working capital - or the cash that is used to pay business expenses incurred during the time lag till cash from sales (or accounts receivable) is gathered - is short-term in nature, so it should be borrowed via a short-term financing tool. Equity, however , should usually be used to finance rapid growth, business expansion, purchases or the purchase of long-term assets, which are defined as assets which are repaid over more than one 12-month business cycle.

But the greatest drawback to bringing equity investors into your business is a possible loss of control. When you sell equity (or shares) within your business to venture capitalists or angels, you are quitting a percentage of ownership in your business, and you may be doing this at an inopportune time. With this dilution of ownership usually comes a loss of control over some or all the most important business decisions that must be made.

Sometimes, owners tend to be enticed to sell equity by the fact that there is little (if any) out-of-pocket expense. Unlike debt financing, you don't generally pay interest with equity financing. The equity trader gains its return via the ownership stake acquired in your business. But the long-term "cost" of selling fairness is always much higher than the short-term cost of debt, in terms of each actual cash cost as well as soft costs like the loss of manage and stewardship of your company and the potential future associated with the ownership shares that are sold.

Alternative Financing Options

But what if your business needs working capital and you don't qualify for some sort of bank loan or line of credit? Alternative financing solutions are often right for injecting working capital into businesses in this situation. Three of the very most common types of alternative financing used by such businesses are:

1. Full-Service Factoring - Businesses sell outstanding accounts receivable on an ongoing basis to a commercial finance (or factoring) company at a discount. The factoring company then manages the actual receivable until it is paid. Factoring is a well-established and even accepted method of temporary alternative finance that is especially suitable for rapidly growing companies and those with customer levels.

2 . Accounts Receivable (A/R) Financing - A/R reduced stress is an ideal solution for companies that are not yet bankable but they have a stable financial condition and a more diverse customer base. Here, the business offers details on all accounts receivable and pledges those resources as collateral. The proceeds of those receivables are delivered to a lockbox while the finance company calculates a borrowing foundation to determine the amount the company can borrow. When the borrower requirements money, it makes an advance request and the finance company improvements money using a percentage of the accounts receivable.

3. Asset-Based Lending (ABL) - This is a credit facility secured through all of a company's assets, which may include A/R, gear and inventory. Unlike with factoring, the business continues to handle and collect its own receivables and submits collateral reviews on an ongoing basis to the finance company, which will review together with periodically audit the reports.

In addition to providing working capital and enabling owners to maintain business control, alternative financing might provide other benefits as well:

It's easy to determine the exact expense of financing and obtain an increase.

Professional collateral management can be integrated depending on the facility type and the lender.

Real-time, online online reporting is often available.

It may provide the business with entry to more capital.

It's flexible - financing ebbs as well as flows with the business' needs.

It's important to note that there are some conditions in which equity is a viable and attractive financing solution. This runs specifically true in cases of business expansion and acquisition and new product roll-outs - these are capital needs that are not generally well suited in order to debt financing. However , equity is not usually the appropriate that loan solution to solve a working capital problem or help connect a cash-flow gap.

A Precious Commodity

Remember that company equity is a precious commodity that should only be considered underneath the right circumstances and at the right time. When equity financing is actually sought, ideally this should be done at a time when the company offers good growth prospects and a significant cash need for this particular growth. Ideally, majority ownership (and thus, absolute control) should remain with the company founder(s).

Alternative financing options like factoring, A/R financing and ABL can provide the significant capital boost many cash-strapped businesses that don't be eligible for bank financing need - without diluting ownership and perhaps giving up business control at an inopportune time for the owner. In case and when these companies become bankable later, it's often an easy changover to some traditional bank line of credit. Your banker may be able to refer you to definitely a commercial finance company that can offer the right type of alternative financing remedy for your particular situation.

Taking the time to understand all the different financing possibilities to your business, and the pros and cons of each, is the best way to be sure you choose the best option for your business. The use of alternative financing will help your company grow without diluting your ownership. After all, it can your business - shouldn't you keep as much of it as possible?