Key Considerations in Alternative Financing

by | May 1, 2012

For businesses looking to grow in the recovery, cash is still hard to find.  Most bankers I talk with say they are open for business and actively looking to lend to businesses.  However, the reality is that many businesses – even long standing, established businesses — that need cash for expansion and growth will not qualify for financing under the banks’ lending criteria.  So what can a business owner do to fill the gap?  Alternative financing can take a number of different forms that we’ll discuss throughout the month.  From a risk and legal standpoint, you must consider of a few key factors in how these will impact your business.

  1. Collateral.  Banks virtually always will require some collateral to protect the bank against default.  If the business has physical or intellectual property assets, the bank would obtain a security interest in those assets as collateral.  In many cases, the assets of the company have already been pledged against a prior loan, so there is no collateral available for the bank.  Sometimes, the owners’ personal assets are used as collateral; and, more often than not, the business owners are required to personally guarantee the loan.  The personal guarantee means that you are personally responsible for the loan if the company defaults.  A variant on the bank loan is “asset-based lending.”  Asset-based lenders will provide financing using the assets of the business as collateral but will lend significantly less against the value of those assets.  Asset-based lending is often available to businesses that are in financial difficulty but absolutely need cash.   These are significant risks for the business but are often necessary to obtain the capital.
  2. Cash flow.  The idea is to get money in the door to fund the company’s growth.  Bank loans carry an interest rate that is market driven.  Similarly, a promissory note that you might sign with a friend or family member will have a fixed or variable interest rate clearly provided for in the documents.   A critical factor is that you ensure the business’ cash flow can support any loan terms agreed upon.
  3. Equity issuances.  When lending is tight, many businesses consider selling equity or stock to “investors” to raise capital for the business.    Providing equity or ownership in the business seems an easy and cost effective solution; however, it can be exactly the opposite.  Offering or selling stock in the company is subject to federal and state securities laws, which means that certain disclosures, sometimes very significant disclosures, are required.  This can be expensive.   In addition, these investors are now owners, which requires them to be informed of decisions being made – even if they don’t have the control to make an impact on a vote.   This complicates the governance of the company.   Bringing on an investor in lieu of a lender can be attractive, but it’s best used where the investor is bringing more than just cash to the table.

It can be incredibly difficult when you know the opportunity for growth is just ahead and you only need a little capital to get you there.   Making smart decisions about how to structure that capital will help your business in both the short and long term.