When it comes to securing funds for your small business, perhaps the no. 1 thing that comes to mind are bank loans. This is an example of debt financing, which is a method of raising capital by borrowing money. Creditors charge interest on this loan that must be paid over a set period of time. Other examples of debt financing include business credit cards, SBA loans, and lines of credit.
Debt financing does not entail giving up a part of business ownership, so you maintain full control. It can be used for various purposes, such as purchasing assets or to fund business expansion.
Another common source of small business funds is equity financing. You raise capital by selling a share or portion of the business ownership. Examples of equity financing include using personal savings, selling stocks, crowdfunding, and receiving capital from angel investors and venture capitalists. In exchange for the funds, small business owners hand over a share or portion of the profits and a stake in the potential future growth of the business.
Equity and debt financing come with their own sets of pros and cons, and can be of great value to any small business. However, they can be difficult to avail, so many small business owners are looking for alternative business financing sources. These non-traditional funding channels are often faster, more flexible, and accessible to small businesses.
Below we discuss several of the alternative financing options that are available for small businesses.
Receivables Financing: Turning Your Unpaid Invoices Into Cash
If you have a significant amount of unpaid invoices or accounts receivables on hand but need cash immediately, you might want to consider receivables financing. Let’s focus on two that are available and more common for small businesses.
Invoice Factoring
Invoice factoring is probably the most common asset-based lending out there. This is a great option for small businesses who have a significant amount of unpaid invoices or accounts receivable that won’t be paid until a later time. You basically sell your outstanding invoices or receivables at a discount to get cash now.
Here’s how it generally works:
- Cash advance. You bring your assets—in this case, unpaid invoices or accounts receivable—to a third-party company, known as a factor, and exchange those for cash. The factor will typically pay you an upfront cash advance which is usually between 70% and 90% of the invoice’s value.
- Collection. The factor then takes on the responsibility of collecting the payment from your customers.
- Final payment. Once all the payments have been collected, the factor takes a factoring fee, which typically ranges from 1% to 5% or more. The remaining balance will be remitted to you.
Receivables Financing
With receivables financing, you’re using your outstanding invoices or accounts receivables as a collateral for a short-term loan or line of credit. Unlike factoring, you retain ownership of your invoices or receivables along with the responsibility to collect payment.
Here’s how invoice factoring and receivables financing differ:
| Receivables Financing | Invoice Factoring | |
| Structure | A loan using invoices as collateral | Sale of an asset (invoice) at a discount |
| Ownership of Receivables | Business retains ownership | Factor purchases and owns the receivables |
| Collections Responsibility | Business handles collections | Factor handles collections |
| Customer Notification | Usually confidential; customers are often unaware | Typically disclosed; customers are notified to pay the factor |
Purchase Order Financing: Funding Large Orders
As a small business, receiving a huge order is great. However, this requires a significant amount of money and/or inventory to fulfill, and herein lies the big gap.
Purchase order financing addresses the issue of insufficient funds when you already have a large, confirmed order. This short-term funding solution is offered by a third-party lender who provides capital or funds to pay your supplier for the goods you need to fulfill the big order.
However, purchase order financing is accessible for small businesses that resell or distribute finished goods but is generally not available for service-based businesses. Lenders often require a minimum total order value and a healthy gross profit margin, and some may require a minimum time in business and a track record of successfully fulfilled orders.
But, if your business meets these eligibility requirements, a factor or finance company will pay your supplier directly so you can fulfill the order. Once your customer pays, they deduct their fees and return the remaining balance to you.
What’s great about this financing option is how the third-party primarily looks at the creditworthiness of your customer and the reliability of your supplier. So, even if you have limited credit history, this is still an accessible financing option for your small business.
Small Business Grants: Free Money (Sort of)
If you would like to receive funding without having to pay it back, then you might want to apply for a small business grant. These are a type of financial assistance offered by the government, corporations, and non-profit organizations.
But, don’t think you’ve hit the jackpot yet because these grants are notorious for being highly competitive. They are also highly targeted toward specific projects, industries, or regions.
Here’s a sampling of the small business grants available out there:
- Government programs, such as the Small Business Technology Transfer (SBIR) program and those offered through the Minority Business Development Agency (MBDA) and the Small Business Administration (SBA)
- Corporate programs, such as the Amber Grant and the FedEx Small Business Grant
Community Development Finance Institutions: The Local Heroes
Community development finance institutions (CDFIs) are basically financial institutions that focus on helping underserved communities. They’re mission-driven, which means they’re more interested in community development than just making profits.
What makes CDFIs different is they’ll often work with businesses that traditional banks won’t touch—maybe because of location, credit issues, or just because the business model is unconventional. They offer various types of financing: loans, grants, technical assistance, etc.
The downside? Well, they typically have limited funds, so there might be waiting lists. Also, they often require more involvement in your business development process. Some entrepreneurs find this helpful (free consulting, basically), while others find it intrusive.