Alternative financing: Where to turn when the bank says ‘No’

Steven and Michael Spolansky started women's accessories maker Amiee Lynn 15 years ago, shipping belts to a handful of retailers from the basement of their parents’ house in Brooklyn and balancing the budget on their credit cards.

In those days, it was hard for the company to get a conventional bank loan, so the Spolansky brothers fueled expansion by turning to a factor.

Factors, financial firms ranging from banking giant Wells Fargo to independent entrepreneurial lenders, purchase a business’ outstanding invoices in exchange for interim financing, less a fee, giving the business quick access to cash to fund growth or overcome cash flow woes.

These days, Amiee Lynn has 200 employees and produces belts, hosiery, jewelry and cold weather items under labels such as Ellen Tracy, Liz Claiborne, and Alexander Julian. Sales to big retailers such as Macy's and Bloomingdale's have helped push the company’s annual revenue to $85 million. But Spolansky still uses his factor, New York-based Capital Business Credit LLC. In 2009, when bank credit tightened up for many firms, factoring helped finance a 200 percent growth spurt as Aimee Lynn expanded into Target, J.C. Penney, and Kohl's. "There used to be a stigma attached to factoring," says Spolansky, the company’s CEO. "It meant you weren't healthy enough to go to a bank. But that stigma no longer exists."

As bank loans dried up for midmarket companies such as Aimee Lynn during the recent credit crisis, factoring and other types of untraditional lending took off. Those alternatives also include lease-back programs for funding equipment purchases, microloans and cash advances on credit-card sales or purchase orders. Here's a rundown on how some of these funding alternatives work, as well as the pros and cons of each.

Factoring
Worldwide, factors dole out an estimated $2 trillion per year, with $150 billion of that in the United States, according to Factors Chain International, a global network of 267 independent factoring companies. Factors essentially purchase outstanding invoices, allowing a business immediate access to capital instead of making it wait 30, 60 or 90 days for a customer to pay. "We buy receivables generally without recourse, meaning we assume the credit risk of your customer," says Andrew Tananbaum, president and CEO of Capital Business Credit. "We're prepared to lend money against those receivables or give you an advance against those receivables prior to the time we collect the proceeds from the retailer or the customer."

For a business that needs funds quickly, a factor can be a better business partner than a bank. "You can ramp up your business very quickly," Spolansky says. "Let's say a bank gave me a $25 million credit line. If one division spiked up and I wanted to borrow more, I'd have to renegotiate. Factoring is based off my sales. If I give them sales for $35 million versus $25 million, that's another $10 million I get to borrow against right away."

Factoring’s upside: factors assume the credit risk if a customer defaults, and provide other services, including collections and accounts-receivable bookkeeping. Factors will also advance up to 80 percent of a company’s receivables. The downside: they charge fees for their services, usually 1 to 5 percent upfront, based on the invoices a company’s borrowing against. That makes the cost of borrowing steeper than with most bank loans. But, factors point out, they also provide credit protection for customers and a collection service, making a comparison to bank loans more difficult.

Equipment Sale and Lease Back
If a business owns expensive equipment or machinery outright – anything from a fork lift to a porcelain dental crown machine -- it can find a lender who will buy the equipment for a lump sum and lease it back. During the term of a lease, the lessor owns the equipment. When it ends, the lessee can buy the equipment from the lessor or give it back and get a newer model, says David Criswell, interactive marketing manager of Direct Capital, a Portsmouth, New Hampshire, finance company.

The upside of equipment sales with a lease back: the business retains use of its equipment and gets an infusion of funds. The downside: by purchasing it new and then leasing it back, the business ends up paying more for the equipment, although those costs may be offset by tax savings if it can write off lease payments instead of depreciating the equipment.

Microloans
Long the salvation of small businesses, microloans became a solution for midsized companies when the credit crunch started in 2008. As the name suggests, microloans tend to be smaller in amount, but can run as much as $150,000. "In many cases, that's enough to help them with working capital for a month or so and that's often all they need," says Gary Lindner, chief operating officer of ACCION Texas, one of about 300 U.S. non-profit micro-enterprise lending institutions.

The Association of Enterprise Opportunity, the microloan industry's trade group, says its members help 300,000 U.S. businesses each year and have lent more than $2 billion over the past 10 years. The upside: microloans are awarded to businesses with lower credit scores than banks accept, and they don't require as much documentation. The downside: interest rates are higher than those of bank loans, ranging between 12 and 18 percent depending on the borrower's credit and other factors.

Merchant Cash Advance
A handful of independent finance companies will give merchants a lump sum upfront in exchange for a share of their future credit-card sales. Different than a loan or lease arrangement, a merchant cash advance is based on a business’ monthly credit-card sales history, says David Goldin, CEO of AmeriMerchant and a founding member of the North American Merchant Advance Association. "It's a buy-and-sell transaction," Goldin says. "We buy $10,000 in future credit card sales today for $8,000 and we get a specified percentage of future sales from customers."

For that reason, cash advances tend to be attractive to mostly retail, service or restaurant businesses that do brisk credit-card sales. The upside: unlike a loan, there are no due dates and no fixed payments and it's faster to get approved. The downside: while there's no traditional interest rate, providers such as AdvanceMe, Merchant Warehouse, or AmeriMerchant will take a cut – called a split -- that is generally 15 to 17 percent of credit-card receivables.

Purchase Order Financing
Businesses turn to purchase order financing if they’re afraid they won’t be able to promptly fulfill a customer's order and risk losing the sale. A financing agent advances money against a signed purchase order for finished goods or value-added products to help fund manufacturing and fulfillment of the order. This type of arrangement is helpful for companies such as import-export firms, which must pay for raw materials immediately but wait to get paid for their finished goods. Once goods are shipped and customers are invoiced, the transaction is closed out. "It's not an ongoing commitment," says Andrej Suskavcevic, CEO of the Commercial Finance Association, a trade association for 300 asset-based lending companies in the U.S., Canada, and Mexico. "That is just one type of financing a lender might offer, although some of them do it exclusively."

The upside of purchase order financing: it depends more on the credit standing of a business’ customer rather than its own. The downside: providers of these advances take a cut of a company’s profits, usually in the range of 4 percent or less.

Some businesses are so taken with alternative financing they don’t plan to give it up even after the current credit crisis is over. Factoring continues to fulfill accessory maker Amiee Lynn's needs by providing capital financing, credit risk protection and professional advice to help fuel growth. "We get everything we need from our factor," Spolansky says.

Originally published on Inside Edge, April 27,  2010.