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Not Ready for Revenue-Based Financing? Startup Finance Options to Tide You Over

At Lighter Capital, we like to fund as many companies as possible. But not all businesses are at the right stage for our revenue-based financing model. If you don’t yet have monthly revenues of at least $15K or gross margins over 50%, where can you turn for financing?

A traditional bank

A traditional bank is the best place to start. They will always give you the lowest interest rate available, because they have the lowest cost of capital of any lender in the marketplace. Banks borrow directly from the Fed and, currently, the rate that the Fed charges banks to borrow is almost zero as they’re trying to encourage lending in order to foster economic growth.

Start with your local bank first. They are interested in servicing your bank accounts, payroll business, and providing other auxiliary services. They also want to support the local community. To increase your chance of success, develop a relationship with the bank—that is, open a bank account for your business and use it. In addition, develop a relationship with the business loan officer. Ultimately, banks are run by people, so having someone in your corner advocating for you can make the difference between securing funding and walking away empty-handed.

Of course, there are downsides to bank loans. The biggest problem is that the process of applying for financing is painfully slow. Banks require a lot of information and it will take them a while to process it. It can easily take six months before you secure a loan. Try to look at this as a good learning experience, a crash course in what banks want. What financials are they interested in? Where are they pushing with their questions? How might these lines of inquiry be relevant to both the day-to-day operation of your business and your long-term planning? Hopefully, this process will help you better understand your business and be more prepared for pursuing other options if the bank says no.

A/R financing

A/R financing, also known as factoring, is essentially a short-term loan where you borrow money based solely on money owed to your company through accounts receivable. It’s only a short-term fix, but if you’re in a cash crunch and need a little more working capital to get through the next couple of months, it can be a useful option to have in your back pocket.

However, you need to go into this financing option with your eyes wide open. A/R financing provides you with a percentage of your “qualified A/R”, which is generally A/R with less than 90 days outstanding, and has a minimum of $5K per customer. Many A/R financing companies will require that your customers make the payment directly to them. This can work if you’ve only got a few customers and are using this system only for a short period of time, but still, it might require an awkward conversation with your customers’ payment departments.

Most importantly, the cost of borrowing through A/R financing—typically 15–25%—is substantial enough that you really should only use this as a short-term solution if, for example, you are having trouble making payroll because someone is slow in paying you. It certainly isn’t a practical option for funding the future growth of your company.

Online lenders

There are two primary types of online lending: merchant cash advance lenders and peer-to-peer lenders.

Merchant cash advance lenders lend money based on anticipated future credit card sales to customers. The lender takes a certain percentage of every credit card sale you make until you pay back the amount you borrow plus the agreed-upon interest. Merchant cash advances typically charge a high interest rate and require very fast turnaround (less than 24 months). Because the lender collects payments from credit card sales either daily or weekly, merchant cash advances provide you with very little time to actually utilize the capital.

Peer-to-peer lenders are online match-makers who connect you with people interested in making higher yields on their capital by lending out money rather than putting their savings in a bank, where deposits are earning trivial interest rates. These loans tend to be structured like traditional loans, with longer terms, monthly payments, and either interest-only or fully-amortizing repayment plans. Peer-to-peer loans are definitely cheaper than the merchant cash advance option.

With any online lending option, make sure you understand the fees associated with the loan and don’t forget to read the fine print. If you approach online lending with caution, you might find a reasonably-priced source of capital.

It always pays to do your homework and make sure you understand the terms and real costs of any type of financing. The effective APR is the “mathematically-true” interest rate for each year and will help you compare different loans.


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