If you’re like most business owners, the notion of financing extends only in three or four different directions — cash flow, bank loans, investors/partners and public or private stock offerings.
But what happens when your company taps out its credit line at the bank, the investors say make do with what you have and it’s simply not feasible for your privately held, $20 million manufacturing operation to go public?
Waiting on the sidelines of the funding game are numerous alternative-financing solutions. Which one to consider depends on your company’s maturity level, its asset position and your existing client base.
Here are three options worth investigating.
Mezzanine financing
Mezzanine financing is just what it sounds like — financing that fits on a company’s balance sheet somewhere between traditional commercial bank debt and shareholder’s equity. It’s considered a form of debt, though it’s often referred to as an investment, and is used during transitional periods of a company’s life.
Typically, a business owner seeks mezzanine financing for things such as equipment purchases, management buy-outs and strategic acquisitions, and only when the company’s regular commercial bank is unable to loan it further money and the owners don’t want to sell equity in the company to raise more cash. Because they’re riskier than traditional bank loans, mezzanine financing loans normally carry an interest rate of between 3 and 5 percent over prime.
“It is a more cost effective and flexible sort of financing,” explains Greg Ferrence, managing director of the Ohio Mezzanine Fund Ltd. “It’s an option available rather than bringing a partner in and giving up equity.”
Mezzanine funds like Ferrence’s raise money from institutional investors. In Ohio Mezzanine Fund’s case, $9.4 million was secured from such traditional players as Bank One, Charter One Bank, FirstMerit Bank, Huntington National Bank, KeyBank and National City Bank.
The fund’s managers then administer the money to businesses in amounts smaller than most traditional loans — from $100,000 to $750,000. Often, that money is combined with a loan from a larger lending institution.
Purchase order financing
It’s not uncommon for a growing business to find itself generating sales faster than the company’s coffers can keep up with. And, in the early stages of a company’s growth, few lending institutions will extend bottomless credit lines to cover that type of growth.
Worse, even if you can show a stack of purchase orders to substantiate your company’s assertion that it needs more cash to meet orders, unless you have an invoice that shows you’ve already billed customers for delivered products or services, simple purchase orders aren’t considered collectible nor lendable by traditional financiers.
That’s where purchase order financing comes in.
“We find someone willing to take the commercial risk for holding that order,” explains Lee Tenenbaum, president of Chagrin Financial Services Inc. “They put up the money or credit to allow the business owner to complete the transaction, whether it’s buying extra raw materials or supplies or having enough money to cover a temporarily larger payroll.”
It’s a riskier proposition, Tenenbaum says, because the confirmed purchase order becomes collateral for the money. In essence, the lender banks on the notion that the products are presold to customers who will follow through and pay the invoices in a timely manner.
And, as with mezzanine financing, purchase order financing transactions are completed at a higher level of interest than traditional financing. But, says Tenenbaum, it’s worth it, considering that in the long run, purchase order financing is done to conduct business that otherwise wouldn’t have been possible.
Factoring
Factoring is the practice of selling a company’s accounts receivable. A business owner makes a sale and issues an invoice to the customer.
Since most invoices run on 30-, 60- or 90-day payment terms, there’s a lot of legroom for a small growing company to run into cash flow problems in the interim.
With factoring, a business owner could sell that invoice to a factor — essentially an investor looking to make a not-so-high risk investment at a substantial profitable gain — who advances the business owner cash against the invoice’s face value, typically 70 percent or more within 24 hours, explains Tenenbaum.
The factor handles the collection process and the customer remits payment directly to the factor. Factoring fees are negotiated on a case-by-case basis, but because they’re generally considered lower risk investments — there’s an invoice issued that’s legally collectible — the fees typically are not as high as for other alternative financing methods.
Size of the invoice, number of customers, total volume of business activity, collection period terms and the credit worthiness of the receivables are all taken into consideration in determining the factoring expense rate. How to reach: Chagrin Financial Services, (216) 292-2802; Ohio Mezzanine Fund Ltd., (216) 573-3738
Dustin Klein ([email protected]) is editor of SBN.
