The challenges facing small and medium-sized businesses in today’s economic environment can be daunting. Changing market conditions, supply chain disruptions and difficulty hiring staff have emerged as new barriers to success. As these challenges arise, a constant barrier remains from the pre-pandemic era – traditional lenders continue to restrict business credit to SMBs limiting their access to working capital. Fortunately, alternative lenders such as invoice factoring companies have stepped up to the plate by offering business financing solutions designed specifically for small and medium size companies. Now, thanks to technology and credit management innovations, these non-bank lenders have changed the financial landscape and have made small business financing easy!
Breaking Down the Barriers to Small Business Financing
Nearly 100% of all businesses are small businesses, the engine that keeps the economic machine functioning. This sector accounts for 44% of the nation’s economic activity according to a report issued by the Small Business Administration (SBA) in 2019. Small business created two-thirds of new jobs and delivered 43.5% of the gross domestic product (GDP). Yet despite the significant importance of SMBs, they suffer a huge disadvantage when seeking traditional forms of small business financing. Four out of five small business are denied loan approvals from commercial banks, and that number is now significantly greater since the advent of the pandemic. However, there is reason for optimism – the growing popularity of invoice factoring as a preferred funding option for small business is rapidly breaking down the barriers that have restricted SMB’s access to working capital.
The Restrictive Nature of Traditional Lending
There are two traditional sources of business financing for growing companies – debt lenders and equity lenders. As a general rule, these lenders are not interested in a company’s vision for a great business, instead they are solely interested in risk management and the capacity of the business to repay the credit that is advanced.
Debt Lenders: Banks and other traditional lenders follow the Five Cs of Credit to assess the creditworthiness of potential borrowers. Basically, they take assets as collateral and make their lending decisions based on the company’s cash flow and operational performance. Without a solid business credit history and a healthy balance sheet, your company’s chances of securing bank financing is slim to none. If your company does manage to meet the bank’s lending criteria and you succeed in getting a commercial line of credit, the quest to secure easy access to working capital is far from over. To safeguard their investment, banks impose loan covenants to control your company’s financial management. These covenants take independent financial decision making away from the business and place fiscal control in the hands of the bank. This generally constrains investment in business development and restricts the company’s ability to grow.
Equity Lenders: These investors are varied with differing needs and objectives. Angel investors are looking for businesses that can quickly achieve a cash flow positive position, while venture capital investors look for businesses that can go grow very quickly and become significantly more valuable. All equity investors are looking for an exit strategy – an opportunity to turn their equity into a high gain financial return. For business owners looking for a long-term financial solution, equity investors are not the best option.
A Flexible Financial Solution
Invoice factoring is an alternative form of funding based on an entirely different approach to small business financing. Instead of focusing primarily on the credit worthiness of a business, an invoice factoring company assesses the credit worthiness of the business’s customers. If the business generates invoice receivables and issues them to customers with good business credit, in all likelihood that business will qualify for funding. Invoice receivables of this nature are considered high quality assets that are leveraged to provide the working capital businesses need to operate and grow. This approach is a game changer for the financing eligibility status of small and medium size businesses. Once approved and funding begins the company is free to independently manage their working capital needs. This flexibility allows SMBs to autonomously channel financial resources to support the company’s strategic goals.
How Does Invoice Factoring Work
Invoice factoring is the practice of selling invoice receivables at a discount in exchange for immediate payment. It’s a very simple funding process:
- The business delivers products or services and issues invoice receivables to credit worthy customers. A copy of the invoice(s) is sent to the factoring company.
- The factoring company verifies the invoice(s) and within 24 hours transfers an advance payment of up to 90% of the invoice(s) face value. The remaining balance is held as a reserve.
- The customer remits full payment of the invoice(s) to the factoring company.
- The factoring company transfers the reserve amount (the remaining balance) to the business and the transaction is complete.
- A small fee (the discount) is deducted to manage the transactions.
Benefits of Invoice Factoring
By far, the biggest benefit is the easy qualification requirements. As long as the business has customers with good business credit, companies of all sizes, no matter if they are new or established, are well on their way to first funding. Once funding begins, access to working capital keeps pace with the frequency of invoices being issued. This is great news for startups and growing companies – the more invoices generated, the more access to working capital is achieved. Unlike bank financing that can restrict growth, invoice factoring can be used to pay bills, build cash reserves, feed expansion, or be used in whatever fashion best suits the company’s direction and goals.
Winning Against the Odds
Despite providing the economy with an overwhelming number of benefits, small businesses lack the advantages commercial financial institutions and government agencies provide to large corporate entities. Small businesses do not receive the same tax breaks, incentives programs or receive federal bail-out money in times of financial turmoil. Yet despite over-whelming odds, small business continues to thrive and capitalize on the entrepreneurial spirit that formed this nation. Invoice factoring companies celebrate this resilient spirit and support its vitality with flexible cash flow solutions designed for small business.
For more information about the benefits of invoice factoring as an easy to manage solution for small business financing, visit eCapital.com