Short-term Financing Options for Small Businesses

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short term financing

Short term financing is business financing that one can obtain generally for a term of one year or less. The term is usually six to twenty four months. Sometimes ones business may require a short term financing to use as working capital. A working capital is the business money that one may need for the day-to-day operations of the business. There may be a need to pay suppliers, buy some equipment or just to pay the utilities. The cash flow is not always sufficient at the time one needs it most so one may have to seek funding from another source. There are several options are available for you to gain access to the working capital.

Lines-of-Credit

A line-of-credit acts as a cushion for the cash flow and also a hedge against the unexpected expenses. Lines-of-credit may be developed in several ways. One may pre-qualify for a credit limit with their bank or other funding source. The advantage of this is that one will have an immediate access to a capital when needed and only pay interest on the amount of money that one may use. For example, if one has a credit line of $50,000 and you use only $15,000, you will only be paying an interest on the $15,000 balance. Once the balance is repaid, the full $50,000 credit line available to you again.

A business credit card from any of the major card companies is another way to get a line-of-credit. One can use a credit card to purchase inventory, raw materials or supplies. One must use a credit card for their business as cautiously as one would use a personal card. You don’t want to be burden your business with an unnecessary credit card debt, especially when one is trying to build cash flow.

Short Term Financing Overdraft Protection

One can acquire an overdraft protection for their business account in the same way as their personal account. If your cash flow slip and your become overextended, then the overdraft protection kicks in and save you from the embarrassment of not being able to meet your responsibilities. The protection of your reliability with your bank and the suppliers is worth the minimal cost for an overdraft protection on your account.

One can seek a short-term loan for a specific amount from their funding source. For example, if your business is a seasonal one, you may take out a loan at a time when your cash flow is strong. Then use this short term financing for operations during the slower months. The objective always should be to pay off a short-term loan as soon as possible.

Trade Credit

The Trade credit is credit given by your suppliers. The suppliers may not be willing to extend you a credit if you are a new business or do not have a good credit rating. One may have to pay with credit cards for their first few orders until the creditability with the supplier is established. A supplier usually extends credit with an offer of a 2% discount if one pays the invoice within 10 days. The net payment is usually due in 30 days from the date of purchase. This payment arrangement is normally referred to as “net 30” by the company’s Account Receivables Department.

One may receive the discount of 2% if you pay early. You may be required to pay a penalty if the payment is done after the 30-day period has elapsed. The late payment penalty will be significantly higher than the 2% discount.

Here are some of the popular types of short-term funding that are available to a small business:

1. Bootstrapping

Bootstrapping is a quite a witty word for a smart financial concept. The term comes from the popular phrase “pulling oneself up by one’s bootstraps.” A person is said to be bootstrapping when he/she attempts to build a company from his /her personal finances or from the operating revenues of the new company. More than 80% of new start-ups receive their funding from the founder’s personal finances. It could be from a savings account, a zero interest credit cards, or leveraging some personal assets like selling a house or car and cashing in on a 401(k). This way your business is your own—you do not have to answer investors.

What are the benefits and the drawbacks of bootstrapping?
The business owners who use bootstrap funding do not have to worry about diluting ownership between investors. They do not need to issue equity, and they are able to focus debt on personal sources. The drawbacks are that the unnecessary financial risk is entirely on the entrepreneur and bootstrapping might not provide adequate investment for the company to become successful at a reasonable rate.

2. Family and friends

One can always depend on their family and friends. With a good business plan in hand, sell your ideas to the people closest to you, explain your ideas and how they’ll stand to benefit by backing your business.

What are the benefits and drawbacks of this method?
Be frank and honest about the risks and put all the rules behind the investment in writing. Whether you’re taking a loan, an investment, or even a gift, always remember that each of these comes with strings attached. In case of loans and investments, one will have to pay the money back: and remember you cannot file bankruptcy if the business fails.

3. Equipment Financing

Equipment financing is an asset-based loan. An asset is a thing that your business owns—it could be a vehicle, a piece of equipment or machinery, or a selection of inventory.

While traditional debt-based small business financing uses ones borrowing and business history—like their credit score, bank statements, and the tax returns—to regulate what you qualify for (and at what rates, and on what term), the asset-based loans rely on the value of the asset, which acts as a collateral.

In other words, the asset-based lenders care more about how much that new piece of equipment costs rather than about your credit score.
A lender may be more willing to lend to you if have a collateral to back against your loan because—in a scenario where you can’t pay back your loan—the lender may simply seize the collateral and liquidate the assets to recover their losses.

What can one expect with Equipment Financing?
One can potentially finance up to 100% of the cost of a piece of equipment and have monthly payments with 8% to 30% interest. Moreover, the equipment financing will last for the expected lifetime of that tool or the machinery, so you will not need to pay for longer than you will get use out of that new equipment.

And after the loan payment ends, one can own that equipment outright—as opposed to leasing it, which is another option to consider.
Equipment financing is a great option if one can’t afford the price tag of a piece of equipment upfront, but are confident that the revenue one will get from the use of the equipment outweighs those interest payments.

4. Invoice Financing

This is another type of asset-based small business financing, invoice financing uses ones outstanding invoices as a collateral (as opposed to a piece of equipment, like with equipment financing).

How can Invoice Financing fix cash flow issues?
It solves a common business problem: you are waiting on a customer to pay you dues, but their delays mean a risky cash flow gap and the potential missed payments at your end.

By paying a fee to one’s lender, one can get most of that cash right away for those outstanding invoices, basically trading in some of the money one has earned for capital now instead of later.

There are a few different variations of the invoice financing, but in most cases one will receive around 85% of the cash for those invoices that one wants to finance upfront—then you will receive the remaining 15%, minus fees, when your customer pays.

Sometimes a lender may give you 100% of that invoice and a weekly repayment schedule, or other times your lender may “buy” the invoices from you—this means they’ll chase down your customers for payment, so that the late payments won’t affect your business.

5. Angel Investors

An angel investor is an individual who happens to have the time, money, and the inclination to invest in a small business and entrepreneurial start-ups by themselves.

What are the advantages or disadvantages of an angel investor?
An angel investor may offer you a lot of money before your business starts making any at all, but always remember, equity also means sharing your decision-making power.

Unlike financing a small business with a debt, equity involves a long-term partnerships. If an investor’s vision for the business is fundamentally different from yours—or if you disagree on something basic—then that small business financing may not be worth the cost. With equity, you receive experience, time, expertise, resources, energy, connections and attention.

6. Venture Capital

A venture capital firm is an all-inclusive company dedicated to exchanging capital for equity in new ideas and growing businesses.

How does venture capital work?
Venture capital is a competitive form of small business financing. You generally decide on how much money you are looking for and how much equity you are willing to part with, and then shop around.

Venture capital is normally circulated in “rounds,” with the companies and firms matching up for more money in return for more equity. Start-ups move from their seed round through their Series A, B, and C rounds, then maturing as a business until they’re ready to IPO (or offer stocks to the general public).

Who is eligible for venture capital funding?
Most small businesses do not qualify as targets for venture capital business financing: These firms generally aim for the technology-centric “disruptors” with a much higher funding needs and a faster-moving business plans, like the traditional start-ups one might be familiar with.
But it’s an advisable option to investigate if an equity-based business financing is what you are thinking about.

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A lawyer with 14 years' experience, Vikram has worked with several well-known corporate law firms before joining Vakilsearch.

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