Financial Credit for SMBs

Financial credit is the "holy grail" of SMB financing -- much sought-after, but seemingly hard-to-get. Happily, there are sources other than big banks who do extend credit to SMBs. We'll tell you who and how.

Traditional Bank Credit

Traditional banks -- once that are legally allowed to use the word "bank" in their name, take deposits, etc. -- are a tough place for SMBs to seek credit. We have a detailed writeup on why SMBs rarely get capital from traditional banks which you may want to read.

But it may be sufficient simply to realize that banks are used to dealing with big companies, and you can't just shrink down a big-company solution and expect it to work right for a small company.

Factoring and Purchase-Order Financing

Factoring and purchase-order (PO) financing are slightly different, but both are ways of getting some cash up front once you have an order from a big customer. They may be suitable if you sell to large companies (or maybe the government), but they won't help if you sell to consumers.

A "factor" will look at your accounts receivable -- unpaid invoices you've already sent for goods and services -- and will give you a certain amount of cash in exchange for those future payments. The factor takes the risk that your customer will pay him on time. (But be aware, most factors will put your business on the hook if they don't get paid.)

A PO financier is like an earlier factor. They take a purchase order from a very large customer, and they will advance you some money needed to fulfill that order. They're taking more risk than a factor and will take a larger cut for themselves on average.

Merchant Cash Advance

A merchant cash advance is a loan-like arrangement where the SMB gets cash up front, and then some amount is repaid (typically daily) as a fixed amount or a percentage of each day's credit card receipts. They may be suitable if you sell a regular, high volume of credit card transactions.

Merchant cash advance is typically a very expensive form of money. It is sometimes likened to the "payday loans" of the SMB finance world. It has its place, but it can also be a trap for the unwary.

Online Alternative Lenders

A variety of online lenders have popped up in recent years, offering loans to SMBs. While there is a wide variety of online lenders, some better than others, overall the category is legitimate for simple economic reasons: The use of the Web and credit data allows them to be faster, more flexible, and better suited to SMB needs than banks can be.

Most online lenders offer some variation on a term loan. They extend credit of a certain dollar amount, and get repaid periodically (sometimes daily in tiny increments). Other online lenders offer a variation on merchant cash advance, factoring, revenue-based financing, or other non-traditional products.

Each lender has a different process and different criteria for extending credit, but it usually requires the SMB to provide some data in a Web-based form, including linking to credit, financial, or transactional sources. Although this may seem odd to a traditional business, it's what allows the flexibility and speed that online alternative lenders offer.

Crowdfunding and "Other"

Most "crowdfunding" systems that are legal today in the US are actually forms of donation or pre-sales. They aren't really extensions of financial credit, exactly. (In the UK, however, there are lots of business loans being done via crowdfunding.)

A few "crowdfunding" or "peer-to-peer" platforms have opened up or have announced that they will open (as of late 2013), and are targeting lending to small businesses. You should think of these platforms or sites as being like Online Alternative Lenders who happen to get the money from many smaller investors.

What's Beyond?

We suggest you look at the world of trade credit which is three times as large as the world of formal credit for SMBs. We also have an article on hidden credit which may provide food for thought (though sadly, it won't put cash in your pocket).

We don't suggest thinking of venture capital (VC) or angel investors as a route for SMBs. Only about one in a thousand companies raises venture capital. Plus, those investors don't generally extend credit; they buy shares in a business.

Best Foot Forward

The way to put your best foot forward in the world of financial credit is to demonstrate trustworthiness with using all forms of credit over time.

That means, if you do not yet have financial credit, you should take particular care to demonstrate good use of trade credit. Creditors of all types want to see historical evidence that you are willing and able to pay as agreed.

Finally, having your books and records in order will help to demonstrate your creditworthiness. (Even if you never walk into a granite-and-brass lobby with papers in order to get an extension of credit.)


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