Credit crunch forces firms to look elsewhere for funding

Credit crunch forces firms to look elsewhere for funding

In the past, when a business owner needed funding to start a business, expand a company or purchase new equipment, he could simply visit his bank and take out a loan or line of credit. Now, however, the credit crunch has forced businesses to seek other lending methods because banks have tightened their purse strings.

According to an article by John Tozzi of BusinessWeek.com, banks have significantly narrowed their lending standards on the side of caution. Businesses that would previously have warranted a sizable loan might not even be able to secure a new credit card in the current economic climate.

This presents a unique and frustrating challenge for businesses that have come through the falling economy but still need help to keep their ventures afloat. Even if projections indicate they will continue to thrive over the next five years, their industry or history of sales might preclude a loan or credit cards.

Tozzi says that when traditional loans and credit cards are no longer available, alternative methods of funding become far more attractive to businesses. He names three: asset-based lending, factoring and merchant cash advances.

Asset-based lending is one of the most attractive alternatives to credit cards and business loans. Although they generally represent a higher cost to the borrower, they do not require high credit scores or positive histories in business because these loans are secured by collateral. Essentially, if the borrower is unable to make good on the loan, the asset is seized by the lender.

Factoring, on the other hand, allows businesses to "sell" their accounts receivables to another company in exchange for immediate cash. The accounts are sold at discount so they do lose money on the back end, but the immediate cash flow allows them to upgrade their equipment, purchase new land, increase their advertising circulation and much more. This method is not nearly as simple as taking out loans or credit cards, but it has proven effective for many business owners.

And finally, a merchant cash advance is a unique lending alternative that involves borrowing against future credit card transactions. The money borrowed is less than the amount of the prospective sale, which is how the merchant account holders make money, while the business owner receives cash up front, just like in factoring.

Although the credit crunch has closed certain avenues of funding like credit cards and business loans, it has also opened up new opportunities on both sides of the table. Not only do business owners have an opportunity to find funding in a pinch, but finance industry entrepreneurs can also find new ways to make money.

According to Tozzi, most bank loan officers plan to continue holding off on credit cards and loans for riskier businesses at least over the next couple of years. This means that alternative funding sources have a chance to prosper and perhaps even replace some of the reliance on credit cards and loans.

However, most of these alternative funding sources do cost business owners more money in the long run. Once their businesses are flourishing and they are considered lesser risks, many business owners will return to credit cards and loans as the preferred source of funding.

Article by Steve Thompson

Published: September 23,2023