Small and start‐up businesses in search of financing often look at only two alternatives: banks and
venture capital investors. Banks are the traditional resource for a loan or line of credit, while venture
capitalists provide long term business capital. While there are advantages and disadvantages to each of
these resources, it’s important that the entrepreneur understand that neither of these is often the best
alternative for a growing business.

Traditional Bank Financing
Bank financing is everyone’s first choice, a relatively low cost method of funding a business. But bank
financing can be allusive. One applicant told me that his local bank would agree to lend him $100,000
only if he pledged $100,000 in cash collateral. To quote Bob Hope, “A bank is a place that will lend you
money if you can prove that you don’t need it.” Banks just don’t seem interested in taking a risk on
small and startup business. The application process is long and torturous, the requirements often
unreasonable. How can you show three consecutive years of profitability if you haven’t even been in
business that long?

This leads many to alternative stop #1: the private venture capital investor. Is this a smart decision? Is
venture capital the only alternative to bank financing?

The Cost of Venture Capital
Private investors typically – but not always – provide companies with equity rather than debt. That
means they want a piece of ownership in exchange for their cash. How do you measure the cost of
venture capital, given that there is no loan and no interest? One method is to look at the portion of
ownership given up to investors. Loss of ownership share means surrendering some degree of control,
as well as a percentage of the company’s future earnings. If the company becomes successful, that loss
can be substantial. If the new “partner” is meddlesome and difficult, the company may never make
money at all.

Negotiating with an investor can be tricky. How much ownership interest should they get? Since its
nearly impossible to calculate the future value of a small company, there is no easy answer to that
question. Many investors will want a big chunk of stock for relatively little money, and may take
advantage of a liquidity crisis by obtaining more control than their money is worth.
Venture capital is more easily obtainable, but it is very expensive. Is there an option that is both
affordable and available?

The Factoring Alternative
Factoring is a method by which a company can obtain advances against its unpaid accounts
receivable. The factoring company isn’t technically lending; it “buys” the unpaid invoices at a
discount. The funds advanced are repaid by the company’s customers as the receivables mature. For
many growing businesses, the money locked up in unpaid accounts receivable is their largest single asset
so the ability to draw against that asset can provide a significant liquidity boost. Since the factor is
relying on the quality of the accounts receivable as the source of repayment, the factor is less concerned
than a bank might be about the company’s history or financial condition. For this reason, it is far easier
and quicker to obtain financing from a factor than from a bank.

The factor’s invoice discount fees translate to being more expensive than bank interest. This is because
the factor has costs associated with the managing, collecting and handling of the accounts, in addition to
the cost of funds. But those credit management services provide value to the client. In essence, the
factor acts as both “bank” and an outsourced credit/collection department, enabling the client to offset
some administrative costs. When these value‐added services are taken into consideration, factoring
fees really are comparable to bank interest charges.

Of course, if the bank is not willing to lend, the comparison is moot. How does factoring compare to
venture capital? Consider that the factor will typically advance 80% of the company’s outstanding A/R,
and that the A/R is often the largest single asset of the business. For a growing company, it’s not
unusual for the factor’s cash funding to be 3‐5 times greater than what the owner himself has invested
in the business. A venture capitalist would insist on a large or controlling share of the business for that
level of investment. Factors take no ownership, exert no control over management, and have no claim
over the copany’s earnings. The other consideration is exit strategy. Venture capitalists can be very
hard to buy out if the relationship doesn’t work. Factors typically work on short term contracts, and
repayment is as simple as collecting the receivables.

Call Us For a Quote
Factoring is a great financial alternative for growing companies with accounts receivable. Of course, not
all factoring companies are created equal. When searching for factor, the most important qualities are
stability, service and price.