Alternative Sources of Financing for Entrepreneurs and Small Business

In the midst of the COVID-19 outbreak and with new developments happening in Ontario, Canada and across the world every day, there is significant uncertainty for businesses when it comes to predicting sales and revenues over the next quarter (or two). Small to medium sized businesses are among those who are going to be hardest hit by the economic slowdown.

In addition to the economic supports being rolled out by the governments of Canada and Ontario, below is a list of alternative financing options for businesses who may be forced offside their financial covenants with their traditional lenders and require some liquidity in the meantime.

Second Mortgages

For any businesses that own real property, the secondary mortgage market is a key option to consider. Second mortgages come in a few different types of loan products, depending on what you qualify for and what you’d like to use the funds for. A revolving Home Equity Line of Credit (HELOC) allows the borrower with continuing access to equity provided they pay down what they previously owe. There are also closed second mortgages which provide one lump sum of cash that is gradually paid down over time. Most second mortgages allow borrowers to access up to 80% of the equity that is built up in the property – some lenders may approve a higher loan to value (LTV) – but each case is different and there may be trade-offs to consider, such as higher interest rates.

Receivables Financing

Receivables financing typically allows access of up to 90% of the value of an invoice as early as one business day after the invoice has been issued. Once the customer has paid the invoice, the lender pays the balance of the invoice minus any fees. This type of financing is beneficial for small to medium sized businesses as it allows access to early and fast cash, and in some cases, the lender can manage invoice collection. It is best used for businesses that sell to other businesses, extend trade credit terms to customers, provide invoices as soon as the product or service has been supplied, and/or majority of the time do not encounter disputed invoices or fewer than 5% customer returns.

Factoring

The main distinction between factoring and receivables financing is the ownership of the invoices. Receivables financing done by banks requires the invoices to be pledged or assigned as collateral for a loan, whereas with factoring, the ownership of the invoices is transferred from a business to factors who will buy the invoices outright for a discounted rate. Both are similar in that businesses can access upfront a significant portion of their sales upon the issuance of an invoice.

Merchant Cash Advance

For businesses where a significant portion of their sales are paid for through either credit cards or debit cards, a merchant cash advance is a type of loan advanced based on future credit card sales from a business. An agreement is made between the business owner and merchant cash advance provider, and once made, the advance is done in exchange for a future percentage of the business’ credit card receipts or receivables. A “holdback” will be withheld from the business’ daily revenues until the advance is paid back in full. To qualify, most businesses will be required to have a brick and mortar storefront, accept all forms of credit cards/debit cards, process a minimum amount of sales through credit cards and debit cards, and have a minimum amount of processing history, e.g. six months.