Cash flow financing is generally available to very small businesses that do not accept credit cards. Lenders use software to review online sales, bank transactions, bidding history, shipping information, customer comments/assessments in social media, and even restaurant health results, if applicable. These metrics provide evidence of consistent sales volumes, revenues and quality. Loans are usually short-term and for small amounts. Annual effective interest rates can be high. However, loans can be financed within one or two days.
Cash withdrawals to merchants are based on credit/debit cards and electronic revenue streams related to payments. Advances can be secured by cash or the future sale of credit cards and usually do not require personal guarantees, pledges or collaterals. Advances do not have a fixed payment schedule and restrictions on business use. Funds may be used for the purchase of new equipment, inventories, expansion, alteration, repayment of debts or taxes and for emergency financing. In general, restaurants and other retailers who do not have sales invoices benefit from this form of financing. Annual interest rates can be cumbersome.
Non-bank loans can be offered by financial firms or private lenders. Repayment terms may be based on a fixed amount and percentage of cash flows and equity in the form of warrants. In general, all terms and conditions are negotiated. Annual interest rates are usually much higher than traditional bank financing.
Community Development Finance Institutions (CDFIs) typically provide loans to micro and other uncreditworthy enterprises. The CDFI can be compared to small local banks. CDFI financing is usually for small amounts and the interest rate is higher than for traditional loans.
Peer-to-Peer loans/investments, also known as social loans, are direct financing from investors, often available to new businesses. This form of credit/investment has increased as a direct consequence of the 2008 financial crisis and the subsequent tightening of bank lending conditions. Advances in internet technology have facilitated its development. In the absence of a financial intermediary, interest rates on loans/peer-to-peer investments are generally lower than traditional sources of funding. Peer-to-Peer lending/investments can be direct (the company receives funding from one lender) or indirect (several pooling funds of lenders).
Direct lending has the advantage of allowing the lender and the investor to develop the relationship. The investment decision is essentially based on the credit rating of the company and the business plan. Indirect lending is essentially based on the credit rating of the company. Intermediate loans spread the risk among lenders in the pool.
Non-bank lenders offer greater flexibility in assessing collateral and cash flow. They may have a higher appetite for risk and facilitate more risky lending. Typically, non-bank lenders do not have deposit accounts. Non-bank lenders may not be as well known as their big-bank counterparts. To ensure that you are dealing with a reputable lender, make sure you carefully examine the lender.
Despite the advantage that banks and credit unions have in the form of low cost capital – almost 0% of customer deposits – alternative forms of financing have developed over the past few years to meet the demand of small and medium-sized enterprises. This increase will certainly continue as alternative forms of financing become more competitive, given the downward trend in the cost of capital borne by these lenders.
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