Figuring out how much you need to start a business can be a very iffy proposition. Some experts estimate that the average cost is about $30,000 but of course that’s the average. By definition, it can be smaller and you may only need just $3,000 to run a micro-business at home.
But then again, your capital needs may be much bigger than you anticipated, and now you’re wondering where to get additional funding. If you did your research right you may have read about factoring accounts receivable.
In account receivable factoring, you use your accounts receivable (AR) as your collateral so you can get the funds you need. The factor gives you an advance (somewhere around 80%) of the value of the account receivable, and then the factor sends you the rest of the money after your customer has paid and the factor has taken its fees.
And when exactly should you take advantage of this type of funding? Critics and supporters of this alternative lending method disagree (for some, this is actually their first option), but even detractors grudgingly admit that the following scenarios call for account receivable factoring:
Your Conventional Funding Sources Have All Dried Up
You’ve tried everything. Maybe you’ve gone to a bank and gotten a loan before, but now you can’t get additional funding. You’ve tried going to credit unions and got nothing. Or perhaps your bank even yanked your line of credit.
Now you can always try borrowing from your friends and family, but you may already have done that before. And it may be a blow to your pride, or you’re afraid it may cause some awkwardness in your personal relationships.
So what are you going to do?
Now regardless of your personal views regarding factoring, if it’s factoring versus closing shop, obviously you have no other rational option left but to go for the former.
You Want a Reliable Source of Funding for a Business Opportunity
Let’s say you now have a demand for your product, which gives you a tidy 25% profit. You can either go with factoring, which has a rather high approval rate for funding, and pay their fees. These fees can be as high as 5% for some AR factoring companies. But that still leaves you with a nice 20% profit.
In addition, you’ve satisfied the needs of a customer so there’s a good chance of repeat business coming your way. Your satisfied customer can sell your product, other retailers and companies see them making sales, and they flock to you to buy your product. As a result, you make more money.
Or you can go to a traditional bank, where the approval rates for small business loans can be “dismal” at best. Then if you don’t get your funding, you get nothing.
You Need Working Capital RIGHT NOW
Even if you think that your bank may grant you a loan, in some circumstances that’s not sufficient for your needs. Sometimes you just need working capital ASAP!
There are many circumstances when the need for working capital is truly dire and immediate. Often it’s because you see the next payday looming on the horizon and you don’t have the cash to hand out. It can be the office rental or the payment for utilities.
Maybe your suppliers are demanding payment up front and you don’t have the money to pay. Or perhaps a crucial piece of expensive machinery has broken down and you need money for repairs or replacement.
If the need wasn’t so immediate then you could have waited for your accounts receivable to mature and your customers to pay up in full, but you don’t have the luxury of waiting 30 to 90 days to wait up for the payment.
And that’s when you should opt for account receivable factoring. Setting it up only takes a week or two, and when it’s done, every AR can get you the bulk of the value in just a day.