Types of Debt Financing
There are different types of debt financing for businesses. Financing for small businesses can become a challenging process as many startups lack cash flow, credit history, or don’t have assets. Luckily there are lenders out there that can help startups bridge the gap to meet customer purchase orders or pay their employees. In this blog, we will discuss the different types of debt financing.
Cash Flow-Based Loans
Cash Flow Based Loans allow businesses to receive financing based on the historical cash flow and the projected future cash flow analysis. So, companies use generated cash flow to pay their loan. Cash flow-based loans suit companies with positive margins that generate high month-over-month sales but do not have assets to use as collateral. For example, this type of loan is suitable for service companies.
- One of the cash-flow-based financings is Merchant Cash Advances. This loan suits businesses that could not qualify for other business loans. The payback is bounded to the revenues, which secure the company when it suffers from low incomes. However, the disadvantage of this loan is that sometimes APR for this loan can reach even 100%, which makes it one of the most expensive loan types.
- SBA is another type of loan for small businesses that may meet specific qualifications like solid financials and good credit history. Certain SBA loans are best suited for companies that have been doing business for a few years. SBA loan amounts can reach up to $5 million and usually have an APR from 7% to 25%.
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Asset-based lending is a prevalent way of receiving financing for startups at an early stage. An early-stage startup cannot provide sufficient cash flow or assets to approve the loan. In this case, the company can use land, building, equipment, accounts receivable, customer purchase orders, inventory, or other assets for financing.
The main difference between asset-based and cash-flow-based loans is that the risk for the lender is high due to the little liquidity of the assets. The loan is riskier than others; therefore, the amount to be received will be less than what the assets are worth. The interest rate still depends on the asset and the asset’s generating cash flow. Also, other variables, such as credit history and business operation period, affect the interest rate. The most common asset-based borrowers are early-stage startups to more mature small businesses with physical assets to use as collateral with poor cash flow.
- One of the options for this form of loan is Equipment financing. Business owners receive enough money to purchase the equipment and pay the loan at a 4% to 40% interest rate. It typically does not require a high credit score.
- Another popular asset-based loan type is Invoice Financing. Businesses use it to cover payroll, rent, and other operating expenses. For the lender, the unpaid invoices act as collateral for the advance. It can cover up to 100% of the invoice value charging around a 3% processing fee.
- Some lenders will be able to finance against a percentage of customer purchase orders and a percentage of open accounts receivable. The formula to calculate this availability includes many factors: how fast you can collect the accounts receivable and the number of open POs.
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Types of loans that are offered to small businesses.
Different types of startup loans vary by industry, loan purpose, and loan structure. Let’s explore some of the financing options that are the most suitable for startups and that we have worked with before:
- PayPal Working Capital is a loan with a flexible payment system bound to sales settled with PayPal. It is a good finance option for e-commerce businesses.
- PayPal Working Capital charges one affordable fixed fee and the payout is deducted as a percentage of PayPal sales. For example, the business can select the payment of 30% from the sales. This is a form of finance against your cash flow or revenue stream mentioned above.
- Shopify Capital is another financing offered for e-commerce companies. It works similarly to PayPal financing. The remittance rate is charged daily as a percentage of the daily sales until the loan amount is remitted. Total owed amounts consist of two numbers: fixed borrowing cost (the fee) and the loan amount. The loan term has 60 days.
Other types of loans
- Flexport capital allows access to cash to cover supply chain or inventory purchase costs. This loan has extended payment terms for up to 120 days and can advance up to 80% of commercial invoices. You can use 100% of the loan pay for customs duties. Flexport Capital pays suppliers directly with no additional fees to the borrower.
- Clearco offers to fund marketing and inventory spending for e-commerce businesses. Loans varies from $10,000 up to $20 million. Clearco offers revenue-based financing, and the payments are made when the business generates sales.
- Circle-up is a lending option that provides flexible capital for CPG businesses. Companies can use them to purchase inventory or increase marketing dollars. Circle Up offers both cash-flow-based loans and asset-based loans. They use open customer purchase orders and/or accounts receivable to determine the availability of funding. This type of loan is an asset based.
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How to pick the right loan for your business?
The main criteria while choosing the loans typically are:
- The purpose of borrowing money.
- Qualifications for the loan.
- Financing form.
- Payment terms.
- Annual Percentage Rate (APR).
APR gives the actual costs bound to the loan, which considers fees and payments. There are many loan payment calculators that businesses can use to estimate loan APR, but the general calculating formula for APR is:
APR = ((Fees+Interest/ Principal/ N) x 365 ) x 100
Where interest is the total interest paid over the loan life, the principal is the loan amount, and N is the number of days in the loan term.
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How can Startup Tandem CFO help?
Startup Tandem CFO helps startup owners understand their working capital needs and creates an analysis of possible solutions to choose the best suitable option. We will look at your current cash burn, develop a plan to help you meet your customer demands, scale the business or even pay your employees. We work with many debt lenders that can help you obtain necessary cash for your business plans. contact us to know more or make an appointment to see us at our Los Angeles CFO location.