There are many potential financing options for small manufacturing companies, but some may be more beneficial than others. How do you know which option to choose, and how can you be sure that option will be the solution you need? We have put together a list to help guide you to the right choice for your business.
In this post, we will look at the types of lending typically available to manufacturers, and examine their offerings and conditions while assessing their pros and cons.
Option 1: Commercial and Community Banks
These are the conventional lenders that you probably think of first when you consider business financing. A recent study showed that 48% of small business owners fund their companies through commercial bank loans, and 34% use regional or community bank loans.
These providers may be corporate giants (Bank of America, JPMorgan Chase, etc.), or small organizations like local banks, but they all offer a similar scenario:
The borrower receives a lump sum of capital and repays it in monthly installments, with interest. Your lender of choice may also offer you a line of credit, which works very much like a credit card: The money is there to be used, but you don’t withdraw it or pay interest on it until you need it.
The catch, is that these banks have a very low acceptance rate, especially in recent years. In the past few years, the rate of rejected applications has skyrocketed to 80%, so you might need to jump through quite a lot of hoops to get funded. Conventional loans also tend to have a higher down payment of 20-40% and variable, unpredictable interest rates.
Option 2: Independent Lenders
These are the types of lenders that you might have seen advertising on TV, like Lending Tree. They often have the word “capital” in their name. They will lend more readily than the banks, so they are favored by those with a limited or poor credit history, or those who are in risky fields that banks are hesitant to fund. Independent lenders might also be able to close more quickly than conventional lenders, which makes them appealing to small business owners in a time crunch.
The catch here, is that these lenders generally offer money on less favorable terms, in smaller amounts and for shorter periods of time. Independent lenders also tend to ask for higher interest rates.
According to founder and CEO of Business Money Today, Joseph Lizio, the reason for these higher interest rates is this: “Private lenders either have to get funds from investors who are looking for decent returns, or from other financial institutions who lend these private lenders funds at higher rates. Either of these scenarios raises private lender’s cost of funds, which in turns gets passed on in their loan rates.” These interest rates can get as high as 10-12%, which can be quite difficult for small manufacturers to accommodate financially.
Option 3: Working Capital Loans
This is a type of financing rather than a type of lender. You can receive a working capital loan from a bank or an independent lender. These loans are intended for immediate, short-term needs, such as meeting immediate expenses or making urgent purchases.
You might find a working capital loan with agreeable terms, but loan conditions can vary widely (sometimes including interest rates that approach 100%), and are generally granted in sums of less than $1 million and for short terms. They are not suitable for financing long-term goals (other than remaining in business), and generally won’t help with important, large-scale purchases like buying a building.
Option 4: Asset-Based Funding and Invoice Factoring
These are two closely related types of financing that are available from banks and industry partners. These kinds of financing offer quick cash but are usually high risk, complicated to implement, and have the potential of being seen as ethically dubious by your customers.
With asset-based financing, the borrower is expected to provide a very high, but easily accessible, amount of collateral to secure a loan. Usually this collateral is your company’s inventory and usually a loan is granted for 50% of its face value. This method of financing has the benefit of providing cash quickly, but if your inventory is used as collateral and you are unable to repay the loan, you forfeit your collateral (inventory) and your business will be left in very precarious health.
Invoice factoring uses outstanding invoices as collateral and pays 65-90% of their value, but usually only on invoices made out to customers with good payment records. Then the factoring company begins to collect those debts.
When a debtor pays, you receive the amount of the invoice minus the amount already paid by the factor, the interest, and any fees, such as a service charge or audit fee. While you receive credit and the factoring company collects debts for you (freeing time for you to conduct your business), if your customers notice that their payments are going to a factoring company, it may make an undesirable impression.
Option 5: Merchant Cash Advances
A merchant cash advance is not a loan, but an advance. The difference is that the repayment is made automatically and daily from the business’s bank account. This option was originally designed for businesses that receive a large volume of payments by credit card (such as a restaurant or retail operations), but has expanded to cover most businesses.
This is an attractive option to some business owners because advances are granted quickly and do not require collateral. However, the interest rates on this type of advance are high, and payments can be fixed or proportional to the business’s turnover.
The main problem with flexible payments is that, when the size of the daily payment is reduced and the term of the repayment increases, the annual percentage rate (APR) of the advance rises. In this way, the interest on the advance can easily top 100% and even reach 300%.
The Solution: The SBA 504 Loan
The 504 loan, offered by the Small Business Administration (SBA) is a loan designed to help business owners and our local economy and could be the solution you are looking for. This loan is an affordable option that can be used to acquire or upgrade fixed assets such as land, buildings, or long-term equipment. Most for-profit businesses are eligible to participate in the program and conditions are quite favorable. This makes the 504 loan one of the most accessible and affordable financing options there are.
For instance, down payment requirements of a commercial bank loan can reach up to 40%, while the 504 loan down payment requirement is only 10%. All SBA 504 loans also have a fixed, below-market interest rate with 10-, 20-, or (come 2018) 25-year terms. In addition to offering favorable terms, the SBA offers additional incentives for manufacturing projects as well as energy efficient projects. You can even take out multiple 504 loans to cover additional expenses!
Perhaps the best asset of the 504 loan is the guidance a Certified Development Company (CDC) offers small business owners. CDCs guide the borrower through the prequalification and application processes smoothly and quickly.
An SBA 504 loan is often the best choice for businesses in need of financing. You can speak to a TMC Financing loan expert to find out more about the SBA 504 loan program. TMC Financing is a Premier Certified Lender with the SBA, which gives us increased authority and the ability to expedite the loan process . Our responsive, expert staff is ready to help every step of the way.