What is startup financing?

Startup financing is a series of solutions designed to help startup companies obtain the capital they need for day-to-day operations or expansion. Options include the business owner’s own resources, venture capital, SBA loans and factoring.

One of the most common ways entrepreneurs make their ideas a reality is relying on their own resources, such as credit cards, savings or friends’ and family members’ money.

Once a business gains traction, it might make sense to look for venture capital (VC), which is money lent to a business or structured as an equity investment (i.e., in exchange for some share of interest in the business). Here is why venture capital may be hard to get and not suitable for your business:

• In order to evaluate an investment, venture capitalists will want to know how much your business it is poised to grow. “Hockey stick” growth, i.e., exponential growth after the first couple years is what these investors are usually after so that they can get an appropriate return on their investment. Such pattern of growth is often limited to technology companies. Getting a VC investment for a non-technology company might therefore prove to be a challenge.
• Large venture funds in particular look to make sizeable investments because they have a lot of capital to deploy. In practical terms, that means that if a business is looking for a $1 million investment, it should search for smaller venture funds for which such an investment would make sense. But if a business only needs $10,000 or $20,000, venture capital is not the right option.
• Even if the desired investment is large enough, venture capital may be hard to come by. More and more, startup founders are looking for alternative ways to fund their business, both because VC is scarce and because VC firms might have a vision of their business that greatly diverges from their own.

Alternatives include SBA loans and factoring, which will be discussed in this article.

Factoring

Factoring is the sale of outstanding invoices (accounts receivable) at a discount to a third-party factoring company or a bank. The discount typically ranges from 1% to 5%, and a factor may charge other fees for its services.

Factoring may be a good option for startups as long as they’ve gained enough traction.

Factoring may be a good option for startups as long as they’ve gained enough traction to have larger, creditworthy clients, either in the business world or the government. If they sell to other startups or are focused on the business-to-consumer (B2C) market, factoring may not the best alternative because of the higher risk associated with retail or startup clients.

Factoring, also referred to as invoice or accounts receivable factoring, can be done on a recourse or a non-recourse basis. In the first case, a factor advances funds against the invoices for a certain agreed-upon time period, such as three months. At the end of this period, if the startup’s client not paid, the startup must repay the advance or replace the invoice with another one. Most factors provide recourse factoring to lower their risk.

“Factoring may be a good option for startups as long as they’ve gained enough traction to have larger, creditworthy clients, either in the business world or the government.”

In non-recourse factoring, a startup outright sells its invoices to a factor. Once the sale is completed, the factor becomes responsible for the collection of these invoices on a permanent basis. If the invoices are not ultimately collected or the startup’s client files for bankruptcy, the factor absorbs the loss. To avoid losses, factors check the account debtor’s credit before purchasing the invoices and monitor payment trends after the purchase. Factors will not buy past-due invoices.

Business Factors offers non-recourse factoring, allowing startup founders to focus on growing their businesses instead of worrying about replacing or repaying the accounts receivable if their client does not pay. Business Factors does not require any monthly minimums and offers spot factoring, which is the purchase of one or two invoices (as opposed to the whole book of receivables). Spot factoring is a convenient way to try out factoring. Depending on the needs of the business and dollar amount of an invoice, funds can be wired to a business’s account in as little as 24 to 48 hours. Contact us today to get started.

“If startups sell to other startups or are focused on the business-to-consumer (B2C) market, factoring may not the best alternative because of the higher risk associated with retail or startup clients.”

For more information about factoring, please visit our Frequently Asked Questions page.

Let’s take a look at a couple of examples of factoring transactions. Please note that these are theoretical transactions. To get a quote for a particular actual transaction, reach out to one of our executives today.

How does factoring work?

• The startup company provides a factor with the invoice that was sent to the startup’s client, who is known as the account debtor.
• The factor verifies the invoice and evaluates account debtor’s credit profile.
• The factor advances a portion of the outstanding amount to the startup. The remaining portion, which the factor holds until the invoice is paid, is called the reserve.
• Once the invoice is paid, the factor sends the reserve to the startup, minus the discount rate How much does it cost? On and any additional fees. The discount and fees are the cost of factoring.

Below are some examples.

Example 1

• Invoice amount: $10,000
• Advance rate: 90%, or $9,000
• Reserve: 10%, or $1,000
• Discount rate: Monthly fee of 2.19%, or $219
• Type of arrangement: Non-recourse

In this example, an upstart logistics company pays $219 per month to factor a $10,000 invoice from one of its main clients. The arrangement is non-recourse, meaning that the factoring arrangement is essentially an asset sale. This means that the logistics company will not have any additional obligation to the factoring company if the invoice is not collected. However, the logistics company will be charged $219 per month as long as the invoice is outstanding.

Example 2

• Invoice amount: $10,000
• Advance rate: 90%, or $9,000
• Reserve: 10%, or $1,000
• Discount rate: Monthly fee of 2.19%, or $219
• Type of arrangement: Recourse after three months

In this example, the logistics company pays $219 per month to factor a $10,000 invoice from one of its main clients. The arrangement is recourse, meaning that if the invoice is not collected after three months, the logistics company must repay the $9,000 advance or give the factor another invoice to replace the one that cannot be collected.

“Business Factors specializes in SBA loans and can help your business prepare a winning application.”

SBA loans

The Small Business Administration (SBA) is a government agency whose goal is to protect and assist the interests of small businesses in the United States. SBA does not provide loans directly. Instead, it furnishes a guarantee of repayment, lowering the risk for the commercial lender that actually extends the loan. To learn more about different types of SBA loans, please visit our SBA loans page.

Applications for SBA loans can be daunting, but with the right partner, startups have a higher chance of success.

The SBA also connects entrepreneurs with partner organizations that offer mentoring on various topics, ranging from capital raising to intellectual property rights and public relations.

One type of an SBA loan that might work for startups is a microloan. As described on our SBA loans page, microloans are more of a short-term solution aimed at filling a gap when cash is tight. The maximum amount of such a loan is $50,000. The rate is usually fixed and the loans come from nonprofit intermediary lenders. The proceeds from this loan can be used for working capital, supplies or inventory expenses.

Applications for SBA loans can be daunting, but with the right partner, startups have a higher chance of success. Business Factors specializes in SBA loans and can help you prepare a winning application. Contact us today to get started.

Conclusion

Startup financing is a series of solutions designed to provide working capital for startups. While many finance their ventures with their own or friends’ and family members’ money, factoring—the sale of invoices at a discount—is a good alternative for startups that already have clients. Startup factoring relies on the creditworthiness of startup’s clients (referred to as account debtors). The invoices are bought by either a specialized factoring company, such as Business Factors, or a bank. Factors charge a fee for their services, known as a discount rate. They often advance a portion of an invoice—ranging from 70% to 96%—and send the rest once the invoice is paid. Factors may also become responsible for invoice collection and sometimes (in the case of non-recourse factoring) absorb the losses if the invoice is not collected. To get started with factoring, a startup may choose to sell just one or a couple of pending invoices in a practice known as spot factoring. Small Business Administration (SBA) loans—particularly microloans—can be another way for startups to obtain working capital. Contact Business Factors today to find the best working-capital solution for your business.