First the good news: Your company has landed a new government contract, one that will result in a significant increase in revenue. Now comes the hard part. To fulfill the contract, you must immediately commit to additional people (payroll), training, materials, and related costs. And you need to plunge into this commitment before you receive a single payment from your new customer, the U.S. government.
Unfortunately the amount of capital required to cover your instant spending needs exceeds the balance available on your existing line of credit or your credit card. So where do you turn? Try these financing alternatives to get your newfound project up and running:
- Existing bank or lender: If your company has an existing line of credit or borrowing arrangement with a bank or other lender, try to negotiate an increase. A responsive lender may provide all the short-term capital needed until the government agency you’re working with begins payment. Be aware, however, that obtaining a significantly higher level of credit might involve committing to a new long-term deal, additional loan covenants, greater reporting requirements, or higher interest rates. In addition, your credit agreement may constrain your ability to take on other types of debt or lease obligations.
- Factoring: This is the sale of your invoices to a bank or finance company (the “factor”). The factor advances a percentage, usually between 75 percent and 90 percent, of the invoice amount; the balance is refundable upon receipt of payment, less interest and transaction costs. Some factors also provide weekly or midmonth funding of unbilled accounts receivable. The initial approval process is usually a matter of days, not weeks or months. Because factors base their credit criteria primarily on the customer from whom you expect payment, they are usually willing to finance government contracts, even if your business is a startup or has a weak credit history. Usually more costly, factoring is a viable alternative to traditional bank financing because of its increased flexibility.
- Asset-based lending: This type of financing is provided by most banks and commercial financial companies. The primary asset used in this type of lending is your company’s accounts receivable, although inventory or fixed assets may be used to collateralize additional long-term financing requirements. With asset-based lending, your, as well as your customers’, credit worthiness will determine the percentage of the receivables that will be advanced, usually between 75 percent and 90 percent.
- Contract/PO financing: You may be able to negotiate financing based on your federal government customer purchase orders. Purchase order financing is easiest when your products or services are well-established. If your products are new, or services are nonstandard or unproven, purchase order financing is more difficult to obtain. There are several purchase order finance companies around the country, as well as banks, nonbank finance companies, and factors, that provide this service.
- SBA loan: The Small Business Association, an independent agency of the federal government, offers numerous loan programs to assist small businesses. The SBA is primarily a guarantor of loans made by banks, savings and loans, credit unions, and other specialized lenders that provide small business loans under SBA guidelines. When a business applies for an SBA loan, it is actually applying for a commercial loan with an SBA guaranty. SBA-guaranteed loans may not be made to a small business if the borrower has access to other financing on reasonable terms.
- SBIR and grants: Small Business Innovation Research is a federal government program administered by 11 federal agencies to help provide early-stage research-and-development funding to small technology companies. Administered by the SBA Office of Technology, this program ensures that small high-tech, innovative businesses get government funding. Grants.gov is the source to find and apply for federal government grants.
None of these alternatives is mutually exclusive. In many cases, combinations are very effective. However, there are significant legal and operational differences in these financing arrangements. The terms of some borrowing agreements may limit your ability to take on additional debt, and they should be entered into only as part of a coherent financing strategy.
Richard W. Lewis is founder and president of Financial Engineering Counselors Ltd. in Falls Church, Va. FEC works with startup, fast-growth, and disadvantaged businesses in obtaining sufficient cash-flow funding, allowing them to grow and overcome financing hurdles.