Your client is three months late paying you a five-figure invoice. Problem is, your employees still need to be paid each week, and your internet company won’t wait on its bill either. Do you: a) quit paying yourself and resign yourself to living off of ramen until things turn around, b) put all your business expenses on your credit card, and hope you can pay them off before hitting the 18 percent interest period, c) take out a second mortgage on your home, or d) shut down the company before hemorrhaging any more cash?
This challenge probably rings a bell—for most entrepreneurs, cash flow challenges are a huge problem.
A CB Insights study analyzed the reasons why 101 start-ups failed, and cash flow issues were the No. 2 most popular issue, affecting 29 percent of the failed businesses. The 2015 American Dream Gap Report by credit score company Nav revealed that one in five small businesses considered closing their doors the previous year because of cash flow issues, 29 percent said that it’s become harder to reduce operating costs, while more than half (53 percent) said they had applied for business loans or credit lines in the past five years.
Here are some of the pros and pitfalls of various types of debt and when to consider them—and some strategies to keep in mind to help you stay in the black all year round.
One of the best funding sources to start with is the Small Business Administration’s loan program. The SBA partners with banks, lenders, community development organizations, and micro-lending institutions to offer loans to businesses. The SBA is guaranteeing to these lenders that the loan will be repaid, which means much lower interest rates and longer terms for your business. These loans will also take on projects that regular bank loans may not consider. Interest rates vary depending on the lender you’re signing with, but average APR rates vary from 5.50 to 8.70 percent. There are various loans, with the most common being 7(a) loans—where you can borrow any amount up to $5 million. In 2015, the average loan amount was $371,628.
The one drawback is the difficulty of applying: be prepared for a lot of paperwork and strict requirements, from credit scores to bankruptcy history. But the terms are so good that it’s worth the effort to try. Bear in mind that if you get denied somewhere, it doesn’t necessarily mean you’ll be denied with other lenders also working with the SBA, so don’t always settle for the first no. If you end up going the route of a regular bank loan, start with the smaller banks first—their terms are generally more friendly to smaller businesses.
Credit card debt
Business credit cards are excellent tools—they help you track expenses in a granular way and can open your business up to all sorts of special deals. But like the most alluring things in life, they also need to be treated with caution and a great deal of restraint. Don’t consider borrowing money by drawing out cash on your company credit card. Credit cards have very high-interest rates, from averages of 12.99 to 29.99 percent. Only use your business credit card when you can pay it back that month.
Home equity loans
Home equity loans and home equity lines of credit (HELOC) may appear as a possibility in the minds of small business owners on the lookout for funding for their business. But consider this very carefully before launching ahead. A home equity loan is where you use the equity of your own home as collateral. You get a one-time payment and it may feel like a safe route as interest rates tend to be fairly low; in early 2017, rates for a $30,000 FICO-based home equity line of credit in California were approximately 6 percent. That said, keep your eyes on the rising interest rates by the Fed. The main risk here is when it comes to that home of yours.
The only time you would generally want to take out a loan like this is if you have rising home values and stable interest rates. Look at your local property prices: are costs increasing? You want to be living in a stable economy. Also investigate the types of terms you would be able to get, and read the fine print very closely: Does your loan carry adjustable rates? If yes, that’s risky over the long-term.
Peer-to-peer lending is an offshoot of our new digital world, with the internet opening up new ways to match lenders with borrowers—without the need of an intermediary financial institution. The benefits are faster loans and a vetting process that is a lot more simple and less restricted. But you do pay for that with higher interest rates. Two of the largest P2P business lenders are Lending Club, who according to their website, offer a fixed interest rate and a total annualized rate of 8-32 percent—in addition to an origination fee of 0.99-6.99 percent. Prosper is another option, interest rates as written on their website run from 5.99 percent APR (AA) to 36 percent APR (HR). Keep your eye on the interest rates of these options, as Clark Media reports, interest rates from both Prosper and Lending Club are on the rise due to recent market conditions.
You may have money coming into your business, but long invoicing cycles require a balancing act—where you always need enough money sitting in your account to pay for costs, while waiting for new income to come in. Invoice factoring is an option for you to sell your accounts receivable to another company for a low additional fee. The factoring company will “buy” your accounts receivable, and provide you with an advance on payment equivalent to 80 or 90 percent of the total billings. You’ll pay interest (typically two to five percent) for each month that the debt hasn’t been repaid by your clients. Weigh up the pros and cons—if you’re a B2B company with stable, but slow-paying clients, it can be a helpful service if you need some operating capital in a hurry, but do your research to identify the right outlets.
Strategies for maintaining strong cash flow
As a general rule, you only want to invest in a loan as a company-expanding process. The best way to avoid needing a loan is to have a robust cash flow in place.
If you run into issues with your cash flow, first analyze how you got there and make adjustments. Take logical steps to recover from negative tendencies. Keep your costs as scalable as possible—consider hiring more freelancers and casual employees and fewer full-time employees. SaaS companies like Infusionsoft also offer tools such as the Revenue Action Plan, that helps you scale in the right direction. Applying for a loan isn’t necessarily a negative thing—it can be one of the most cunning and liberating business moves you make. It all depends on how logically, carefully, and strategically you approach the step.