Whether during start-up, growth or maturity, raising capital is a recurring need for any business. Common strategies include bootstrapping, crowd funding, debt financing and equity financing. The preferred or viable options will depend on several variables, and each involves different risks, rewards and limitations. As evidenced by a global market of €2.76 trillion, factoring has gained increasing popularity as both an alternative and supplement to other methods of funding.
Factoring in a nutshell
Factoring entails selling your business’ accounts to a third-party organisation. You receive 75% up front as working capital. The factor then collects the amount from your client when payment is due, transferring you the remaining balance minus an agreed upon fee. So how does this compare to other options for raising capital? Let’s run through the pros and cons of each, and how factoring can fill the gaps.
Bootstrapping
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- Simply put, this is self-investment: injecting capital into your business from personal savings, and thereafter – if things go to plan – from sales. This is the most common source of funding for
- .
- Uses and advantages
Full ownership of your business gives you total control. Without pressure from investors, you have time to experiment, and invest full focus into perfecting the product or service. - Limitations and risks
Severely limited capital is likely to inhibit growth. You may not be able to invest enough to make you a competitive supplier. You also bear all the risk: cash flow problems resulting from bad debt or late payments can endanger not just your business, but your livelihood. - The role of factoring
Factoring synergises well with bootstrapping. Once you’ve developed a product or service that clients will pay for, you can offer them attractive credit terms – 30-120 days – because you’ll get cash up front from the factor. Plus, credit checks are included as part of the service.
Crowd Sourcing
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- uses the visibility of internet-based networks to gain smaller investments from many people. Typically, a
- is offered – such as early access to the product.
- Uses and advantages
Crowd sourcing is about getting donations from prospective customers. Not only is this cost-effective, it also tests the market for demand. It also facilitates network-building with future funders and consumers. - Limitations and risks
New technologies dominate crowd funding success stories. Because you are appealing directly to consumers, your idea must generally stand out sharply from – not just compete with – anything else on the market. - The role of factoring
While crowd funding is a no-brainer for niche ideas, B2B operations need wider commercial appeal, so it may not be viable. Here, factoring is a better alternative – providing the working capital required for bulk credit sales to other businesses. However, successful crowd funding may be used to demonstrate commercial appeal. In this case, factoring’s flexibility enables you to scale rapidly to meet B2B demands – the facility expands as your sales do.
Debt financing
- is borrowing money that is paid back in instalments along with interest. A typical example is a bank loan.
- Uses and advantages
Debt financing does not impact your business ownership or control, and you receive all profits. It facilitates capital expenditure necessary for business growth, such as on equipment. The fixed cost of debt repayment is advantageous when your business is performing well; greater profits don’t increase debt finance costs. - Limitations and risks
A fixed cost also presents a substantial risk, however. When profits are low (or worse, negative), your repayment obligation doesn’t change. Moreover, for SMEs – without sufficient credit history and collateral – getting credit can be challenging in the first place. This can limit opportunities for growth. - The role of factoring
Factoring can replace or complement debt financing – mitigating risks and bolstering rewards. For example, a bank loan may be necessary for a large investment, such as a property. However, with factoring, you can easily increase or decrease your expenditure on rented space, as well as stock and equipment (etc), depending on incoming work. This allows you to seize opportunities for growth when they arise, while avoiding excess debt in the case of economic slowdown.
Equity financing
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- In contrast to
- , this involves selling a portion of the ownership rights to your business in exchange for capital. Investors then receive a share of profits.
- Uses and advantages
Since there is no fixed cost, equity financing involves less risk. This grants more flexibility. For example, you can increase capital expenditure without worrying about the short-term profit decrease – your finance cost decreases proportionately. - Limitations and risks
Conversely, when your business is performing well, your finance costs increase proportionately. By sharing your business’s risks, investors also reap its rewards. Plus, selling ownership rights entails giving up a requisite proportion of control. - The role of factoring
Factoring’s role is thus similar to with debt financing but inverted. By using factoring to cover organic growth and decline in expenditure, you prevent excessive equity finance costs arising with strong business performance.
Why choose Merchant Factors?
Merchant Factors has a proven track record of excellence. With over 31 years of experience and a factoring facility tailored to each business’s needs, it provides a financial service that can complement other funding methods – empowering a strong and sustainable strategy for raising capital.
For fast, flexible business finance – contact Merchant Factors today.
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