Alternative Lending

Cynthia Umphrey
July 14, 2008 — 1,464 views  
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Traditional lenders are denier or limiting loans very severely for some small business right now. While this seems to be an overreaction to the economy, until it corrects itself, our clients need some options since waiting 6 or more months for needed financing can shut a business down or cause the loss of a key opportunity.  Here are some thoughts about some alternative lending options and how to get creative when using them.

The Secondary Market

The "secondary market", essentially a group of alternative lenders who make lending decisions based on different information than do banks.  They are also usually a much more expensive source of cash and so are best used only while needed, but are a great resource for the right situation.  It is also very helpful to have a lender who works regularly with a traditional lender to transition clients back into regular lending when they meet the traditional criteria.

Factoring is a classic type of alternative financing and is based on the revenue earned by businesses from their customers.  Basically, it is buying receivables at a moderate to deep discount so the business gets the money now, instead of waiting until the customers pay. 

Factoring is generally used by existing businesses that have a strong bank of receivables but may have slow pay receivable coupled with suppliers who require fast payment terms or the business may simply have cash flow dips and peaks.  Factoring is usually available for companies who gross between $50,000 and $2,000,000.  Factoring takes into account the credit worthiness of the customers more than the business.

Currently, business is especially hard for many builders/developers. These businesses might consider hedge funds or other capital sources specializing in lending on projects whose ability to lend against collateral has been maxed out due to the drop in real estate values, sales and related problems, but which nonetheless demonstrate future growth value.

Using personal income or credit

For start-ups, SBA loans are often a first recourse but the market in SBA loans is also highly restricted right now.  Overall, loan opportunities for start-ups or struggling businesses will rely heavily on personal credit and income stream.  Ideally, one of the business owners should commit to keep his or her outside job until the business produces steady cash flow.  This makes obtaining a loan much more likely than relying solely on the unproven income stream of the new business.  A start up will need a personal guarantee, but you can try to negotiate some limits on it.

An alternative lending option for start-ups is to borrow money from a 401(k) plan.  The interest rates are set by the federal government and are almost always lower than rates of most other lending options.  While the client pays the interest and principal into the 401K over a long-term period, the dollars used to pay back the loan are after tax.  Also, this only works for 401KS as loans are not options for IRAS.

Another creative way to access your retirement money without paying interest and penalties to the government is by having your retirement plan actually own the start-up itself.  There are strict requirements about how this is done.  It will be necessary to establish a C corporation, but when done properly it can allow you access to your entire retirement fund balances to fund your business.  Of course if the business fails, the retirement money will be lost.  So this only makes sense where there is a strong business plan, high risk tolerances and perhaps time to make it up if the retirement money is lost.

Seeking investors and

Other options include angel investors, friends and family, margin loans, sales of life insurance policies and the like.  The key to finding alternative financing and to having a viable business is for your clients to work with an experienced professional, be creative, and understand their risk tolerances.  A solid written business plan detailing realistic financial projections, business goals, market data, management information and the like is critical both for lending and for growing a viable business.

Cynthia Umphrey

Kemp Klein Law Firm

Cynthia Umphrey helps families and business owners make significant personal and professional life decisions. Ms. Umphrey calls upon over 10 years of experience in estate planning, probate administration, business structuring and business exit planning to guide you though life's most important choices.