Alternative funding is generally defined as money provided to a business by a source that is not a traditional, depository bank.
The alternative sources providing money to businesses do so in a number of ways, including loans like lines of credit, term loans, cash advances, and the purchase of accounts receivable.
Whether the funding provided to the business is a loan, an advance or a purchase, the terms and conditions for the repayment of funds can vary greatly and should be clearly understood before the funding is accepted.
There are three key points for a company to consider when seeking alternative funding:
1. Cost of the money
First and foremost, know the interest rate (cost) charged for the money. Sounds simple, but there are alternative sources of funding that do not quote an annual percentage rate (APR) on the money that they provide.
If the alternative source claims that the funding they are providing is not a loan, so an APR does not apply, ask to have the cost of the money presented as an APR. Most mortgages, car loans and credit cards quote the cost of the money in terms of an APR, so nearly everyone is familiar with those quotes. The lower the quoted rate, the better.
However, in the world of alternative funding, many providers only discuss the benefits of the money while avoiding discussing the APR cost of the money. If the prospective provider of the funding refuses to disclose the APR, proceed with caution.
2. When are the charges applied to the funding?
Some alternative sources of funding apply the full charges associated with the money immediately after the money is provided to the business. On Day 1, these funding sources provide the money, on Day 2, the full balance is due, including the principal plus a fee.
Other alternative sources charge a discount against the accounts receivable invoices that are used for funding purposes and continue to charge until the invoice payment is paid directly to them. Still other alternative lenders charge on the actual cash employed for the period, and the cost is calculated on a traditional APR basis.
Alternative sources that immediately add the fee to the principal are generally more expensive than factoring or alternative lenders that provide funding that charges an interest rate on the funds employed. Have a clear understanding of when the costs are charged before signing for the money.
3. Terms of repayment
A new style of alternative funding has recently emerged where short-term (under one year, most often six months) funding is provided and the money is then repaid on a daily basis via ACH withdrawals from the business checking account.
If you are considering funding with a daily ACH repayment program, consider the immediate impact of these daily repayments on your cash flow, especially when the total charges are immediately added to the amount to be repaid.
Be sure to carefully review these points and all other terms and conditions prior to accepting alternative funding, regardless of the urgency for the money.