Small Business

Where to Go When the Bank Says No

Alternative financing options for when your loan application is rejected

Written by Alma Johns

If you run a small-to-medium-sized enterprise (SME) that’s experiencing growth and struggling to find the capital to fill customers’ orders, you’re not alone. Thousands of business owners find themselves in the same predicament. Banks often have a cursory, one-size-fit-all process for dealing with SMEs because of your risk profile.

According to a 2014 Harvard Business School study, 40% of businesses applying for credit get rejected. Of these companies who fail to win approval, approximately one-third will return to banks with a fresh perspective in presenting their proposal. But what about the businesses that see their bank applications declined and can’t try again?

Here are some options beyond the banks that entrepreneurs can tap into once they have exhausted obvious resources like friends and family.

Accounts Receivable Factoring

Mature companies that generate good revenues but have temporary cash flow constraints are best positioned to access accounts receivable financing, especially if their customers are established brands, big box retailers, or SMEs with excellent credit history. Available through factoring services, this form of funding converts the value of outstanding invoices into cash, and is becoming increasingly common in Canada.

Expect to pay anywhere from 1.75% to 4% for every 30 to 45 days that the invoice is outstanding. This option is not a cheaper alternative to a bank line of credit, where rates can vary from Prime + 1% to Prime + 3% (Prime is currently at 2.85% at most chartered banks). The size of an eligible invoice can range anywhere from $20,000 to a few million dollars.

Purchase Order Financing

Some factoring companies provide purchase order (P.O.) financing, but some don’t. This type of financing is a great option for companies that buy finished goods inventories, whether sourced locally or overseas.

A P.O. financing provider pays the supplier cash for goods upon delivery (C.O.D.), or a few days after the invoice was issued. The buyer then pays the P.O. financing provider upon receiving payments from their own customers. Typically, rates are slightly higher than factoring since converting inventory to cash takes longer than doing the same for Accounts Receivable.

Mezzanine Loans

Often used by businesses that have achieved a certain level of revenue, mezzanine loans are a hybrid of debt and equity. The risk is therefore higher than traditional bank loans but lower than equity. So if bank loans interest rates is 4€“ 6% and the typical required return on equity is 20€“ 40%, mezzanine loans rates are anywhere from 10€“15% + PIKS (payment-in-kind) of approximately 2%.

Royalty Financing

Royalty financiers receive a percentage of sales revenue in exchange for their financing. A relatively new concept in Canada, it is suitable for companies that are either highly leveraged—meaning their debt levels are higher than what banks will tolerate—or businesses whose owners are not willing to dilute their share ownership to access funding.

Cash Flow Term Loan

Typically sourced through banks, the lending criteria for cash flow loans are even more stringent than traditional loans. Such loans are usually advanced to companies that are highly leveraged but have high growth, good cash flows and exceptional market prospects.

Cash flow loans have terms lasting three to five years, and are paid with a “balloon” payment at the end of term. It is also typical to see a “cash sweep” provision, meaning any cash flow in excess of normal operating expenses and debt repayments are “swept” by the lender at the end of every fiscal year in order to accelerate repayment.

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Business owners also have access to a few other common options including leasing for capital assets or equipment purchase, merchant financing for retailers where funds are advanced based on receivables from credit card companies, government grants and private equity—a lengthy subject for another article.

The financial industry continues to invent creative financing alternatives for viable businesses. Don’t rely solely upon the bank to grow your business—explore other options instead.

Alma Johns, MBA, is President of Bench Capital Advisory Inc., a corporate finance advisory firm focused on senior debt and alternative financing transactions for SMEs. She has two decades of experience in corporate and commercial banking from three financial institutions. She received her MBA from Schulich School of Business and has published articles on financing, succession planning, management buyouts and business valuation.


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