So, what options do companies have for financing working capital?
Private debt
Private credit is provided in the form of term loans which can be short or medium term in nature. These loans can be secured, unsecured or come with a personal guarantee. The key advantages of private debt is that they are highly flexible and can be executed quickly.
Bank financing
There are two types of bank financing for working capital. The first is a revolving credit facility, which is also known as a revolver or a working capital credit facility. This is a pre-approved source of funding which serves as a useful safety net, as the borrower only pays interest on drawn/outstanding funds.
However, such financing is difficult to secure, especially for small companies post the Global Financial Crisis in 2008 as bank lending and underwriting standards have tightened considerably. The loanable amount is also traditionally tied to your accounts receivables and inventory, which technology companies do not have, though the bank does evaluate your cash flows which is typically made up of recurring payments.
The second type of working capital financing banks offer is the overdraft. Similarly, not many companies can secure it and even if they do, credit limits are low as it is a form of unsecured lending.
Invoice factoring and financing
Invoice factoring refers to selling a company’s accounts receivables in exchange for a discounted (e.g. 80%) upfront payment. When your customer makes the full payment, the lender will disburse the remaining balance (e.g. 20%) net of fees to you.
Invoice financing is similar, but the concept is different. It is about applying for a loan using your accounts receivables as collateral. You could receive 80-100% of the receivables net of fees, which you have to pay back over a period of time.
Both invoice factoring and financing are very commonly used methods of financing working capital. However, these methods are more applicable for non-technology companies which sell products and have high levels of account receivables.
For technology companies where these methods make sense, the advantage is that funds can be disbursed quickly, but the loanable amounts are limited by the value of your accounts receivables.
Trade financing
Both banks and third parties provide trade financing, which ensures that international shipments of goods go through. However, this is more applicable for exporters and importers of goods, rather than for technology companies in general.
Asset refinancing
As the name suggests, this working capital financing method is not applicable for technology businesses as most do not have much tangible assets.
Other niche financing methods
There are many other working capital financing methods. These methods are categorized here as they are niche methods and amount of loanable funds is typically low. These methods include customer advances, merchant cash advances, tax bill funding, trade credit/vendor credit, business credit cards, payroll loans, auto financing, etc.
Evaluation of the various financing tools for working capital
As such, we believe that with the right partner, private debt can be the most attractive working capital financing method for fast growing, small-mid size technology businesses.
This is because this option is highly flexible, not difficult to access, allows access to larger funding amounts, is fast to execute, can be covenant lite and not restrictive, and is inexpensive.
