Earnings and growth bring more options for borrowing

Most small businesses have to borrow money.

The challenge is deciding which type of financing is right.

Start-ups typically have few options other than tapping their savings and borrowing from friends. And the options remain limited for companies with weak profits or spotty credit histories.

But businesses that are profitable and growing can borrow from a variety of sources. Here is a look at some of them:

Bank loans. The first stop for many small businesses is a bank.

Many business owners focus solely on the interest rate and fees they’ll be charged. But there are other considerations, experts say.

Competition among banks means loan rates may not differ much, said Neil Berdiev, a small-business consultant in Arlington, Mass., and author of “Loan Financing Guide for Small Business Owners.”

It’s important to consider all the bank services you may need and to tally the total cost, he said.

“Banks may try to undercut each other on loan pricing but they make it up on other things,” Berdiev said.

It’s often best to look for a bank specializing in small businesses, and to ask whether you’ll be assigned an account manager who will be familiar with your company.

Joe Kennedy, a small-business consultant in Los Angeles and the author of “The Small Business Owner’s Manual,” recommends applying for a revolving line of credit as soon as you begin a banking relationship to guarantee access to short-term funds.

Asset-based lending. Companies that buy a lot of equipment often use asset-based financing. As the name implies, the assets themselves serve as collateral in case the loan is not repaid.

Asset-based financing is best for buyers of heavy equipment, rather than for service-oriented businesses that need computers or copiers, Kennedy said. A machine tool is far more likely to hold its value than quickly depreciating computer equipment.

Businesses typically can borrow 70% to 80% of the value of the assets being used as collateral, Kennedy said.

Asset-based loans, however, require a lot of paperwork.

Equipment leasing. Companies that can’t get financing or that want to use their capital elsewhere should consider equipment leasing.

“These days, some of the biggest companies lease their equipment,” Kennedy said.

Among other benefits, he said, lease payments can be claimed as tax deductions.

Business owners can purchase the equipment at the end of the lease. The key, Kennedy said, is to aggressively negotiate the buyout price with banks or leasing companies.

“The last thing they want is to take back equipment” because a buyout fell through, Kennedy said.

Accounts receivable financing. This is often a last-ditch option.

It involves a finance company buying a company’s accounts receivable -- amounts that the business is owed by its customers.

Finance companies typically pay 70% to 90% of face value. The finance company can then collect the outstanding bills and pocket the other 10% to 30%.

Accounts receivable financing entails a lot of paperwork and is expensive, with effective interest rates approaching 40%, Kennedy said.

“It’s just a little bit more expensive than the Mafia,” he said.