Where to go when the bank says no

You need cash and the bank says no.  Most small business owners have been in a situation where they have an excellent opportunity but they are short on cash and traditional funding is not an option.  Are there non-bank options available to help a business owner get the cash they need quickly?

First, before going into alternative financing /non-bank financing, we need to discuss why traditional funding is frequently not an option.  After the 2007 meltdown in banking and subsequent bank failures, increased regulation and considerable consolidation occurred.  Gone are the days of the small local bank that knows your business and lends on a handshake.  In the new banking era, either loans fit the banks’ lending guidelines (i.e. it fits perfectly in the box) or the loan is turned down.  There is substantially less room for banks to make loans that make sense if they don’t line up on paper perfectly. 

As a result of this new banking era, many borrowers are unable to obtain traditional financing and are now looking at other sources for their cash needs.  Assuming that you have exhausted traditional small business financing avenues (and explored a home equity line of credit on your property) and that you do not want to bring in a partner that could dilute your equity, what are your options?

Fortunately alternatives are available to traditional bank financing.  One very broad category of alternative lending is called "hard money".  Unfortunately hard money is frequently misunderstood and if one were to ask 10 people to define hard money, 11 answers would likely be given. 

What is the definition of hard money?  The irony of the phrase is that hard money is not hard to obtain.  Hard money is a very broad term that could be used to describe any loan secured by a “hard asset”.  This hard asset could be real estate, accounts receivable, equipment, inventory, credit card receipts, etc. A hard money loan is also commonly referred to as a bridge loan, private loan, asset loan, etc… 

Why would a lender make a loan that a bank would not? In a hard money transaction the lender is looking to the asset as collateral as opposed to primarily focusing on the borrower.  The value of this collateral is key to underwriting for a private lender.  The lender is able to provide financing up to a certain loan to value on each asset to reduce their risk.  This loan to value (ltv) ratio will vary based on asset class, loan amount, loan term, etc…  By focusing heavily on the asset the lender many times is able to close loans that traditional lenders are unable to fund.

The vast majority of private lenders are non-bank entities and are therefore not bound by the traditional rigidity of banking.  Many are backed by private investors, hedge funds, etc… which provide the flexibility to make loans that make sense for the borrower and the lender.

There are two main categories of hard money:  factoring and real estate based transactions.  In factoring the lender typically provides a discount on the asset.  For example if you have a receivable worth 100 dollars, they factor might buy (or you assign) that invoice from you for 95 dollars and the payee has typically 30 days or less to pay.  So in essence the borrower is paying 5 percent/ 30 day cycle.  This type of financing can be useful to get quick cash but it needs to be used judicially if even at all since the interest expense can quickly add up; for example 5 percent a month is an annual rate of 60 percent and what happens if the payee does not pay the invoice?  Things could get messy really quickly.

The second main category of hard money is real estate financing.  In this case the lender takes a first mortgage on a piece of commercial/investment real estate (basically a non-primary residence).  Lenders typically lend up to 60 percent off the value of the property and secure their loan via a mortgage on the property.  Rates range from 10-15 percent and can be either interest only or amortizing depending on the borrower’s needs. 

Terms are typically 6 months to 2 years (some lenders like myself can go as long as 10 years with no fee for prepayment prior to the term).  The intention of the hard money real estate loan is to be utilized as a bridge for short/medium term funding needs.  Although private real estate rates are more expensive than traditional financing, they are substantially less than other forms of hard money like factoring.

Even though hard money is more expensive than traditional financing, when a business needs cash and a bank is not an option, a hard money loan could be a fit.  A non-conventional loan is typically much cheaper than bringing in an equity partner or foregoing lucrative opportunities.  In many cases it can greatly assist a small business with their cash flow needs and enable them to take advantage of business opportunities that were otherwise unattainable.