6 Alternative Finance Terms Every Small Business Owner Needs To Know

By Eyal Lifshitz of BlueVine

Paperwork is the bane of every small business owner’s existence. Going over financing agreements is not only a tedious, time-consuming process — on average, small businesses spend 25 hours filling out paperwork before securing some form of credit. But unless you know what to look for, it is easy to be surprised later by obscure terms or fees.

 

screen shot 2015 07 27 at 12 01 40 pm 6 Alternative Finance Terms Every Small Business Owner Needs To Know
eyal lifshitz 6 Alternative Finance Terms Every Small Business Owner Needs To Know

Eyal Lifshitz
(Photo courtesy of Eyal Lifshitz)

screen shot 2015 07 27 at 12 01 40 pm 6 Alternative Finance Terms Every Small Business Owner Needs To Know
screen shot 2015 07 27 at 12 01 40 pm 6 Alternative Finance Terms Every Small Business Owner Needs To Know

Alternative lending has existed for decades and traditionally operated with long contracts and dubious fees. But recently a number of online companies have ushered this segment into the modern age with conveniences like paperless submissions, lightning-quick approval times and much-needed transparency.

Whether you opt for a cash flow loan, merchant cash advance (MCA), or invoice factoring, there are a number of terms you should know about before choosing an alternative lender.

 

Liens

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A lien is a legal right to a business asset or assets that is used to secure a debt – essentially an official notification by a lender that the business owes them money, and that if the business doesn’t pay it back, the lender has the right to the business asset. All else being equal, businesses clear of liens can more easily get financing.

Unfortunately, lenders don’t always get rid of their liens immediately after you pay off the corresponding financing. You can always search your state lien database to see your liens, and if any look obsolete, call the “secured party” (the lender) and have them remove the lien.

You should also be on the lookout for “lien search fees.” Some alternative lenders even charge clients a monthly lien search fee, even though they will likely only perform this search once. If a company imposes these unwarranted fees, it is a likely indicator that there are other bad surprises waiting for you in the fine print.

 

Origination Fees

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Many alternative lenders charge an upfront fee at the time of the financing. This is typically a fixed percent of the total amount financed (e.g. 3 percent). While seeming small, these fees dramatically raise your effective interest rate – particularly for short-term financing – so it’s important to be aware of them, or better, work with a lender that doesn’t charge origination fees.

A best practice is to work with alternative lenders that provide simple, clear and transparent pricing. If you don’t understand something, and the company’s answer is just as confusing, that is a red flag.

 

Going Deeper: Invoice Factoring

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Invoice factoring, in which a business receives an advance on its unpaid invoices from a third party (e.g., a factoring company) at a discount, has specialized vocabulary that is important to understand.

 

Notification & Non-Notification

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Most factors operate on a “notification” basis. This means your factoring company will notify your customers that invoice payments should be sent directly to them and in their name. In contrast, a “non-notification” arrangement allows you to retain full control of your client relationships. The tradeoff is that all else being equal, notification is less risky for the factoring company. Therefore, it is likely that you would qualify for a larger credit line with notification.

 

Spot Factoring

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“Spot factoring” is an arrangement that lets you advance one or multiple invoices instead of committing to factoring every single invoice for a pre-determined period.

Many traditional factoring contracts lock you in for at least a year, contain exclusivity clauses, carry large cancellation penalties and frequently have monthly minimums. Since invoice financing should be driven by your cash flow needs, which can fluctuate from month to month, it’s best to avoid long-term contracts and minimums if you want control over your costs.

 

Recourse

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“Recourse” factoring is a common arrangement requiring businesses to repurchase an invoice if their customer fails to pay the invoice. This aligns incentives: both the business and the factor want to make sure the customer pays the invoice. Factors — especially ones that do not rely on contracts — want to foster strong, lasting relationship with small businesses, and businesses want to maintain access to factoring.

 

Small businesses should be able to take advantage of alternative lending — not be taken advantage of. For too long, small business owners seeking to remedy their cash flow problems had to deal with lenders that failed to put first the needs of the business they lend to. Fortunately, with a new wave of alternative lenders that is no longer the case. Knowing these six terms will equip you to ask the right questions to find the funding you need, with a financing partner you can trust.

 

This article is written and provided by Eyal Lifshitz. Eyal is founder and CEO of BlueVine, a leading online provider of working capital financing to small businesses, and a former principal at Greylock IL (now 83North).

The views, opinions and positions expressed within this guest post are those of the authors alone and do not represent those of CBS Small Business Pulse or the CBS Corporation. The accuracy, completeness and validity of any statements made within this article are verified solely by the authors.
screen shot 2015 07 27 at 12 01 40 pm 6 Alternative Finance Terms Every Small Business Owner Needs To Know

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