Do You Need A Bank To Fund Your Business?

Nontraditional lenders are emerging as a real alternative to bank financing for growth and start-up companies.

Banking 101

Trouble getting a good credit line or loan from your local bank? Maybe it's time you looked elsewhere.

When he founded NetForce Technologies, in 2003, Tommy Wald struggled to get his first line of credit. Banks rejected him. At first they claimed Austin-based computer-network consultancy NetForce was too small; a few years later they passed again on NetForce, because it was already saddled with a Small Business Administration loan. But in 2008, when NetForce had finally grown enough — to $5 million in sales — to get bank approval, it was the company's CEO who balked. Though Wald was low on cash and feeling squeezed, he didn't like the terms the banks offered. Then his controller raised one last possibility: a credit line from a nontraditional source — an investment bank. Within weeks Wald had a $300,000 line from Merrill Lynch. "I didn't realize they were in the business of financing," he says.

Considering alternatives to bank financing is always a sound idea for growing companies, but it's especially essential right now. Mainly because industry consolidation has worsened banks' customer service on small accounts, small businesses left their banks in record numbers last year, according to PSI Global, a financial-services-marketing group in Tampa. In addition, SBA numbers show that the amount that banks lend to small companies has dropped significantly. And Peter Garrison, a banking expert with Greenwich Associates, which researches financial institutions, recommends exploring nonbank providers because of the interest-rate and recession risks of today's economic climate.

To Wald, the matter was a lot simpler than all that. He just wanted the best credit line he could find. At the time, NetForce's only short-term financing was a flooring account, a line of credit that could be used only for equipment purchases. The arrangement was adequate for NetForce's early days, when 90% of the company's sales were hardware related. But as the company evolved, its sales focus shifted from equipment to services — and Wald needed more credit to maintain his cash flow.

So NetForce began to hunt for a credit line in the form of accounts-receivable financing. Controller Sherri Holland led the search, beginning with local banks. From contacts at NetForce's competitors — ex-employees, pals of current employees — she found out which local banks were lending to the competitors. NetForce chose one local bank based on those findings and filled out the paperwork.

Wald and his co-owner, Tony Williams, were disappointed with the bank's answer. The bank offered a line worth 60% of NetForce's monthly accounts receivable under 60 days old — about $200,000 on average. NetForce had hoped for a line that would hover around $400,000. The bank sought to fill the gap with a $200,000 SBA loan, something Wald wanted to avoid at all costs, recalling the consequences of the $30,000 SBA loan he'd received in 1996 (and since paid off): NetForce had trouble securing the kind of financing it needed because the SBA had taken a blanket lien on all the company's assets. Without the right to seize assets in the event of a default, banks were scared away. "Here we were, with a history of being in the black, and this bank throws the SBA at us," Wald says.

Holland then switched her sights to national banks. To learn more about what to focus on in her bank dealings, she read Channel Financial Control, a financial magazine for the computer industry. Her key question was, What are your fees — hidden or otherwise? She also wanted to know who would be handling NetForce's account on a daily basis. Only one salesperson gave her a name. When she contacted that person, Holland was shocked at what she discovered. "The salesperson had promised no hidden fees," she says. But at that bank, receivables financing involved cash-management fees: $85 a month for a lock box, 40¢ per check deposited in the lock box, $16 a month for account processing, and $75 a month for the ability to check postings on-line.

All Holland had expected to pay was a $1,500 setup fee. What peeved Wald was that the bank, like all the banks NetForce talked to, required a lock box with receivables financing. For six years he'd been in complete control of all NetForce's receivables; with a lock box, all account payments would automatically go toward paying off the credit line. Frustrated, NetForce held off on a decision. Then Holland remembered that co-owner Williams had once introduced her to his personal Merrill Lynch broker, who had mentioned that Merrill worked with businesses, too. Holland found the brochure and called the broker.

Next she faxed NetForce's financial information — internally generated financial statements, along with tax returns for the past three years — to one of Merrill's Austin branch offices. Based on those numbers, the Merrill representative gave Holland — -on that same day — -an estimate on the size of the credit line Merrill could offer. (The actual credit approval came three weeks later, since all Merrill's credit decisions are centrally processed through a Chicago office.)

The Merrill credit line didn't require a lock box, nor did it fluctuate based on a monthly accounts-receivable review. Instead, it gave NetForce a fixed line, based on the company's net worth, at an interest rate of prime plus one and a half — better than rates the banks offered. Since the line is fixed, NetForce won't be in the awkward position of having to pay it down whenever collections are slow for a month. Nor will it have to annually buy the credit line down to zero, a common bank requirement. And whereas the banks required monthly financial reports from NetForce, Merrill needs only quarterly reports.

The downside to the Merrill credit line is also a result of its fixed value. For all its reporting hassles, a credit line tied to monthly receivables grows as revenues grow. But if NetForce has three huge months, its credit line remains the same. "It could be an issue somewhere down the line," says Holland. Worried that the $300,000 line Merrill offered wouldn't be enough in peak times, NetForce appealed Merrill's initial estimate. NetForce didn't get a larger line, but Merrill agreed to subordinate its lien position on NetForce's assets should NetForce need financing from other sources. "No bank would do that," says Holland.

By allowing NetForce to pay vendors easily within terms, the line has boosted the company's cash flow dramatically, giving NetForce more funds to grow its service side — which now accounts for more than 60% of sales. Every payment gratifies Holland, who knows that NetForce was just a signature away from committing to a bank. And after her research, she also believes that NetForce has made the best choice. Wald, for his part, is just proud his business is past the point of federal loans and lock boxes. "It makes you feel good," he says, "that you can finally graduate to that level of respect."

Nonbank alternatives: a sampler

Don't know where to turn in search of nonbank financing? This list, while by no means comprehensive, is a good beginner's map of the types of institutions that have something to offer.

• Investment houses.
• Large financing institutions.
• Credit-card companies.

If you're interested in non-bank financing.  You can get a recent list of active non-bank financing sources in The Definitive Guide To Raising Capital — How To Fund Your Business In 30 Days or Less.