Categories of Banks
Convertible Debt Instrument
External Sources of Cash
In another article, I told you about Sue and generating cash from sources within her business. I will not detail her entire story at this time, but will tell you that we were successful in obtaining external cash allowing her to grow the business with the piece of mind of a constant and predictable cash flow.
We need to make sure we are all talking about the same thing when we hear or see the phrase “external sources of cash”. So, today I am going to define external sources of cash, and in the future, I will share situations where the different types are best utilized.
There are two sources of external sources cash for businesses: lenders and equity investors. I will begin with the least costly.
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1st Source of External Cash: Lenders
Always remember that borrowing, no matter what the sources, will be less costly than equity. There are two classifications of lenders to discuss. However, within the classifications there are various sub categories. First and by far the least costly is traditional bank financing. What I am talking about here is when the bank takes all of the financial risk on your loan. Examples of these loans would be traditional lines of credit, loans for equipment, and building loans. Additionally, banks offer other products when they do not take all the risk and these products are more costly. Examples of these products are Small Business Administration (SBA) loans, equipment leasing, and factoring. Later in the series we will discuss the various differences in the lending philosophy of banks and different types of banks such as state vs. national, and community vs. multi state.
The second types of lenders are what I will call alternative lenders. Probably a term you may not be familiar with, but include such companies as asset based lenders, accounts receivable lenders, factoring companies and hard money lenders. These lenders take greater risk in their lending activities than banks. The reasons alternative lenders may be a better source than banks vary on a case by case basis. In future articles, each one of these will be discussed with examples and stories.
2nd Source of External Cash: Equity Investment
The second type of external cash for a business is equity investment. This by far is the most expensive cash or capital a business can acquire. You may be asking “why is this most expensive… I don’t have to pay it back”. Well, the answer is you are sharing part of your profits each year for the growth cash with your partner, and then upon the sale of the business, you share the return on equity with the partner.
Understanding the two different external sources of cash is critical because each or all may be needed in your business’s situation. For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.