It's a quandary, to be sure.
The owner of a five-person cleaning firm lands a short-term job cleaning the branch office of a large local company and parlays that into a contract to handle all the client's local office space. A lucrative payday is looming, but so are expenses.
What's an ambitious entrepreneur to do?
Bank loans and credit cards are common solutions to such cash-flow crunches, but small-business owners increasingly have another option: using unpaid invoices as collateral to borrow money from investors.
So-called "invoice factoring" could help that cleaning company owner cover her costs until she collects from her new client. She could borrow what she needed--as much as 80 percent of the invoice value--and transfer ownership of the invoice. Once the invoice is paid, lenders typically take a monthly fee ranging from 1 percent to 5 percent of the borrowed amount from the remaining balance.
Once reserved for large companies, the alternative form of financing is becoming more common among small businesses as investors make additional capital available, but experts caution that the loans can be an expensive option.
"It's not something that we would recommend in our typical buffet of financing or something that we teach about as a normal part of business," said Johannes Denekamp, faculty fellow at Indiana University's Johnson Center for Entrepreneurship & Innovation. "It is ... the payday loan of small business."
Even so, industry insiders say the funding option has made a difference for companies with contracts that would mean amazing growth but not enough resources to convince banks or other traditional lenders to give them the chance to pull it off.
"It can be a great tool for a fast-growing company," said Doug Terry, owner of Indianapolis-based FWB Capital Group, which makes invoice loans. "Until the past few years, it hasn't been available to the smaller businesses."
In fact, some bad players in the field charged outrageous rates and gave invoice factoring a bad name, said Gordon Trask, vice president of sales for the Midwest region of British-based Bibby Financial Services Ltd., which made $6 billion in such loans worldwide last year.
Bibby has backed invoice loans for amounts ranging from $5,000 to $10 million, but Trask said 85 percent of its clients "graduate" to traditional lending.
"We're more flexible and quicker than a traditional bank loan," he said. "We will get creative."
Banks make invoice loans to large companies, in fact, but small businesses are seeing more opportunities as low interest rates prompt individual investors looking for higher returns to make additional capital available. They're willing to take on smaller loan amounts and deal with small businesses.
"Those investors wanted avenues [for a return] and found invoice factoring worth the risk," said Omar Benkato, a professor of finance at Ball State University's Miller College of Business.
The costs of such loans vary depending on the amount of the invoice and the credit-worthiness of the business expected to pay. In some cases, the lender charges a higher fee and assumes the risk that the invoice won't be paid.
Invoice loans have been common for decades in some fields, such as the fashion and film industry, according to Doug Johnson, assistant professor of marketing and management at Ball State University's Miller College of Business.
"Independent producers will often 'presell' a film at one of the major film festivals and then use these 'assets' as collateral to finish the film," Johnson said. Ditto for new clothing lines at fashion shows. And it's also a common tool in some manufacturing fields.
But it's hard to get national statistics. One trade organization--the International Factoring Association--estimates that $100 billion in invoice loans are made in the United States each year. Executive Director Bert Goldberg said the group doesn't keep historical figures, but pegs overall growth at somewhere between 5 percent and 10 percent per year. Breaking out loans to small businesses is even more difficult.
"It's becoming a more well-known tool than it was in the past," Goldberg said, and small businesses are among those catching on.
FWB Capital's Terry said the loans are appropriate for specific types of businesses.
He said he often deals with companies--like the fictional cleaning service--that have no collateral other than the invoice, which makes getting a bank loan unlikely. But businesses that opt for the loans need relatively high profit margins to be able to afford the fees.
Terry, who has run his business on Indianapolis' east side for three years, said typical clients include small firms that provide temporary staffing, data entry or security services.
Still, some observers caution business owners against going after the quick fix. Local small-business counselor Rogelio Lara said he'd advise clients to try other, cheaper funding options first.
"These days, the best way to get funding would be loans backed by the [U.S.] Small Business Administration" or a bank, said Lara, a volunteer with Indianapolis SCORE, which is affiliated with the SBA.
If those aren't options and a business has clients that are paying on time, invoice loans could be an option--albeit an expensive one.
"It's a tool that's available, but the fees can be onerous," he said.
Although more small-business owners are opting for such loans, they're still in the minority. Larry White, an adviser with the Indianapolis Small Business Development Center, said he's talked with three clients in three years about invoice factoring.
"It's an unknown option for folks," he said. "Most of our folks operate cash businesses or they don't have enough receivables that it's of interest to a factoring company."
But that's a battle Terry and others in the field want to take on. Terry talks to bankers about the option, and attends government-backed small-business trainings and venture club meetings trying to spread the word.
"The biggest issue for clients is, they can't get traditional financing," he said. "With factoring, you could be a business that started yesterday because a friend has hired you to clean his local Starbucks shops. It's about the strength of your client over you personally."