ImpactAlpha, June 10 – For many founders, getting access to traditional sources of debt to fuel their companies can feel like a chicken-and-egg scenario. Banks want to see a credit history (i.e. a history of repaying loans), but how do you build a credit history if a bank won’t lend to you?
Impact entrepreneurs have several options to consider that can serve as a bridge towards building a credit history –and there are ways that alternative lenders and impact investors can help them.
Invoice factoring, shipment financing and purchase order financing are short-term funding options that allow impact enterprises to borrow against invoices, shipping bills or customers’ orders to finance working capital. This type of funding is likely more expensive than many other types of financing, but it can be useful for early-stage and/or seasonal businesses that are looking to build a credit history to access other types of debt.
In South Africa, the founders of The People’s Fund saw small, Black-owned businesses struggle to access the capital they needed fulfill large orders from corporate buyers. So they crowdfunded capital from investors to be able to offer purchase-order financing . Over the past three years, they’ve extended 200 million South African rand ($15 million) to more than 1,000 small businesses, facilitating more than 400 million rand in revenues.
Factoring primarily helps businesses regulate cash flow for their operational needs. It does not really solve core financial issues that a business may find affecting its balance sheet, however.
Also, factoring is short-term financing—often only a few weeks or months—it can be expensive for the business when calculated on an annual rate.
Factoring should therefore be evaluated based on opportunity cost and used to bridge a cash gap or allow companies to maximize production capability to scale—not to survive month-to-month over a long period of time.
For companies use invoice factoring, funders might ask for personal guarantees, so founders will need to evaluate the risk that this presents to them when they consider signing an agreement.
Supply-chain financing, or “reverse factoring” uses pre-payments from customers to help finance working capital needs. Entrepreneurs can ask their customers to pay for their purchase orders early or to pre-pay at a discount.
As consumers, we often do this for companies. Think about the last time you were offered a cheaper rate to purchase a yearly subscription rather than paying monthly. If you chose to pay for the yearly subscription upfront, you helped that company fund its ongoing working capital needs.
Some suppliers have established supply-chain financing programs that businesses can participate in and companies like Finvex.tech have built technology platforms to enable medium to large companies to offer supply chain financing frictionlessly. Impact enterprises can also try leveraging their relationships with larger, regular customers outside of formal supply-chain financing programs
Recoverable grants and forgivable loans
Recoverable grants are another option for founders who need timely “bridging” capital, low risk proof-of-concept capital, an opportunity to build a credit history, or flexible capital to on-lend or invest.
Both nonprofit and for-profit founders can face funding gaps between billing and project cycles. Timely capital to bridge operational and working capital gaps can be critical for business continuity and the achievement of social objectives. Funders that have the flexibility to offer recoverable grants, which are only repaid once additional funding is secured, offer such organizations breathing room.
Landesa, a non-profit in West Bengal, India that educates women about land rights and livelihood skills, faced a funding gap to expand the reach of its programs. Open Road Alliance provided a recoverable grant for $70,500 to enable Landesa to grow from 20 communities to 300 and meet requirements to participate in a government funding program.
Alternatively, recoverable grants can also be structured as “forgivable loans.”
Recoverable grants are also well suited to enterprises that are still in a proof-of-concept stage, testing an early-stage product, building out a new market, or operating in “high risk” and challenging markets. In these situations, risk capital is often scarce, in spite of the significant “upside” potential for social or environmental impact.
For entrepreneurs who are trying to establish creditworthiness in the market and track record with funders, repaying a recoverable grant or forgivable loan helps organizations prove their ability to take on more traditional debt. It can also help organizations build the internal systems necessary to interact with traditional lenders.
For funders interested in using recoverable grants as an impact enterprise financing tool, recoverable grants may be most relevant to non-profit organizations that on-lend other impact organizations or make equity investments in early-stage social enterprises.
Beneficial Returns, for example, is an impact-lender that raises recoverable grants to on-lend to social enterprises at below-market rates. By targeting a 2% return to donors, Beneficial is able to support social enterprises that need low-cost capital while covering its own fund management costs.
Prime Impact Fund has also raised recoverable grants as part of their $50 million equity fund for early-stage, climate-focused technology companies. Prime Impact Fund uses the flexibility of recoverable grant agreements from its investors to support companies that would be considered too risky by conventional investors.
All forms of enterprise financing, but particularly alternative structures, require a balancing of financial returns and impact priorities. It’s important for both founders and funders to make sure that alternative capital sources like trade finance, recoverable grants and forgivable loans, are mission-aligned.
Aunnie Patton Power is a lecturer at the University of Oxford, the London School of Economics and the University of Cape Town, as well as an advisor and angel investor. Her first book, Adventure Finance, aims to help founders and funders navigate the spectrum of funding options that blend profit and purpose.