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The Business of Buying Accounts Receivables

written by: •edited by: Michele McDonough•updated: 1/2/2011

A new way venture capitalists are helping to fund businesses is by buying a liquid asset such as your accounts receivable and turning it into cash. At one time or another, almost every small business needs cash, but does this new venture capitalist idea work?

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    Purchasing of Accounts Receivables - How It Works

    Cash Register 99 by Zizzy Baloobah 

    Cash flow is something every small business owner thinks about. If there is a cash crunch, how will you make payroll? How will your vendors get paid? It might have looked as though you were cash rich when you opened the business but cash can easily get eaten by inventory, payroll, insurance requirements, and other expenses you didn't expect.

    The business of purchasing accounts receivable through a venture capitalist firm is not new, but becoming more popular in this tight economy. Venture capitalists call this factoring receivables where you turn those anticipated receivables into needed cash.

    Here's how it works. A venture capitalist firm purchases your business' accounts receivables, gives you cash based on a percentage of your receivables and you pay them back, including fees. Some business analysts feel this is a good idea. You get cash and the venture capitalist firm gets a fee or a return on their investment.

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    Is It Safe?

    The answer to this is yes because every venture capitalist firm that offers this type of receivable financing takes a detailed look at your customers, their credit worthiness, and how reliable their payments are. If you have a bunch of deadbeat accounts receivables, a venture capitalist firm won't consider them as viable.

    For example, if you purchase an existing business and have $50,000 in accounts receivables, take a good look at those receivables before you consider this option. Is there truly $50,000 there or are some receivables so old you may never recover them or be paid? If you analyze your receivables and of that $50,000, you determine only $25,000 will be honored, this may not be a good idea for your small business. Venture capitalist firms who fund accounts receivables often charge up to seven percent interest, a fee often higher than a conventional loan to fund your business and cash flow.

    If you do find you have receivables that can be collected, keep in mind that venture capitalist funding in this way should be considered a short-term cash opportunity, not long term. The venture capitalist firm will more than likely want monthly reports from you on how those debts are coming along and if they aren't coming through, they may demand the funds they loaned you back in full along with their fees.

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    Things to Consider

    There are a few things to consider if you want to try venture capitalists accounts receivable funding:

    1. How It Looks - Even if this does work for you and you got the cash and paid it back along with your fees, it may harm your chances at getting conventional financing in the future. Some finance companies look at your business as unhealthy because you chose this option in the first place.
    2. Funds Received - If you have a small amount of reliable accounts receivables, will the venture capitalist funding really be enough to help with cash flow needs?
    3. Other Funding Sources - Have you looked at local, state, and federal programs to fund your business?
    4. The SBA - Have you checked into the 2009 Recovery Act? Through the Small Business Administration, the government is offering loans up to $35,000 for small business to help pay vendors and credit card bills. Read about the ARC loan program before you decide to pursue venture capitalist accounts receivable funding.
    5. Be Determined - If you've tried to apply for a conventional loan or an SBA 7(a) or 504 loan through a conventional lender and have been turned away, be determined not to give up. To aid you in getting that loan, contact your state's economic development department. All states have these offices, not only in major cities but offer satellite offices in smaller towns. These services are free to business owners and often having them behind you along with their contacts can help you get the funds you need.

    Just as with your business, venture capitalists want to make money. If you feel your accounts receivables are strong, this may be a program for you. If you do decide to go this route, make sure you have your attorney or accountant look over the venture capital agreement before you make a final decision.