For many entrepreneurs, finding money to start a small business is one of the most challenging aspects of being an entrepreneur. It’s just hard. But in this article, we discuss two great – but seldom discussed –ways to finance your business: your vendors and your clients.
Both vendors and clients can be a great source of funding – if you know how to approach them and if you use them effectively. Keep in mind that this is not financing in the traditional sense of the word. Your clients and vendors won’t invest in your business by purchasing equity or lending you money. Actually, let me rephrase that. They will be lending you money, but they won’t call it a loan…
Getting clients to fund your business
Getting financing from your clients is very difficult – but possible. The way to get financing from them is by requesting a prepayment for an order. Once your client prepays, your business gets the funds it needs to deliver. Obviously, you must use the funds to deliver the order. Don’t use the funds for anything else.
As you can imagine, your clients must have a good reason to prepay for your products or services. For instance, they may be willing to prepay if:
- Your services are unique
- Your business is really good at what it does
- Your product is unique and they really need it
Unfortunately, if your products or services don’t meet these conditions, it’s unlikely that you will get a prepayment. The prospective client can just go to a competitor who provides the same service and offers 30- to 60-day payment terms.
Some rules about prepayments
You should treat your client’s prepayment very carefully. Getting a prepayment should be considered a privilege. Follow these rules:
- Take the payment only if you are 100% sure you can deliver – no exceptions
- Use the funds exclusively and specifically to deliver the product/service to the client
- If you don’t deliver, you must return the money
- Alert your client of any issues affecting delivery
Client prepayments can work exceptionally well if your company resells products or if it has vendors in general. This allows you to combine prepayments with another financing tool – supplier credit.
Supplier credit improves your cash flow
Most large and midsize companies can negotiate payment terms from their suppliers. They get the product or service immediately, but they get 30 to 60 days to pay the vendor’s invoice. This is often referred to as “trade credit” or “vendor credit.”
Getting vendor credit allows you to use their product/service while delaying payment. This improves your cash flow and allows you to use your own money more effectively. However, there are cases in which you can fully fund your business using only your vendor’s credit terms.
Here’s an example. Let’s say that you are a widget reseller. You buy widgets from various vendors, repackage them, add some value, and sell them to other customers. Assume that you sell your products to commercial clients who pay you in net-30 days.
Now, consider what would happen if you were able to negotiate net-45 payment terms from your vendors. In principle, you could buy the goods from your vendor, sell them to your client, and get paid by your client before you have to pay your vendor. This transaction works very well – if you can pull it off. These transactions are often referred to as a “self-liquidating transactions.”
Realistically, most entrepreneurs won’t be able to finance their businesses solely with supplier credit. But using supplier credit can can do wonders for your cash flow. In turn, this allows you to rely less on other types of financing.
Although I have written about how to get credit from vendors before, here’s a summary of how it’s done.
Step #1: Ask your vendor for credit
The first step is to request net-30 terms from your vendor. Most suppliers offer terms to clients who have good commercial credit. Vendors will check your commercial credit though one of the credit bureaus, such as Dun & Bradstreet, Ansonia, or Experian. If your report is good, you get credit. If it isn’t, you don’t.
If your supplier tells you that they can’t offer credit terms to you, try to negotiate a smaller line and a shorter payment term. Even getting five days helps. It’s ok if you don’t get credit, though. You can build it.
Step #2: Pay ahead of time – every time
If you don’t get credit, you must pay upon receipt of invoice (or prepay). If you do get credit – even if it’s a small amount and a short term – try to pay a little early. If you get 10 days, pay in 5. If you get 20 days, pay in 15. You get the gist. You want to establish your reputation as a solid payer.
Ask if your vendors report information to credit bureaus. Paying your credit-reporting vendors early is a great way to start building a credit profile.
Step 3: Wait a little and ask for better terms
Once you have built a track record (i.e., five months) of paying a little early , call your vendor and request better terms. Ask for a longer payment term, a higher line, or both. If you had no terms, ask for 10 days. If you had 10 days, try to get 25 or 30 days. Then, go back to step #2 and repeat the process again until you get as much credit as your supplier can offer.