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Another approach used by finance companies is asset-based lending inwhich a lender carefully evaluates and lends against asset

collateralvalue, placing less emphasis on the firms overall balance sheet andfinancial ratios. An asset-based lending approach can improve loana v a i l a b i l i t y a n d t e r m s f o r small firms with good quality assets b u t weaker overall credit. Commercial finance companies also are morelikely to offer factoring than banks. Trade credit extended by vendors is a fourth alternative for small firms.While trade credit does not finance permanent or long-term workingc a p i t a l , i t h e l p s a d d r e s s short-term borrowing needs. E x t e n d i n g payment periods and increasing credit limits with major suppliers is afast and cost-effective way to finance some working capital needs thatc a n b e p a r t o f a firms overall plan to manage s e a s o n a l b o r r o w i n g needs.O t h e r

working capital finance options e x i s t b e y o n d t h e s e t h r e e conventional credit sources. Business development corporations (BDCs)are a second alternative source for working capital loans. BDCs arehigh-risk lending arms of the banking industry that exist in almost everys t a t e . T h e y borrow funds from a large base of m e m b e r b a n k s a n d specialize in providing subordinate debt and lending to higher-riskbusinesses. While BDCs rely heavily on bank loan officers for referrals,economic development practitioners need to understand their debtproducts and build good working relationships with their staffs.Venture capital firms also finance working capital, especially permanentw o r k i n g c a p i t a l t o s u p p o r t rapid growth. While venture c a p i t a l i s t s typically provide equity financing, some also provide debt capital. Agrowing set of mezzanine funds,7 often managed by venture capitalists,

supply medium-term subordinate debt and take warrants that increasetheir potential returns. This type of financing is appropriate to financel o n g - t e r m w o r k i n g c a p i t a l n e e d s a n d i s a l o w e r - c o s t a l t e r n a t i v e t o raising equity.However, the availability of venture capital and mezzanine debt islimited to fast-growing firms, often in industries and markets viewed aso f f e r i n g t h e potential for high returns. G o v e r n m e n t a n d n o n p r o f i t revolving loan funds also supply working capital loans. While small intotal capital, these funds help firms access conventional bank debt byproviding subordinate loans, offering smaller loans, and serving firmsthat do not qualify for conventional working capital credit.Many entrepreneurs and small firms also rely on personal credit sourcesto finance working capital, especially credit cards and second mortgageloans on the business owners home. These sources are easy to comeby and involve few transaction costs, but they have certain limits. First,they provide only

modest amounts of capital. Second, credit card debt isexpensive with interest rates of 18% or higher, which reduces cash flowfor other business purposes.Third, personal credit links the business owners personal assets to thefirms success, putting important household assets, such as the ownershome, at risk. Finally, credit cards and second mortgage loans are notviable for entrepreneurs who do not own a home or lack a formal credithistory.Immigrant or low-income business owners, in particular, are least ablet o u s e p e r s o n a l credit to finance a business. Given these many limitations, it is desirable to move entrepreneurs from informal andpersonal credit sources into formal business working capital loans thatare structured to address the credit needs of their firms.

Working capital finance may be c l a s s i f i e d i n t o t h e following:


Spontaneous source of finance:

Finance that naturally arises in the course of business is called asspontaneous financing. For example: Trade creditors, credit f r o m employees, credit from suppliers of services etc.

Negotiated financing:
Financing which has to be negotiated with lenders (commercial banks,f i n a n c i a l institutions, and general public) is c a l l e d a s n e g o t i a t e d financing. This kind of financing may short term or long term in nature.Between spontaneous and negotiated sources of finance, the latter ism o r e expensive and inconvenient to raise. S p o n t a n e o u s s o u r c e o f finance reduces the amount of negotiated financing. The working capital may be financed in either of the followingways, keeping in view of accessibility to different sources aswell as the cost factor-Hedging Approach to Working Capital Financing:

Under hedging approach to financing working capital requirements of afirm each asset in the balance sheet asset side would be off set with afinancing instrument of the same approximate maturity. The basicapproach of this method of financing is that the permanent componentof current assets and fixed assets would be met with long-term fundsand the short term or seasonal variation in current assets would befinanced with shortterm debt. If the long-term funds are used for short-