What you need to know about alternative business finance
It’s no secret that small businesses struggle to get finance from high street banks. Ever since the financial crisis of 2008, the business finance market has changed a lot — a variety of alternative lenders have emerged and with them a wide range of alternative business funding.
Funding is crucial to growing your business, and with most of the non-bank lenders you’ll have access to the funds much faster than you may think. However, business finance now comes in many different shapes and sizes, so it can be difficult to choose the right option for your situation. Let’s take a look at the key points to bear in mind when looking for business funding.
Before you choose an alternative funding option, there’s one thing every lender will have to do: assess your business’s creditworthiness. This means the lender will want to check your bank statements, annual turnover, profit margin, and credit rating to find out how much your business is eligible for.
Sometimes, you’ll have a chance to talk to the underwriter to explain specific aspects of your business’s history. This way the lender can take more information into account to assess your eligibility.
One of the common questions you should prepare for is ‘how long has the business been trading?’. Normally, a trading history of at least 1–2 years is required, but some providers also offer loans to startups or fairly new businesses. However, these may come with a lower maximum credit limit.
Unsecured business loans
Usually, younger businesses don’t have any assets to secure finance, so an unsecured business loan may be a solution. As its name implies, this type of finance doesn’t require any collateral, and is normally backed up by a business’s trading position. Based on how your business has done in the recent past, the lender will make a fair estimate on its future.
Many lenders think of the loan amount as a percentage of your turnover. You may be able to borrow around 10–30% of your annual turnover, but bear in mind that your business will need to be profitable and demonstrate affordability.
The downside of unsecured loans is that without any security, the lender carries a higher risk. This may well lead to a higher interest rate, and lenders will also want a personal guarantee for an unsecured loan. Giving a personal guarantee means you agree to repay if the business can’t — so you should think carefully before agreeing to one, and talk to a lawyer before signing anything.
Revolving credit facilities
Another option may be a revolving credit facility. Just like your credit card, you’ll have a pre-approved credit limit from which you can draw funds. There are no setup fees, and you’ll only pay interest on the outstanding amount. So, instead of a fixed business loan, you’ll have a ‘rolling agreement’ with the lender which you can dip into when you need.
However, revolving credit facilities tend to have higher interest rates since they’re another type of unsecured lending. That doesn’t necessarily mean a higher total cost — because if you only use it some of the time, the cost can work out lower than a fixed business loan. In fact, revolving credit facilities can be very similar to business credit cards in practice, used as a short-term buffer for those times when you need a bit of extra working capital.
Merchant cash advances
If your business uses card machines and isn’t eligible for an unsecured loan yet, a merchant cash advance could be a good option for you. They’re ideal for businesses with a high volume of card transactions every month, such as retail businesses or the leisure sector.
Technically they’re an advance rather than a loan, which means the total cost is agreed up front. The amount advanced is based on your monthly sales, and then the amount you repay is taken as a percentage of future sales. This means the amount you repay goes up and down with your overall takings, which can be a really useful thing for businesses with unpredictable revenue.
Because there’s not interest running constantly, it’s a fixed finish line. This can be convenient because you don’t have to worry about missing a repayment, or interest building up — it’s all handled automatically. This flexibility comes at a cost though, and merchant cash advances tend to be relatively expensive compared to other types of unsecured funding.
If you’re waiting for money that customers owe your business, you may have another option for securing finance. With invoice finance, you’re given an advance based on the value of outstanding invoices. This comes in handy when you haven’t been paid for the last job yet, but you need to spend money for the next one.
Many businesses have payment terms of anything from 14 days up to 90 days or more, making invoice finance really useful for tiding you over to the next payment. The lender gives you most of the money you’re owed (e.g. 85% of the invoice value) immediately, and you’ll get the remainder minus their fees when the invoice has been settled by your customer. This way, unpaid invoices don’t hold you back from taking on new challenges.
Peer-to-peer business loans
Many people already know about peer-to-peer lending, which connects several private investors with businesses on the lookout for finance. Peer-to-peer lending basically gives you a loan, but instead of only one lender, the money is coming from multiple individuals. This funding option is popular because in theory it’s a win-win situation — investors and borrowers get a better experience than going through their bank.
However, peer-to-peer lending platforms are known to have rigorous eligibility processes to protect their investors, and sometimes, less glamorous businesses can struggle to appeal to investors. Generally speaking, smaller or newer businesses will do better to look elsewhere — although they may also consider equity crowdfunding.
A real life example
Womenswear and textile designer Mariam Sonekan was looking for funds to boost her newly set up business. An online designer marketplace wanted to sell her clothes, which meant that Mariam had to produce lots of orders at the same time instead of just one-off commissioned pieces — a big deal for her brand-new business.
The young designer was worried she wouldn’t be able to pay the suppliers for the material months before she would get paid herself, so she got in touch with Funding Options and spoke to a Business Finance Specialist.
Her situation was tricky because her brand-new business didn’t have a long enough trading history for many lenders, but after some negotiations we were able to get Mariam a business loan based on her strong personal credit history so she could move her fashion business forward.
There are many types of alternative business finance, so when you’re looking for funding it’s helpful to keep an open mind, to give your firm the best chance of getting the right funding option.
Whether you’re looking for long-term growth funding, or just something to tide you over until the next contract is paid, the list of business funding options is far more comprehensive than it used to be — for many different sectors and purposes.
Conrad Ford is Chief Executive of Funding Options, recently described by the Telegraph as “the matchmaking website for small businesses and lenders”. Funding Options has been selected by HM Treasury to help businesses find finance when they’re unsuccessful with the major banks, as part of the Bank Referral Scheme that launched in November 2016. @FundingOptions