10 Alternative Financing Options For Your SME
Small and Medium Enterprises (SMEs) are primary catalysts for economic development, representing up to 90% of businesses and responsible for 70% of employment worldwide. And while a recent study found that small businesses that acquire external capital are more likely to grow and scale their businesses, access to finance is a major struggle for most SMEs, despite loans being essential to fund them.
Startlingly, according to a new report, small business owners have an 80% chance of being rejected for bank loans. This is likely a result of an increase in regulations that have forced banks to be extra cautious when it comes to their risk. As most SMEs battle to show creditworthiness to lenders and traditional banks due to their lack of credit history and their small size, many have to rely on internal funds to launch and initially run their enterprises.
Therefore, when traditional financial institutions can’t offer small business owners the capital they need to grow their companies, it’s critical that they learn to approach their loan search differently. Instead of solely relying on incumbent banks for credit, SMEs should explore the multiple ways to fund their organisation by discovering alternate sources of funding.
A Good Starting Point
Before applying for any form of financing, it’s crucial for SMEs to assess their borrowing capacity and current financial standing to counter sudden external shock factors. The most effective way to do this is to conduct an audit to determine their assets and debt, to work out how much capital they need and how much collateral they have — most banks and lenders will require collateral as security. It’s also important to consider the current economic climate, and if it’s the right time to be borrowing funds considering the external factors and industry trends shaped by the COVID-19 pandemic.
By running up-to-date borrowing capacity assessments, requesting and obtaining financing even during a crisis is much smoother, faster, and gives more confidence to the lender. If fast-growing companies can weigh up the above and show their strengths via high gross margins, high inventory turnover and revenue growth year-over-year (YOY), they have a much higher chance of securing the capital they need — even during adverse times.
The Best Lenders For Your Business
Businesses tend to evolve in their funding experiences as their organisations grow. Gathering vital market data research so you have a wide range of options for accessing working capital can help you implement the best financial option for your company, ultimately ensuring its survival in the long run.
Given the decline in banks offering loans to SMEs, the alternative lending industry is booming. Coupled with government funding packages in certain jurisdictions, and there are a variety of options available to SMEs. Here are a few ways to raise capital for your business, without relying on traditional banks:
Government Rescue Packages
Considering the unmeasurable impact of the COVID-19 pandemic on businesses across all sectors, countries have put specific measures in place to support them. Governments across the globe have introduced generous rescue schemes to mitigate the economic impact of the outbreak on companies. Specifically, many countries have deployed urgent measures to support SMEs through loan guarantee initiatives to sustain short-term liquidity. Some government bodies are also providing grants and lump-sum subsidies to SMEs, as well as certain tax exemptions. Small business owners should investigate the government relief options available to them that have come off the back of the crisis.
Venture Capital Funding
Venture capitalists (VCs) engage in private equity funding that takes place over several rounds. After each round of financing, SMEs are expected to reach certain milestones. In exchange for capital, VCs take part ownership of the companies they invest in. Raising VC funding is very competitive as investors tend to prefer repeat-entrepreneurs with proven track records. According to a recent Stanford University study, VCs consider up to 100 companies for every business they choose to fund. Many SMEs actively seek VC funding as it comes with a host of expertise, industry knowledge, influence and a clear direction for the business.
Similar to venture capitalists, angel investors are likely to invest directly in early-stage businesses that don’t necessarily have demonstrable growth. Not only do angel investors provide funds to the businesses they believe in, but they usually assist them with their growth. While angel investors are usually driven by financial interests or invest in companies that contribute to the greater social good, they are known to require greater ownership as a condition of funding. Therefore, SMEs that desire total control are better off finding alternate forms of finance.
If SMEs want to raise capital without surrendering equity or taking on debt, then revenue-based financing (RBF) is a viable option — especially as VC funding becomes harder to obtain due to COVID-19. Through RBF, business owners pay back a fixed sum over a period of time, based on their incoming revenue. Therefore, investors receive a percentage of their loan back with every sale an SME makes. While businesses typically raise less through RBF than they could through VC funding, there are no hidden terms involved, giving owners immediate access to the capital they need to scale without sacrificing ownership or equity.
Intended as a quick and simple way for small businesses to access funds, crowdfunding allows companies to pool small investments from several investors instead of seeking out a single source. By utilising certain crowdfunding online platforms, SMEs can pitch their business idea with the hopes that interested parties offer them some form of capital in exchange for shares or early access to products. Crowdfunding usually includes a lack of upfront fees, along with a fair amount of publicity. Conversely, this method isn’t ideal for companies who are seeking millions of dollars, with another pitfall being that pledged funds are usually returned to investors if the SMEs target isn’t met. While crowdfunding campaigns can be slow and demanding, they are a great way for smaller businesses to gauge market demand.
An option that is usually overlooked, strategic partner financing sees another industry player funding the growth of a company in exchange for special access to product, distribution rights, a percentage of every sale — or a combination of all three. Strategic partners are typically larger organisations that have relevant resources, customers, marketing strategies and staff that SMEs can utilise. However, a criticism of strategic investors is that they are known to try to exert too much influence on company operations as the business outcome needs to be aligned with their own strategic interests.
Peer-to-Peer Lending (P2P)
This form of lending is made possible thanks to the internet that directly connects interested lenders or investors with SMEs looking to raise capital. Interest rates tend to be lower on these straightforward loans, with the application process being relatively quick and the money often available within a few days. Most P2P platforms are run by fintech companies who leverage technology to streamline and optimise the process, removing the hassle of bank applications. These types of loans are ideal for SMEs who can’t risk putting up business-critical assets as collateral.
Considered a viable way to fund an SME, convertible debt allows businesses to borrow money from an investor on the grounds that they convert this debt into equity in the future. The loan agreement specifies the repayment terms, including the interest rate, timeline and the price per share for the conversion of the debt. Lenders tend to prefer this type of contract as the borrower would need to pay them a set rate of interest until they trigger the conversion, at which point they will become shareholders. While relinquishing some ownership or control of the business is a drawback to this type of financing, convertible loans don’t place strain on cash flow.
Merchant Cash Advances
eSellers face various costs, including marketing, logistics expenses and upfront payments to suppliers. Coupled with the delayed collection of sales revenue and a high turnover of inventory, eSellers are challenged to keep their business running without interruption. Awarding competitive rates and fees, merchant cash advances are offered by payment gateways like Shopify and Paypal. Using their inventory as collateral, borrowers can usually access up to a month’s turnover through merchant cash advances, generally only repaying what they can afford.
Considered an approachable and agile solution for fast-growing businesses, invoice factoring has become increasingly popular with over 26% of SMEs favouring the service to boost growth and company evaluation. The financing route sees a service provider fronting the business with the money they need on their outstanding accounts receivable, that they repay when their customer settles the bill. There are two types of invoice factoring: recourse factoring, where the credit risk stays with the borrower, and non-recourse factoring, where the credit risk is borne by the factor (lender), who enters an agreement with the borrower. While the former usually comes with lower interest rates and administrative costs, the latter offers more protection. Overall, the cost of invoice factoring is lower than a loan and vastly improves cash flow.