One of the keys areas I’m regularly asked to comment on or assist with is how to apply for funding for small businesses. This involves sourcing many different types of funding depending on the circumstances at the time.
Most business owners are familiar with funding supplied via the bank, in particular overdrafts and loans, although overdrafts are not as common these days due to the bank’s preferring to use other methods of funding as a more secure substitute.
Whilst banks tend to offer finer interest rates, this doesn’t always mean that bank finance is the best option for a business. Some business owners like to spread risk rather than place it all with one lender, especially a bank. A bank may ask for additional security, something a business owner may not consider necessary or be willing to provide. Additionally, whilst the business may still be a viable concern, the bank may decide that they are at the maximum of their lending threshold. It is then imperative that other sources of finance are identified to stabilise and assist the business.
Before I detail the options, let’s cover an important aspect of borrowing money – the type of business you operate and the implications it has to you personally when borrowing.
- If the business is a sole trader or partnership, then the owner is personally responsible for repaying the lender if the business defaults. This means, all of your personal assets are on the line.
- Limited companies are different. Before providing any finance to a business, the lender will require a director’s guarantee which is limited to the amount of the funding. This means the director will be asked to repay the balance if the business fails. However, there is a limit to this and therefore may protect the director’s personal assets from the lender. The bottom line is that, as a business owner you should be fully aware what you are committing to and the consequences if the business fails to pay. Take advice if you are unsure.
4 alternative funding solutions for small businesses
1) Invoice finance
There are many types of invoice finance, however once your strip away their names, there are basically two types; factoring and invoice discounting. The function of this service is the same, it’s how the paperwork, fees and system to repay are calculated which sets them apart.
This finance is ideal for those selling products business to business. Invoices are issued and a copy is passed to the lender. The lender pays a set percentage of the value of the invoice to the business with the balance paid less fees when your customer pays the invoice. Typically a lender will advance 70-80% of the invoice value.
For a growing business the advantage of this finance option, is the facility can grow with you. However, it can be expensive as you pay interest and administration fees each month. If the funding allows the business to trade successfully, it works very well.
2) Asset finance.
These are loans for vehicles, plant and machinery, fixtures and fittings and lots of other costs such as computers and software. The list goes on. Asset finance companies remain the owner of the asset until the last payment is made. They therefore have an element of security in the asset itself.
Asset finance companies tend to offer two types of funding, hire purchase (loans) or lease purchase. With hire purchase, the asset can be included on the business’ balance sheet with the corresponding loan also included from the day of purchase. With lease purchase deals, the asset remains off the balance sheet until the final payment and option to purchase fee has been paid. It is then included at current value. Many retailers offer in-house finance on asset sales these days so it’s worth looking at the numbers and then comparing to the market.
3) Funding platforms
There are a number of these within the UK. The business sends data, such as bank statements, previous accounts to the administrator of the platform so they can initially vet the business. If they agree the business is stable and profitable enough to be placed on the platform, a full application must be written by the business. These platforms basically provide a place where investors can invest in a business with relatively little risk.
When the application is placed on the platform, investors bid to lend the money to the business at an interest rate they choose. If the loan is fully subscribed, then an average interest rate is agreed. When all paperwork is completed, the platform releases the funds to the business and they administer repaying all the investors every month following receipt of the loan repayment from the business.
This is a very clever format and works very well indeed. Interest rates are a little higher and the funds raised could come from a combination of 50 + investors, depending on the value of the loan required.
Of course, with most loans there is an arrangement fee to pay, and this is the fee the funding platform charges for providing the service that unites multiple investors with one business. Typically this is 2.5-3% of the value of the loan. However, for long term funding this could be a superb option, albeit slightly more expensive than a bank. I have used this type of funding many times for clients.
4) Merchant Cash Advance
These are loans which can be agreed and transferred very quickly. An applicant needs to receive payment for some but not all of their sales through a credit card machine. The lender analyses the total weekly and monthly sales made through the business and agrees a percentage of the total as a loan. Therefore the higher value of transactions will attract a higher loan from a lender.
An intermediary account is then established between the credit card company and the applicant’s bank account. Funds received from the credit card company are applied to this “middle” account and the lender takes a small percentage before sending the funds to the applicant, same day.
This means that a little of the loan is repaid every day without starving the business of much needed cash. It’s a clever way of funding for a business that takes most payments through a card machine. Businesses that suit this type of funding are hotels, retail, therapists etc.
As you would expect, “alternative” funding sources are not as cheap as a bank, however they all have a place and can provide much-needed finance when bank finance is not an option. Sometimes it is more important to receive the right funding at the right time rather than trying to find the cheapest option. After all, the cost of not having this funding in place can be severe.
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