Finding a business loan used to be a pretty black and white affair. You’d call up your local bank and book an appointment, wait a few weeks (or months) and then sit down with the bank manager, explain why your business needed some money, and hope that you’d caught them after their morning coffee.
Since the birth of Alternative Finance, however, getting your hands on funding to grow your business has become a lot easier, but equally, a whole lot more complicated. This guide will explore the various different types of alternative finance out there, help you decide whether it’s a viable route for you, and how to prepare your business to raise finance.
Banks vs. Alternative Lenders
Banks have been the main source of funding for small and startup businesses for thousands of years, but finance products (and the needs of borrowers) have changed a lot since then.
Your high street bank will generally have a few different types of finance product, from overdrafts and commercial mortgages to business loans and invoice finance, and will recommend one or two depending on what type of business you run, your financial situation, and your growth plans.
During the 2008 recession, and subsequent austerity measures however, banks became very wary of lending to small businesses. Small businesses carry greater risk of defaulting on business loans, and with banks under the microscope, it became difficult for entrepreneurs to find success with their bank.
This situation brought about (or at least accelerated) the birth of Alternative Finance. The Alternative Finance space is very different to the banking sector, with lots of small providers specialising in innovative new types of finance;
Peer-to-Peer and Crowdfunding
Peer-to-peer (P2P) lenders and Crowdfunding platforms are an increasingly popular route for small business owners looking for funding.
Crowdfunding centres around the principle of many investors lending smaller amounts to a business, through a Crowdfunding platform. There are a few different types of Crowdfunding available;
Rewards-based crowdfunding
Heard of Kickstarter and Indiegogo? Well, these platforms are probably the two most well-known rewards-based Crowdfunding platforms – You set a goal, outline a number of rewards for different levels of investment, and launch your campaign.
Equity-based crowdfunding
This is similar to Rewards-based Crowdfunding, except investors get equity in your business, rather than a reward or perk.
Debt-based crowdfunding
Investors will lend small amounts to multiple businesses, and the business will repay them at a set by the Crowdfunding platform, based on several factors.
Advantages & Disadvantages of Crowdfunding
Most Crowdfunding platforms have an extensive community of investors always looking for new opportunities to lend to small businesses, diversify their portfolio and minimise their risk. It can therefore be a very quick way to obtain funding if you have an exciting business, with an attractive brand and a good track record.
Some business owners, however, find the process of Crowdfunding to be more rigorous than other Alternative Finance methods, due to the Crowdfunding platforms wanting to protect their investors as much as possible.
Invoice Finance
Invoice Finance is an attractive route for many small businesses who struggle with late payments from customers. It is an effective way to release capital trapped in unpaid invoices, allowing you to get on with running your business, rather than chasing customers for payment.
Invoice Finance comes in two main forms;
Invoice Factoring
With invoice factoring you’ll send a copy of your invoice to your Invoice Factoring provider who will advance you up to 90% of the value of the invoice. They will then chase your customer for payment (with some providers, your customer doesn’t even need to know that you use an Invoice Finance company).
Once your customer has paid the provider, they will then release the remainder of your invoice to you, minus any fees.
Invoice Discounting
Invoice discounting works in a similar way, however the credit control element of the process remains with you.
Advantages & Disadvantages of Invoice Finance
Invoice finance is an effective way of releasing capital tied up in unpaid invoices and are therefore a great option for businesses needing a quick source of funding.
Another point to consider is that most Invoice Finance providers won’t require an asset to be provided as collateral. Invoice Finance can only be provided on commercial invoices, however, and so B2C companies would not be able to benefit from it.
Invoice Finance will also eat into profit margins more than other sources of Alternative Finance. Generally speaking, Invoice Finance is used in addition to other sources of funding, as a back-up in case other providers are unable to help.
Asset Finance
Asset Finance, like the two previous forms of finance, comes in a few different varieties, but is essentially a form of finance that is tied to the value of an asset, such as a piece of machinery or a vehicle.
Hire Purchase
Hire Purchase is where you purchase an asset, but spread the cost over a set repayment period, often a few years. Instead of having to pay a lump sum to purchase the asset outright, you make monthly repayments to cover the cost.
The final amount you repay will be higher than the original cost, but is effective for businesses looking to protect their cashflow while purchasing an expensive asset that they will own at the end of the repayment period.
Equipment Leasing
Rather than buying the asset but spreading the cost over a few years, with Equipment Leasing, you never actually own the asset – you simply rent it for a fixed period.
There are benefits to this – service and maintenance costs are often covered by the finance provider, and upgrading your equipment is made easy. However, as you will never own the asset, it will only really be an option for those looking for a piece of equipment for a short period of time.
Advantages & Disadvantages of Asset Finance
Depending on which format you opt for, there are a number of benefits and drawbacks to Asset Finance.
Firstly, it allows you to protect your cashflow while investing in equipment that can grow your business.
On top of this, the finance is usually secured against the asset, and not your home for example. This means that in the worst-case scenario of you defaulting on the loan, you’d lose the asset, rather than your home. However, you will end up paying significantly more for the asset than you would by paying upfront.
Business Loans
Business Loans are one of the simplest forms of funding available to small businesses, and there are a number of different alternative lenders, many of whom specialise in a particular type of Business Loan.
Revenue-based Finance
A more flexible form of a traditional business loan where your repayments are tied to your revenue, so you pay more during busy periods and less during quieter months.
Fixed Repayments
Similar to a traditional bank loan, fixed-repayment loans are always a popular option, as knowing how much you’ll be repaying each month enables you to forecast effectively. Though, unlike the banks, many alternative lenders are now able to approve applications in a matter of days, sometimes hours.
Merchant Cash Advance
This type of funding advances you a percentage of your future revenue, and your repayments are made by deducting a percentage of future card sales.
A Merchant Cash Advance is an attractive short-term cashflow solution for retailers who take a high percentage of their sales through card sales, but it can work out to be very expensive if used longer term.
Advantages & Disadvantages of Business Loans
Business Loans will always be a popular choice for small business owners. Many alternative lenders offer flexible features with their funding to help your small business grow, such as top-ups and repayment holidays, and some business lenders won’t charge early repayment fees, in case you find yourself feeling flush.
There are also a few alternative business lenders that charge interest on a reducing balance, meaning the more you pay off, the less you pay in interest.
As always, your eligibility for a Business Loan will be dependent on your personal credit status and business finances however, generally speaking, alternative business lenders are more understanding of a less-than-perfect credit history and can lend to younger businesses than the banks can.
Preparing your business to raise finance
As is the case when taking out any form of finance, it is essential that you take the time to thoroughly understand the commitment you and your business are taking on.
If you are unsure of the ideal type of funding for your business, it may be worth approaching a credible local business association, as they’ll be able to point you in the direction of any local business enterprise funding groups who specialise in finance for businesses in your area.
Or if you’d prefer more hands-on help, it may be worth speaking to a commercial finance broker, who will be able to give you an in-depth explanation of the different types of funding available to you and handle your application with lenders, however you’ll be charged a fee for this service.
Prior to submitting an application for funding, it’s a good idea to go through your numbers in advance of applying and, if possible, begin to get together supporting documents such as Profit & Loss statements, bank statements for the last few months, filed accounts and VAT returns (if you’re VAT-registered), as these are documents that many lenders will ask to see during the early stages of your funding application.
