Alternative finance for SMEs: finding the right funding fit

Women in BusinessWhere alternative funding for UK SMEs is concerned, there are numerous options available, to suit a wide range of businesses. Tony Smith, of Business Expert, focuses on three types.

Much has been written about sources of SME funding, such as crowdfunding and angel investments – so we're going to focus on three types of alternative funding (and not just the crowd-pleasers):

These are:

  • micro loans
  • equity finance
  • invoice finance

We’re also going to explore how certain types of funding may be particularly well-suited to specific business types.

Micro loans

If you only need a relatively small amount of money to get your startup off the ground, or to help your small business to grow, a micro loan could be an appropriate option for you.

There are a number of providers across the UK, many of them region-specific, that offer debt investment to businesses that require finance to achieve their growth plans. Typically, loan amounts range from £5,000 to £50,000, and come with generous repayment terms of between one and seven years, depending on the provider.

As with bank loans, businesses will need to demonstrate a strong case for a micro loan when applying. This should include a business plan showing the vision for growth and ability to repay the loan. In many cases, the funds are distributed through not-for-profit, community-based lenders, which can lead to more competitive rates then you’d receive from mainstream lenders, such as banks.  

Micro loans are suited to…

Micro loans are typically made available to businesses that do not qualify for a bank loan and lack access to the capital that they need to grow. However, this doesn’t mean that you’ll be able to get by with a poor credit history. Lenders will want to see businesses that have passed the concept development stage and have specific goals that they require external finance to achieve.

Lenders will also expect to see a well-thought-out business plan and a balance sheet and budget for the next few years.

Equity finance

UK SMEs are increasingly willing to shun debt finance in favour of a long-term equity finance deal. In fact, research by a UK lender found that 44 percent of business owners would be willing to give up equity in return for financial support, up from just 12 per cent in 2013.  

Put simply, equity finance is the process of raising capital by selling a share in the company. Unlike a bank loan, which has to be repaid with interest, an equity finance provider receives a stake in the company, which entitles them to a share of future profits. This frees up the business from the costs associated with servicing debt finance, so the capital can be used solely for business activities. However, you will lose a share of your business, which diminishes your level of control and your share of the profits.  

Equity finance is suited to…

The growing demand for equity finance in favour of debt finance, particularly by the so-called Dragon’s Den generation (under the age of 35), shows that younger CEOs are shifting to a more entrepreneurial model that’s typically seen in the US.

Appetite for equity finance is strongest among IT and telecom firms, as well as manufacturers and transportation and distribution companies. It can take many forms and is available at different stages of a business’s development. However, generally speaking, it is best suited to financing high-risk, high-return, early-stage businesses.  

Invoice finance

Almost all growing businesses will face a shortage of cash flow at one time or another that can impact growth, and even lead to insolvency. Factoring and invoice discounting, the two funding methods that fall within the umbrella term of invoice finance, give businesses a way to release the value tied up in unpaid invoices almost as soon as they are issued.

Rather than wait for 30, 60 or even 90 days for customer payments to be made, businesses can use an invoice finance provider to free up between 70 and 95 per cent of the value of an invoice, within just 24 hours. The business then receives the balance of the invoice, minus the finance provider’s fee, when the invoice is finally paid.  

Invoice finance is suited to…

With record levels of invoice finance lending to UK businesses in 2017, all sorts of businesses are now waking up to the potential benefits that this alternative finance type can bring. However, it is only suitable for businesses that:

  • sell products or services to commercial customers or government agencies
  • have creditworthy customers
  • issue invoices to customers
  • need quick access to funds to be able to run their businesses effectively

Businesses that flock towards invoice finance are those that operate in industries where there is a significant delay between the provision of a service or the sale of a product, and the payment being made. Recruitment agencies, construction firms, transport and haulage companies, and professional service providers, are all examples of businesses that commonly use this finance type.

Take your time

When searching for the most appropriate alternative finance type for your business, it’s essential that you take the time to consider the potential benefits and pitfalls of every lending type. There’s no such thing as a perfect source of business finance, but that shouldn’t prevent you from finding the right fit.   

About the author

Tony Smith is a senior director at Business Expert, an online platform that gives business owners the opportunity to compare the UK’s leading invoice finance providers to find the best deal.