Financing small business growth: Options beyond traditional bank loans
It seems simple to secure a business loan through a traditional bank, but when it comes time to do so, applicants find otherwise. The process is lengthy and complicated; each lender offers myriad requirements; and thousands of functional businesses do not qualify for the chosen lender as they are deemed ‘too new,’ haven’t reached revenue levels yet, or lack collateral.
But all is not lost. Banks are not the only option available, and for the modern day small business, this is a silver lining. Thanks to an increasingly complex funding market, small business owners have more options than ever when it comes to financing, and sometimes, these options serve businesses better at different developmental stages.
Why traditional bank loans don’t work for every business
Banks want to see proven results. They want to lend to businesses that exist for over two years, have proven revenues, and can demonstrate repeat income patterns. They require collateral, extensive breakdowns of business expenses in the form of financial statements, and credit scores that make them happy.
For a new business, a business in crisis, or even a profitable business in a risk adverse industry, these stipulations create an insurmountable barrier. For example, a company may have been in existence for years, showing profit, but if they lack collateral or fall into a category that banks do not want to take risks on (like construction), then traditional lending solutions will not work for them.
Business lines of credit
Think of a line of credit like a credit card, albeit a better one that comes with lower interest rates. A lender approves an overall limit and the ability to draw from it as necessary, as long as payments are made on time and it falls within your budget.
Lines of credit can be excellent solutions for businesses looking to boost cash flow temporarily and those looking to offset inflation related costs or financial slow months in their business cycles. However, like other forms of traditional financing, lines of credit require good credit history (usually at least one year in business for $10k+ revenue levels).
Additionally, interest rates fluctuate, but are typically lower than credit cards.
Invoice financing and factoring
For many businesses that invoice clients and leave payment terms open (net 30 or net 60), waiting for those clients to pay can create temporary cash flow problems. Invoice financing allows businesses to offset expected payments as cash flow and borrow against them until due dates.
With invoice financing, the business maintains control of payment collection. With factoring, however, the factoring company buys the invoices outright and collects the money themselves, albeit at higher rates since that responsibility has been removed from the small business owner.
Both solutions work well for B2B companies with longstanding clients, although fees can add up quickly based on how long it takes for payment to come due. Typically fees amount to 1% to 5% of the invoice value.
Personal loans for business purposes
At this junction, things become interesting, and complicated. Many business owners initially use personal loans or lines of credit to fund their endeavors. For example, this could mean personal credit cards, home equity lines, or forbrukslån uten sikkerhet (consumer loan without collateral).
This is ideal for many business owners who cannot obtain traditional lending solutions at this time because personal loans are easier to obtain, they have quicker approval and do not require extensive records proving a successful business over several years before lending.
However, this creates risk with personal responsibility taking charge. If a business fails, personal debt continues; even unsecured loans implicate personal assets if things go badly. Furthermore, using personal assets for business purposes makes it more difficult down the line to establish business credit once separated entities are preferable moving forward.
Online business lenders
Increasingly common with technological advances, online lenders rely on alternative means of processing funds through automated systems versus traditional banks. This means they don’t require tax returns or credit scores but rely upon bank activity and online sales data.
They can approve loans in days versus weeks or months and are often more lenient with newer businesses or those with questionable credit scores. However, online loans usually come at higher interest rates than anticipated by banks, and merchant cash advances can be particularly high. Merchant cash advances allow lenders to evaluate future sales and take a percentage from daily credit card transactions until repaid; those APRs often reach triple digits!
Equipment financing
If any business needs to secure equipment, machinery or vehicles, equipment financing makes sense since it uses the purchase as collateral, even if such collateral isn’t necessary through traditional means.
Equipment financing provides lenders with peace of mind since the small business owner must repay the loan while using the collateral directly related to generating revenue. Lenders typically finance 80% to 100% of the purchase price; repayment mirrors depreciation so if small businesses know they’ll be using equipment for some time before needing to pay it back during its lifespan, this is a good option.
Crowdfunding and revenue based financing
Finally, crowdfunding has opened the last realm of possibilities. If an entrepreneur has a compelling narrative or created something unique that resonates with millions of small investors instead of one lender, crowdfunding can help connect the dots. For example, reward based crowdfunding allows pre sale opportunities or gifts for backers who contribute; equity crowdfunding sells off ownership shares.
Revenue based financing is becoming increasingly popular now with investors who want a percentage cut monthly based on gross revenues instead of fixed repayments until they receive a profit agreement for participating.
When revenues decrease month to month (like during summer months when foot traffic reduced in retail operations), repayment automatically decreases which helps businesses during these times.
Determine which works best for your needs
Ultimately, different financing works for different scenarios, a retail store with heavy inventory projections might benefit from a line of credit; a manufacturing company might need equipment financing; and those service offerings with countless outstanding invoices would benefit from invoice financing solutions.
However, it’s crucial to look beyond the surface level APR interest. What other fees exist? What’s the repayment plan? What’s it going to cost if things go bad? Sometimes bad looking financing with high APRs provides options that are worth paying for due to flexibility; sometimes attractive looking loans with APRs undercut businesses with restrictions and offers they cannot get behind.
Finally, business credit should matter in the equation, even if personal financing makes sense now; if an entrepreneur desires growth down the line with alternative avenues available (having secured new revenue), separating personal and business financing means personal expenses need to be kept separate across multiple platforms to transition gradually to business financing offerings down the line.
It’s clear that conventional options are no longer what’s best for an emerging small business; an array of options exist that empower entrepreneurs to create solutions that meet their small businesses without breaking their budgets in the process.
