It is all to common to hear the traditional Australian banks preaching their support for small businesses but falling short on delivery. Why? It is to costly for them lend to a small business. That is why there is a renaissance in small business lending!
A new wave of non-bank alternative finance startups (aka Fintechs) are listening to the cries of the capital constrained businesses and addressing a $60bn funding gap forged by the big banks. Fintechs are capitalising on a fresh canvas and building technology to not only understand risk better but also deliver a better customer experience.
So what are the alternatives available to a small business today?
Short-term loans have become a popular source of capital in the last 12-18 months with various players fighting for market share. Lenders can collect and analyse financial data quickly by integrating with a business' online accounting software and scraping data from their bank statements. With algorithmic data analysis, lenders determine the funding level and cost of funding within 24-48 hours. Generally this is classified as unsecured lending but it does sometimes require Personal Guarantees and floating charges over the business. Terms of loans can range from 3 months to 3 years. Overall costs (fees and interest rate) range from 20% to 65% per annum. Speed and service comes at a premium but the flexibility gives the borrower more control.
Well suited to a retail business utilising point-of-sale and who have a lot of low-value transactions, merchant finance provides advances based on card sales. Generally, this up to one month’s revenue and is a simple and straightforward solution given it bolts directly into the business merchant facilities. Repayment is made via revenue collected from the card provider. Convenience comes at a cost though with rates going as high as 70%. A few new players are delivering cheaper lines given they are using more streamlined technology.
Invoice finance (aka "Factoring") is a finance product tailored to cash flow management. Unlocking cash from the invoice receivables ledger, you are reinvesting cash back into your business and generating a greater return out of capital that would have otherwise been tied up on the balance sheet. To understand the intricacises of invoice finance click here.
Today there are innovative online platforms that allow provide a borrower absolute control and flexibility. Opposed to leveraging against your whole ledger, business or personal security, you select invoices you wish to get paid earlier opposed to waiting the extended terms of 30,60 or 90 days. Smart platforms use a combination of credit analysis, predictive analytics and invoice verification technology, to advance up to 90% of the invoice upfront. Once the invoice is paid the remaining amount is returned less a fee of 1.5%-3%. Being a pay as you go service and funding only against what you need, you have more control over cash flow needs but more importantly cost of capital.
An interesting financial product tailored to service-based businesses, fee funding is often used by service businesses like law firms and accounting practices. It allows their customer to nominate how they want to pay an invoice: say, monthly over a set period or in bulk at a later date. The funder will pay the business upfront whilst collecting payment from their customer as agreed. The main benefits are that is comes at no cost to the firm, improves cash flow for the firm and their clients, reduces credit control costs and improves customer relationships. Cost of funding is built into the repayment schedule and is estimated to be under 1% / 30 days
Traditionally, as an SME, there have been high-barriers to entry for raising equity with only venture capitalists, private equity or high net-worth Individuals providing the primary source of liquidity. The only alternative was to IPO which is a very expensive process and generally not advisable for a young business.
Online crowdfunding platforms allow investors to purchase a stake in a business. It serves as an effective mechanism for SMEs to unlock capital from many different investors. Spreading equity across multiple investors reduces concentration risk and generates greater funding appetite. In the UK, this has been open to retail investors, high-networth individuals and venture capital funds. With this wide investor base, these platforms also serve as powerful marketing engines for an SME to create awareness and develop close relationships with their target market.
Alternative finance providers are revolutionising financial services for small business by delivering capital quicker, smarter and friendlier. The biggest challenge for these new incumbents is TRUST. So how do fintechs build this trust with their clients? Time to take some notes out of other industries who have embraced technology for transparency. Read more about it here.