Understand the range of alternative business finance products available
Asset-based lending, factoring, invoice discounting, and merchant cash advances, and unsecured business loans are a few alternative forms of business finance that are becoming more popular. Although these forms of funding can help companies make it through tough times, business owners and managers need to be aware of their shortcomings.
Companies that are unable to secure traditional bank funding can turn to asset-based business finance to cover their needs. With asset-based finance, a company uses its assets as collateral to secure structured working capital or term loans. If the business is unable to repay the loan, the lender takes the asset that secured the loan. Asset-based loans can be secured by a range of assets including machinery, equipment, accounts receivable, inventory or real estate.
In its most basic form, asset-based finance involves tangible assets. A business can pledge one or more its assets as collateral to secure a loan. Once the loan is repaid, the lender no longer has a claim on the asset.
With factoring, a business sells its accounts receivable at a discount to a third party, called a factor. The business receives its funds immediately. The factor takes ownership of the receivables and assumes the right to collect on them and takes on the risks of non-payment. Factoring is not a loan, so the factor isn’t concerned with the firm’s creditworthiness but looks at the quality of its accounts receivable. The main drawback for the business is that it doesn’t receive the full value of its receivables. This amount forfeited can be high in percentage terms when compared to traditional forms of business finance.
Firms wanting to improve working capital and cash flow positions can use invoice discounting, also called invoice finance or debtor finance, to borrow a percentage of the value of their receivables. Under these arrangements, the business gets access to a revolving line of credit (sometimes up to 90% of the value of outstanding invoices) which it can draw upon. For the service, the lender charges fees and interest on the amount borrowed.
Like a business overdraft, the business only pays interest on the funds borrowed. In most cases, confidentiality is maintained so that customers and suppliers don’t know the business is borrowing against its receivables.
The main drawbacks of invoice discounting are its high cost compared to other business finance options and the loss of the company’s flexibility to make other finance arrangements once receivables have been dedicated as collateral. Businesses can start to rely on the improved cash flow invoice discounting brings and may find it difficult to leave the arrangement.
Merchant cash advances
A growing number of businesses needing a quick solution to cash flow challenges are turning to merchant cash advances (MCAs) as an alternative business finance option. Merchant cash advance providers offer businesses a lump sum payment in exchange for a share of future credit card sales. This form of business finance has become popular among retail, restaurant and service companies that have strong credit card sales but have poor credit ratings and little or no collateral.
Under an MCA arrangement, the provider collects a set percentage of the company’s daily credit card sales until they recover the amount they advanced plus a premium. The advantage for the business is quick access to funds without the need for a strong credit rating or collateral.
The main drawback of MCAs is their high premiums, which can be over 30% of the money advanced. This has led some to refer to MCAs as ‘payday loans for businesses’. Unlike traditional lenders, MCA providers don’t fall under finance regulations because they are buying receivables, and not making loans.
Unsecured business loan
Unsecured business loans are growing in popularity as an option for SMEs to get the business finance they need. The fact that 66% of business owners in Australia don’t own property makes it almost impossible to get a secured business finance, unless they can pledge some other asset. Companies offering unsecured business finance use cutting-edge technology to evaluate the ability of the business to pay the loan. This includes safely and securely checking bank transactions and credit scores online. Based on this analysis, a decision about providing the unsecured business loan can usually be made within 24 hours and, if approved, funds will be transferred to your account immediately. Go to Unsecured Business Loans for more information.
Stricter lending criteria from banks have made it necessary for companies to look at alternative forms of business finance. Although these can offer benefits, they need to be scrutinised. Read the fine print and make sure you understand all the rates and fees involved before making a decision on any alternative business finance option.
Learn more about the business finance options available in The Complete Guide to Business Loans in Australia.