Finding a way to raise capital can be one of the most challenging and important tasks for a business owner. While traditional bank loans are often the first solution that comes to mind, strict lending criteria makes this option unavailable for many small business owners.
For SMEs in operation for less than 5 years, banks reject 38% of business loan applications. With a high rejection rate, it’s no surprise that many business owners turn to alternative small business finance solutions.
There are many ways to raise capital without getting into long-term debt or putting your home at risk. In this post, we’ll compare some of the most used small business finance solutions to help you find a funding option that’s right for you.
8 Alternative Small Business Funding Solutions
1. Asset-Based Lending
Asset-based lending is a finance solution that enables a business to release capital from the assets it already owns. For example, if you run a logistics business and have lots of your cash tied up in your fleet of vehicles, you can use those assets as collateral to secure funding through asset-based lending.
The finance company will provide a cash advance, and you make regular repayments until you have paid back the principal and interest. This form of funding can be an effective way for businesses short of working capital to unlock the cash they have tied up in their assets. You can get a fast cash injection and still be able to use the equipment and machinery you choose to refinance.
2. Lines of Credit
A line of credit works similarly to a bank overdraft or credit card. The financier will provide access to an agreed amount of credit. The business can draw down and repay the credit as and when it is needed to support working capital. Interest is only charged on the amount of credit that is used.
Typically, lines of credit are for more substantial amounts than a business could access through an overdraft. This form of small business finance can support a company’s cash flow needs but generally should only be used for short-term debt. The rates of interest and fees can be high if the credit is used for long-term funding.
3. Invoice Finance
If your business offers extended payment terms to its customers, you could benefit from an Invoice Finance facility. This finance solution is designed for companies that suffer cash flow gaps due to net payment terms and late-paying customers.
According to the ASBFEO, nearly 40% of Australian small businesses suffer from cash flow pressures due to late-paying customers. Small businesses that sell to large companies are especially at risk, with 50% of their invoices paid late on average.
Invoice Finance allows you to turn your outstanding invoices into an immediate cash flow injection. You can receive up to 95% of the invoice value as a cash advance. Once your customer has paid the invoice, the finance company will pay you the remaining balance of the invoice less fees.
To qualify for Invoice Finance, you’ll need to raise invoices for your products and services, and your customers will need to be creditworthy. Invoice Finance is an umbrella term that covers factoring and discounting.
Read our guide Invoice Discounting vs. Factoring to see which solution is best suited to your business.
4. Merchant Cash Advance
While Invoice Finance is designed for businesses that sell to other businesses, a merchant cash advance is better suited to those that sell directly to consumers.
A merchant cash advance is a type of small business finance that allows a company to use its future credit card sales as collateral to access immediate funding. You can receive an upfront cash advance based on your average card sales income.
The cash advance is repaid automatically over a set period. When a customer pays by card, a percentage of the sale income is deducted to repay the principal and interest.
A merchant cash advance can be a good option for businesses that process a large number of card payments and have seasonal sales fluctuations. The amount you repay is tied to your card sales revenue.
To find out if this type of small business finance is right for you, read our post, The Pros and Cons of a Merchant Cash Advance.
5. Equipment Finance
Equipment Finance is a funding solution that enables businesses to purchase the equipment they need and spread the cost over a more extended period.
The financing company will purchase the asset so the business can immediately put it to use. The business will then make regular repayments to cover the value of the asset plus interest. Depending on funding facility terms, the business will take ownership of the asset after the final repayment is made.
This form of small business finance can be an effective solution for companies that lack sufficient capital to purchase or replace equipment. You can access the tools, machinery, and vehicles you need to expand and increase your capacity and use the additional revenue generated to cover the cost of the finance. Payment terms range from 24 to 60 months, and funding can be used to purchase both new and second-hand assets.
6. Trade Finance
Trade Finance is a flexible type of small business finance designed to help companies release the capital tied up in the supply chain. You can use the increased liquidity to fulfil larger orders, offer extended payment terms to customers, speed up sales cycles, and boost revenue.
For buyers, Trade Finance can provide a revolving line of credit to increase your purchasing power and pay your international and domestic suppliers. Trade Finance can also include Letters of Credit, Documents Against Payment, and other financial instruments to help reduce the risk of dealing with international suppliers.
For sellers, a Trade Finance facility can help you bridge cash flow gaps caused by extended payment terms and maintain liquidity to take on more orders and speed up your sales cycles. Instead of waiting for your invoice to clear, you can get paid upfront and immediately reinvest the funds into your business.
Crowdfunding has seen a considerable increase in popularity over the last decade. You can raise capital by promoting your business on a crowdfunding platform and asking for contributions from investors and potential customers.
Most crowdfunding campaigns involve an exchange of equity for investment, but you can also offer future rewards or products as an incentive for contributions.
However, the average crowdfunding campaign generates less than $700 AUD. To gain traction and raise enough funding, you’ll need to provide an innovative service or product and be prepared to dedicate significant time to marketing and promotion.
8. Business Credit Cards
Business credit cards are one of the most well-known forms of small business finance. The lender will set a credit limit, and you can use the card to cover purchases and short-term cash flow gaps. Card providers may charge an annual fee for the credit facility, and you’ll need to make regular repayments to cover the principal and interest.
Most business credit cards offer an interest-free period of 30+ days. If you clear the balance in this time, credit cards can be an affordable short-term funding solution.
But fees and interest can quickly mount up if you don’t clear the balance. You can fall into expensive long-term and damage your credit score if you don’t manage your business credit card correctly.
Finding the Right Small Business Finance
There are plenty of options when it comes to small business finance. Even if you’re one of the many business owners that don’t qualify for a bank loan, you can use one of the above funding solutions to raise capital.
As with any financing, you should take your time and avoid rushing into any funding arrangement. Ensure you understand the terms, check the interest and fees involved, and know the pros and cons before deciding on the right option for your business.
If you need help securing the capital you need to grow your business, contact the friendly team of business finance advisors here at ScotPac. We’ll help you to understand your options and find a funding solution that works for you.