19/06/2015

By Philip Brennan, head of businesscomparison.com

For small and medium-sized enterprises (SMEs), accessing initial start-up finance or funding for growth can be a daunting and stressful prospect. While bank lending is on the rise, the selective nature means many businesses are still struggling to access the finance they need.

With an increasing amount of alternative finance options available away from traditional institutions, the problem for businesses is now knowing what is out there, and which solution is most suited to them. Here, our quick guide can help put you on the right path.

Invoice finance
Good for: Access to significant line of credit.
Potential costs annualised: 16-25%

Invoice financing draws money from outstanding business invoices. It’s a quick, short-term solution that can help solve temporary cash flow issues. For a fee, investors will advance up to 90 per cent of invoice value, meaning access to funds that could otherwise take up to 120 days to come through. This service is commonly offered by high street banks, however challenger brands such as Bibby, Aldermore and Shawbrook offer comparative rates and slick application processes, although this does incur an extra cost.

As lenders only advance commercial invoices, this method is most suited to companies that mainly sell to other organisations. It’s also a good option for businesses which are expanding quickly, as available finance will grow in sync with a customer base.

Working capital/Short-term lending
Good for: Quick applications and access to funds.
Potential costs annualised: 20-60%
This area has seen the largest number of entrants over the past few years. As these businesses are new they often use the latest technology, so they can offer a much easier process than other options. However, they can become very expensive if a business becomes reliant on them as a long term credit solution.

Working capital can be similar to invoice financing, as it is a short-term loan that provides businesses with quick access to funds to cover the day-to-day costs of running the business. This option allows businesses to protect their credit rating and hold a good reputation with suppliers and vendors by making payments in a timely manner. It is most suited for companies looking to generate funding through the receipt of outstanding payments.

Asset finance
Good for: Buying new equipment or releasing value of your existing assets.
Potential costs annualised: 3-25%

Investing in assets is business critical. However, it’s often a costly task, and the upfront fee can be an issue for SMEs. Asset finance funds this process by breaking down these payments into manageable chunks over an extended period of time, having less impact on a company’s cash flow. This can be done in several ways, including through leasing, hire purchase or contract hire. This option is especially suitable for businesses that rely on expensive equipment or large machinery, such as manufacturing, IT and agriculture companies.

Merchant cash advance
Good for: Flexible payments related to turnover.
Potential costs annualised: 30-60%

Merchant cash advances pay back finance based on existing or predicted credit and debit card sales. The ‘pay as you earn’ nature means a more manageable loan that reflects the business performance — you’ll only pay what the business can afford each month. The flexibility is a key benefit, however it can be a more costly choice than a traditional loan as the agreed advance often takes a percentage of sales made.

This option works well for retailers or businesses that use card terminals for regular transactions, and is also a useful option if a business doesn’t have a clear credit record. As you can see by the annualised APR this can be expensive so make sure you review other options before you make your decision.

Peer-to-peer finance
Potential costs annualised: 7-20%
Good for: Potentially quicker than banks and with comparable rates.

Peer-to-peer, or P2P as it’s commonly known, matches willing investors and businesses through an online pairing process. The industry became regulated in 2014, so funding can now be secured or unsecured, depending on the lender, and usually consists of monthly fixed repayments. Rates are often competitive, but it is important to bear in mind that P2P lending requires full business financial records, so for fledging SMEs this may not be the best option.

Equity crowdfunding
Good for: Companies looking for investment.
Potential costs annualised: n/a

Crowdfunding is an increasingly popular funding option for businesses. It refers to the practice of raising cash contributions from various investors, normally via the internet. Anyone can put a project or company forward for investment, but they must be able to explain why investors should offer monetary contributions and what the funding will be used for. Sites like Kickstarter, GoFundMe and IndieGoGo all require a target to be set, and if this isn’t reached, backers will be refunded. Only businesses willing to lose a percentage of their ownership should put themselves on these platforms.

While it may seem like second nature to visit a high street bank for funding, it can be a real set back if a business loan application is turned down. Having a clear understanding of a company’s needs and the alternative finance options available from the outset can make starting a new business or expanding a current entity a much smoother task.