Since the recession of 2008/2009, there has been a significant reduction in the ability of banks to lend to British SMEs.
Whilst mainstream finance is still great for some businesses, many banks now have lending criteria that small businesses are unable to fulfill.
Fortunately, ‘alternative finance’ can offer a viable substitute for entrepreneurs looking for innovative and flexible ways to fund their business growth.
But before blindly assuming alternative finance is the answer to all your financial woes, there are six things you need to understand before you approach an alternative finance provider looking for funding.
1. There are many different forms of ‘alternative finance’
The term ‘alternative finance’ is a catch-all phrase that describes a number of very different funding arrangements for UK businesses.
From peer-to-peer lending to equity-based crowdfunding, invoice financing, commercial mortgages and flexible loans from online lenders, alternative finance includes multiple instruments that exist outside of the traditional banking system.
Crowdfunding, for instance, involves pooling small amounts of money from many investors through internet platforms, with equity or other rewards offered in return.
On the other hand, peer-to-peer lending (P2P) platforms allow investors to invest in loans for small businesses, in exchange for an attractive rate of interest.
These platforms are distinct from traditional lending platforms in that they’re based online, and don’t require you to book in some time with your bank manager, which can often take weeks.
The Department for Business, Energy and Industrial Strategy also provides a number of loans for UK SMEs, while there are several programmes lending money at local, regional and national level to startups and growing businesses.
These include the Funding for Lending Scheme, the Enterprise Finance Guarantee and the Business Finance Partnership, which have been created as part of the Central Government’s remit to encourage economic growth.
With an abundance of different funding options available, there should be a loan out there that suits your business needs perfectly.
2. These different types have… different types
When businesses are redirected to alternative providers by the banks, they might discover funding solutions that they did not know even existed.
Revenue-based finance, for instance, is a relatively new type of finance, at least for UK businesses.
First introduced in the USA, it works differently to traditional loans, allowing companies to share an agreed percentage of their monthly revenue with a lender, rather than a fixed monthly repayment.
Because it’s aligned with a company’s revenue, it means a business will repay less in months when sales are lower, and more when sales are higher.
For example, if a company has agreed to share 10% of its monthly revenue with a lender, it will repay £1,000 in a month when sales are £10,000, and £500 in a month when sales are £5,000.
Revenue-based finance is therefore an attractive option for seasonal businesses, as it means they don’t have to worry about making a large repayment in a month when sales are comparatively low. Rather than repaying over a fixed term, a business will share an agreed percentage of its revenue with a lender until the balance is paid off in full.
Many of the fixed-term loans offered by alternative lenders also come with a range of flexible features, including top-ups and repayment holidays, with businesses able to select the lending terms that suit them.
Matching an appropriate financial product to your specific requirements will reduce financial risk and business exposure. Whilst, at first glance, alternative finance may seem more expensive, this level of flexibility means it could be more cost-effective for your business in the long-term.
3. It’s time-effective and efficient
Most business owners are time-poor. As such, lengthy application processes may act as a barrier to funding. Using new financial technology to their advantage, alternative lenders are often faster and more agile when it comes to meeting the funding needs of smaller and growing businesses.
One of the most established technological innovations is e-commerce lending, which uses live data from online marketplaces such as eBay and Amazon to drive lending decisions.
Businesses that trade online are able to get quotes very quickly, largely due to clever technology that looks at ratings data, payment accounts, seller status and even social media followings to produce a basis for lending.
Sometimes it is possible to have money in your account within minutes – a timeframe that is unheard of with traditional bank loans.
4. Understand your cash flow
As obvious as this may seem, cash flow is not a synonym for profit, but is the total amount of money being transferred into and out of a business. It is one of the major challenges you’ll have to overcome if you’re looking to survive and succeed as a business.
The state of your cash flow will play a big role in determining the need for alternative finance.
As a business owner, you need to forecast for the months where profits may look healthy but your outgoings far outweigh the incoming capital. Soon, this will turn into a habit of timely payments and cost-effective spending.
By building up a good awareness of cash flow habits and putting these into practice, it means you will know to only take out alternative finance when you need it the most.
5. Review your assets and credit rating
Before you begin any application for a business loan it’s crucial you review your credit rating. A perfect credit score is not essential when seeking funding for your business, but a strong one certainly helps.
Do not be alarmed – this does not mean you need to have high revenue to qualify; sometimes the best credit scores can come from lower turnover companies.
A positive credit score will show alternative lenders that you understand your capital, can manage to pay invoices and file returns on time, this making you appear like a trustworthy candidate for a loan.
Therefore, if your credit score is low, try to take steps to improve this before you apply for a business loan or seek finance.
6. Don’t just hit “I Agree”
As with any industry, there will always be some sites that promise you the world but stitch you up with high interest rates, inflexible repayments and hidden surprises. Make sure you read every part of the agreement, so nothing is left to assumption.
The most reliable and transparent alternative lenders will assign you a dedicated account manager, who will happily answer any query you might have. It is important to use all the resources at your disposal when it comes to applying for alternative finance.
About the author
This article has been written exclusively for ByteStart by Peter Tuvey, co-founder and managing partner of Fleximize, the UK’s first revenue-based finance provider.