Last editedJan 20203 min read
This is a guest post by Funding Options
Although alternative finance has come a long way in the last few years, debt is still a dirty word for many businesses.
But the truth is, debt can be a tool that allows your business to grow, and it’s often a sign of prosperity rather than distress. Many dynamic companies find the cash injection provided by business finance is exactly what they need to give their growth plans a kick start, and there are more types of funding available to businesses than ever before.
The importance of working capital
Every business owner knows that it’s crucial to maintain healthy levels of working capital — doubly so if your firm is growing quickly. But many businesses grow too fast for their working capital to keep up, and suddenly there’s not enough cash available to invest in the next project that comes along. Nobody wants to turn down new customers, but without enough cash in the bank, you might have to.
Other fast-growing firms will get to a point where they risk “overtrading” — in other words, they risk running out of cash halfway through a job because of delays or increasing costs. In these situations, it’s critical to have working capital available at short notice.
Working capital finance
There are various types of business finance that can help you avoid these issues. The right fit for your firm depends on a number of things like your operating structure and the way you get paid by customers, but the good news is that there’s a wide range of finance available for a variety of business types and sectors.
If you get paid on terms via invoice, then there’s a few different invoice-focused products that could help. The most common are invoice factoring and invoice discounting, which are designed for your entire sales ledger.
The way they work is fairly straightforward. When you raise an invoice, the lender gives you an advance based on its face value. Then when the terms elapse and your customer pays, you get the remainder minus the lender’s fees. The lender’s advance is often in the 80–90% range, which means you effectively get paid faster, and can free up cash sooner to reinvest in the next job.
There are also new online products which allow you to finance a single invoice, commonly known as spot factoring. These lenders will usually have a portal where you can upload invoices as you choose, which means you can potentially have the cash within hours of uploading an invoice. They also tend to have simple all-in prices, rather than the confusing structures that can be more common with full ledger facilities.
Merchant cash advances
We’ve seen lots of innovation in fintech in the last few years. For example, businesses often prefer technology-led solutions like GoCardless, because they require less management intervention and reduce the hassle of chasing payments. Similar innovations have happened in business lending, and merchant cash advances are a great example.
They’re interesting for two reasons — first because the loan amount is usually based on average card machine sales, and second because although they don’t have a fixed term, the total cost is decided up front.
For example, a merchant cash advance might mean you get an advance equivalent to one month of card sales, based on the average of the last three months. You’ll agree up front to the total repayment amount which includes the lender’s fees, so in other words you’re effectively selling the lender some of your future card sales at a discount. But the crucial detail is that the timeframe for paying this amount back isn’t set in stone — because repayments are taken directly at the source.
Imagine the merchant cash advance specified an 80/20 split. In this case, a transaction of £100 would automatically repay £20 to the lender, while the remaining £80 would go to your business as normal. Then once the pre-agreed repayment amount is reached, everything goes back to normal.
The lender works with your payments provider, which means once it’s all set up there’s nothing you have to do — you’ll repay a little bit of the advance with every card transaction. For this reason, it’s a popular choice for businesses that make most of their money via card machines and need a short-term working capital boost to invest in growth.
Revolving credit facilities
One more area of alternative finance worth mentioning is revolving credit facilities. Businesses have found it hard to secure bank overdrafts in the last few years, and this area of the market is full of business overdraft alternatives.
Like overdrafts, you get a credit limit and pay interest on whatever funds are outstanding. But one key difference is the technology aspect — many of the providers in this space use clever automation to make very fast lending decisions, and you can often “top up” once you’ve repaid a set amount. They’re also not tied to a specific account, so they’re perhaps a bit more flexible than bank overdrafts too.
With a revolving credit facility set up, you ’ve got a useful safety net that will provide much needed working capital if you’re caught out. Crucially, the ‘revolving’ aspect means you don’t have to borrow anything if you don’t need to — so it may be a comfort if your working capital position is becoming a careful balancing act during a big project.
These are just a few of the products that can help businesses fund growth. But it doesn’t matter whether you make money via invoices, a card machine, or something else. The key thing to remember is that debt isn’t just for businesses in trouble — it can also be a very useful tool for growth.
Conrad Ford is Chief Executive of Funding Options, recently described by the Telegraph as “the matchmaking website for small businesses and lenders”. Funding Options has been selected by HM Treasury to help businesses find finance when they’re unsuccessful with the major banks, as part of the Bank Referral Scheme that launched in November 2016.@FundingOptions