Four finance options outside the banks: How to navigate alternative lenders

You’ve hit a cash crunch.

You’re not sure exactly how, but you think it was a combination of sluggish sales last month and the deposit you just paid for the next lot of inventory.

Coupled with the tax debt the accountant just surprised you with, you’re left feeling anxious as to how you’re going to make next month’s payroll.

If you’re in this scenario, it’s likely you’ve already considered asking your bank for an overdraft facility. 

You may have even tried Google and left even more confused.

The market for business lending has exploded in recent years. Traditional banks are launching new products. New fintech loan providers have sprouted.

The most challenging part for you is deciding who to go with. Who has the cheapest rates? What is the best facility for my requirements? 

I’m going to cut right to the chase and help you navigate the world of alternative lending, where knowing some basics can save you thousands.

The four main types of business financing

1. Invoice finance

   Immediately turns your accounts receivable into cash.

2. Trade finance

   A revolving finance facility pays suppliers, allowing you to defer payments.

3. Working capital finance

   A general loan to fund short-term cash needs.

4. Asset finance

   A loan to fund equipment and general capital purchases.

Invoice finance

Invoice financing is a way for businesses to borrow money against invoices owed from customers. Instead of waiting 30, 60, or even 90 days to get paid, financiers pay you upfront and collect the debt from your suppliers for a fee/interest rate.

Trade finance

Trade finance is a type of ‘line of credit’ facility that you use to pay suppliers. It’s mainly used for inventory purchases. It works like this:

• You upload the supplier invoices you want to be funded, up to the limit of the facility;
• The financier ‘pays’ your supplier; then
• You have up to 120 days to pay back the financier, including interest.

Working capital finance

Working capital finance is a more broad type of funding, where the financier loans you a lump sum of cash. How you spend the cash is up to you, hence why it’s considered a more flexible form of financing compared to trade finance. 

The trade-off for this flexibility is often a higher interest rate.

Repayments terms vary across financiers but are commonly repaid on a percentage of revenue basis.

Asset finance

Asset finance is a type of debt used to purchase equipment, like a motor vehicle. The loan terms vary, but are typically between 3 and 5 years.

Special mention: credit cards

I’ve thrown this in here for good measure because credit cards can be a great form of finance. Small business AMEX limits can go up to $150,000+, making credit cards flexible, accessible, and cheap — as long as you pay it off before within the interest-free period.

The key point here is before jumping ahead with an online lender, firstly understand what type of loan facility you need. For example, many founders resort to short-term working capital facilities, but would actually benefit more from a revolving trade finance facility.

If you’re unsure about the best facility, ask your accountant or finance broker.

Now that you’ve decided the type of facility you need, let’s dive into what to look for when assessing the financiers.

What’s the real cost of debt?

To calculate the cost of your financing, you need to factor:

• The effective interest rate of the loan; and
• Any fees and charges.

There may be some math required as there’s often little consistency among the financiers. Some charge an annual interest rate; some take a percentage of the borrowed amount. 

Whenever you’re assessing the loans and terms, make sure you’re comparing the effective interest rate.

Information requirements

The other consideration is the speed of the loan. A common frustration with dealing with traditional banks is that the process to get finance is a long and often arduous process.

Many online lenders can give almost instant offers as they integrate to your online accounting system, like Xero, allowing them to make an instant credit assessment of your business.

Whatever you do, ensure you leave enough time and are strategic about your funding choice. You don’t want to be that founder that resorts to “opportunistic lenders” that charge premium interest rates.

In other words, plan ahead. Get this financial foresight by maintaining a cash flow forecast and ensure you match the right type of funding with the right need.

Don’t fill up a leaky bucket

As the world of online lending continues to grow, there is a risk that business owners fall into the trap of relying on financing just to stay afloat, rather than fixing the underlying issue.

If you’re suffering from cash flow issues, speak to your accountant to help you diagnose exactly why you need more financing. 

Is it because you have an unprofitable business? Perhaps you’re just carrying too much stock? 

If you don’t resolve the underlying issue, getting access to new finance may compound your problem as it can create a high interest rate debt spiral. In the worst case, it could send you broke.

There’s no point filling up a leaky bucket.