The rise of alternative finance has resulted in greater access to funding options for SMEs. With more financial products and lenders now available, business owners no longer have to settle or compromise. Instead, they can take the time to find a product that works best for their business.
If you’re unfamiliar with the business finance landscape, it can be hard knowing where to start. For this reason, it’s a good idea to keep certain factors in mind when doing your research. This will help prevent you from making the wrong decision, which could harm your business’s future growth.
We’ve pulled together 5 important tips and questions to ask yourself when narrowing down your finance options.
1. Why does your business need finance?
The best way to start is to sit down and identify exactly what it is you need to raise funding for. The type of finance you end up choosing will be largely determined by its purpose, as well as how much it costs and whether it is needed over the short-term or long-term.
Generally speaking, business finance products can be divided into two categories. Those that are spread out over longer periods, and those that are better suited to more immediate needs.
Perhaps you are in your early stages of trading and need to fund set up costs. Alternatively, you might be suffering from cash flow issues and simply in need of extra working capital to tide you through.
From paying staff wages, to funding growth and expansion plans, you need to be certain about what your funding will be used for and calculate the expected return on investment (ROI).
2. Which type of finance best meets your business’s needs?
There is no one size fits all when it comes to obtaining finance. As there are lots of different options available, your decision should be based on individual business needs.
For example, if you are looking to obtain new equipment or machinery, asset finance could be a great place to start. On the other hand, if your business suffers from poor cash flow, invoice finance is a low cost way to access fast, short-term funding. Different types of business finance include:
- Business loans (secured and unsecured)
- Cash advance
- Invoice finance (selective, factoring, discounting)
- Lines of credit
- Asset-based finance (hire purchase, finance lease, asset refinancing)
- Business credit cards
- Angel investors
- Peer to peer lending
- Venture capital
3. What is the financial risk?
As with any business decision, there is going to be a certain amount of risk involved. The two questions you need to ask yourself are:
- How great is the risk?
- What is the potential impact in the event things go wrong?
If your business already has volatile operating profits, or regularly finds itself in cash flow deficits, then you should not consider high levels of borrowing.
It’s important to find out what the consequence will be if you are unable to meet the terms of the finance, as this could have an even worse impact on your business in the long term.
You also need to think about whether or not your business is going to be perceived as higher risk by a lender. If you are a startup, or your business has a bad credit score, then you might find it difficult to secure certain types of funding. This is because your business presents greater risk than more established businesses that have a proven track record of successful borrowing.
4. Have you considered all associated costs and fees?
Ideally, you will be searching for a business finance product that provides you with maximum funds for minimum cost. When doing your research, avoid solely looking at the loan amount. You also need to consider interest rates, fees and the associated costs of borrowing.
When you factor in these additional expenses, some finance options end up being far more expensive than others. If you’re having trouble figuring out the total cost you’d need to pay, a loan calculator can be helpful.
Be sure not to make the mistake of borrowing more than your business can afford to repay.
5. Does the repayment structure work for your business?
Another important factor to consider is repayments. Different lenders have their own terms and policies for reclaiming money owed, but ultimately you should be sure your business can comfortably meet repayments to avoid defaulting and ending up in greater debt.
When it comes to business loans, it is customary to be / you can expect to be asked to make fixed monthly repayments at a pre-agreed interest rate. This means that you will need to set aside enough money each month to ensure you can pay off each installment over the loan term.
Finding financial freedom
The saying there’s no such thing as a free lunch is especially true when it comes to your business’s finances. Unfortunately, there will always be a level of return required when you choose to borrow money for your business. However, some types of business finance are more cost-effective than others…
Penny aims to give businesses financial freedom, which doesn’t involve locking customers into expensive monthly repayments over long terms. Instead, they provide small businesses with quick access to invoice finance in return for one, small fee.