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5 alternatives to bank loans

The Best Financing Alternatives to Business Loans

From invoice finance and asset finance, to crowdfunding and business credit cards – the range of funding options open to small and medium sized businesses has never been bigger.

For years, a business bank loan was the “go-to” option for any business that needed to secure additional capital.

However, while easily accessible at the point of service, the stringent requirements of a traditional bank loan effectively put’s this funding source is out of reach for many small and even medium-sized businesses.

Thankfully, there are alternative funding sources available and range of finance options for businesses has increased in recent years. No matter the nature of your business, there is more than likely, a finance option available to you.

A New Challenge: Choice

With a greater range of financing options available, the new challenge for a business owner becomes choosing the most suitable funding source. One that meets the needs of your business, at a cost – be that financial, business or personal – that’s acceptable to you.

We’ve rounded up five popular alternatives to business loans, which together, provide viable financing options for any type and size of business.

To help evaluate these alternative funding options, let’s remind ourselves of the advantages and disadvantages of a business loan.

Advantages And Disadvantages Of Business Loans

Business loans are often used for larger investments – for example purchasing office space or equipment. A business loan is typically paid back in monthly instalments, at a fixed interest rate. 

Business Loan Advantages

  • Convenience – Approaching a bank about a business loan is straightforward and convenient. And while the application process can be lengthy, it still compares favourably with the time it would take to (for example) approach, negotiate with and broker agreements with investors.   

  • Lower Fees & Interest Rates – Few funding options based on a loan will be able to compete with the low interest rates offered by banks. (Note: not all funding models are based on a loan – we’ll look at Crowdfunding later in this article).

  • No Interference – Most investors would expect a stake in your business, and a share in any future profits, in return for investment in your business. They may also have their own ideas as to how the money is used. A bank on the other hand, is simply interested in whether you are paying back the loan as per the agreed repayment schedule.

Business Loan Disadvantages

  • Strict Eligibility Criteria – Ultimately, for many small businesses, a traditional bank loan is simply unattainable. Banks have strict, non-negotiable conditions attached to their loans. In 2019 (pre-pandemic), statistics showed that traditional lenders approved only 28% of small business loan requests.

    Small and start-up businesses without a significant financial and trading history face more barriers than others. Banks see the loan as especially risky, rejecting many applications and attaching higher interest rates than to those who are established and are successful.

  • Inflexibility – Whereas investors may be open to negotiation, banks will expect the agreed repayment schedule to be adhered to – no matter the fortunes of your business.

  • Partial Funding – A bank may decide to approve a loan to a business, but not the full amount requested. This is problematic for a business owner who has waited patiently for the application process to take its course, and now has to choose between looking at other finance options, or adjusting their plans based on a smaller loan.

The Alternatives To Business Loans

Invoice Finance

Many B2B businesses sell goods or services on a credit basis – allowing customers to pay within 30, 60 or even 120 days.

Invoice Financing (invoice factoring or invoice discounting) is where a business borrows money against those unpaid invoices (or “accounts receivables”). The lender will take a percentage (or fee) of each invoice amount in return for advancing the money before the invoice is paid. 

Invoice financing doesn’t give a business additional funds, but it does allow businesses to access cash quicker. This “early access” can help a business manage cash-flow, or re-invest profits quicker than they would otherwise be able to.

Invoice Factoring is a type of invoice financing whereby the lender also takes on the responsibility of collecting unpaid invoices. You can expect to pay higher fees, but could benefit from not having to deploy time, focus and manpower chasing payments.

Whereas, Invoice Discounting operates in the same manner, but you or your credit control team need to chase and collect unpaid invoices.

Invoice Finance Advantages

Funds are borrowed against unpaid invoices, as opposed to assets owned by the business. As such there is no risk of having assets seized, or incurring damage to business or personal credit ratings. 

Invoice finance is a great alternative finance option for B2B business with a healthy order book. The funds are often released and paid into your bank account within 24 hours of raising an invoice.

Invoice finance facilities can also expand as the business turnover increases, allowing the business to access more cash more readily. Whereas, bank overdrafts and loans tend to be limited to the value of any security guarantees offered.

Two common invoice finance uses include: construction invoice finance and transport invoice finance.

Invoice Finance Disadvantages

Invoice finance does not give a business access to additional capital. It unlocks funds which would eventually become available – assuming your client did not default on the payment.

It’s not suitable for B2C businesses whose customers pay at the point of purchase, and is less suitable for start-up businesses with very few transactions.

Asset Finance

Asset Finance loans typically fall into two categories:

1) – A business borrows money to acquire a new asset, against the value of the asset itself.

For example, a construction company will need specialist equipment such as excavators. If they require a new excavator, the owner could use business asset finance to obtain it. This could be acquired by two forms of asset finance:

A Hire Purchase agreement would allow the construction company to pay the lender for the excavator in instalments. Full ownership of the excavator will transfer to the company once the asset has been paid for in full. Any repairs or maintenance are the responsibility of the construction company.

A Lease Agreement is a more favourable option if the construction company wishes to reduce the upfront costs. It is almost the same as a hire purchase agreement, however, the lender pays any VAT on the excavator upfront on behalf of the construction company.

They then apply VAT to the monthly payments – so this spreads the VAT liability over a longer period. This is really helpful for start-up companies or those who are not VAT registered yet.

2) – A business borrows money against the value of an asset which it already owns, to release capital that can be used elsewhere in the business.

For example, if the construction company already owns an excavator, they could use Asset Refinancing to borrow money against the value of that asset, releasing funds to re-invest elsewhere in the business (for example in marketing or purchasing materials). 

Asset Finance Advantages

Hire purchase and leasing equipment allows a business to invest in assets without building up significant cash reserves in advance to pay for them. Asset refinancing helps a business access capital without time-consuming processes such as applying for a business loan or seeking investors.  

Asset Finance can be ideal for businesses with significant physical operations, large quantities of stock or assets such as vehicles.

Asset Finance Disadvantages

In the event that a business cannot keep up with their repayments, the assets may be seized. This will cause disruption to their operations and ability to service clients.

With an asset finance lease (or capital lease), the business is also responsible for the disposal of the asset at the end of the agreement, for example, selling the asset.

This incurs time and resources that the business may not be able to afford.

Crowdfunding

Crowdfunding is where a business looks to raise funds by appealing to small investors or “backers” – usually via online platforms such as Kickstarter and Indiegogo.

A business can use these platforms to explain who they are, what backers’ cash will be used for and what rewards the backers will receive in return.

Typically, with crowdfunding, a large number of backers contribute relatively small amounts of cash, with the collective goal of reaching the total target amount.

The three most popular types of crowdfunding are:

Reward Crowdfunding – In return for their contribution, backers are offered rewards such as early access to the product or service, or exclusive gifts and merchandise.

Debt Crowdfunding – Backers receive fixed-interest payments over a period of time until their investment is repaid in full (and usually with interest).

Equity Crowdfunding – Backers receive shares in the project, business or product in which they are investing.

Crowdfunding Advantages

Crowdfunding can be a way for a business to fund projects or products that may not appeal to traditional investors or banks. Crowdfunding relies on a business successfully communicating an idea, as opposed to a demonstrable financial and trading history which are vital to obtaining a bank loan.

Crowdfunding is ideal for start-ups with a genuinely unique or innovative idea – one that might appeal to small investors all around the world.

Crowdfunding Disadvantages

Crowdfunding is often an “all or nothing” funding model. A business must set a target funding goal and, if that target is not reached, each small investor will have their money returned.

According to Kickstarter’s own data, just 38.85% of projects are successfully funded, with 11% not raising a single penny.

Unfortunately, to have a successful crowdfunding project, you need significant marketing effort to raise awareness, and to create videos and images that bring a project to life.

Government Backed Small Business Loans

Governments have recognised the challenges some businesses face in obtaining a traditional business loan from a bank or similar institute. In the UK, it’s possible for businesses to apply for government backed new business loans.

The loans offered under these schemes typically have lower interest rates, smaller down payments and longer repayment periods. They allow more businesses to access larger amounts of capital than a traditional loan. 

Start Up Loans in the UK offers government-backed personal loans for individuals looking to start or grow a business in the UK. The loans are specifically designed for businesses who struggle to access other forms of finance and up to £25,000 is available per individual.

Government Backed Loan Advantages

Government backed start-up businessloans are more accessible, have lower interest rates and come with the option of longer repayment schedules.

When approval for other types of loan or finance have been exhausted, on paper at least,these loans are suitable for any small business looking for a UK small business loan.

Government Backed Loan Disadvantages

While requirements are less stringent, application processes and approvals can be time consuming and slow. Lending decisions are based on your personal credit history and the applicant will bear responsibility for repayments.

To increase the chances of being accepted, successful applicants may have to rely on a good personal credit score.

One area of Government backed loans which often catches out applicants, is in relation to the availability of loans in their local areas.

For example, as these types of loans are administered by local authorities, funding which is available through local authorities in Manchester, is unlikely to be offered to a business in Birmingham, even though it is seen as being backed by the UK Government.

Business Credit Cards

Business Credit Cards are a short-term finance option which offer a way for businesses to finance ongoing expenses and manage cash-flow.

The amount a business can borrow using a credit card is almost always lower than what they could access via a business loan. However, the convenience of using credit cards is the main advantage.

It’s much easier for a business to get approved for a credit card than a business loan. Once approved, the business has access to a revolving line of credit to help purchase goods, services and materials.

This might allow a business to buy materials sooner than they otherwise could, or free up capital for use elsewhere in the business (for example, paying employees).

Business Credit Card Advantages

Application criteria for business credit cards are much less stringent than business loans. Nor do businesses have to borrow against their assets, and therefore, risk losing them.

They are ideal for small businesses which need to access small amounts of flexible day-to-day working capital.

Business Credit Card Disadvantages

Business credit cards typically come with high interest rates attached, so penalties for late payments are high. The amount you can borrow is typically smaller than a business loan or the other types of finance mentioned.

Conclusion – Which alternative business finance solution is the best? 

The answer to this question depends on why a business is seeking finance.

If a business is exploring finance as a way of managing cash-flow or being able to make investments quicker – Invoice Finance or Business Credit Cards are likely to be the most suitable options.

These alternative financing options are easier to obtain and can be accessed much quicker than a bank business loan.

If a business is looking for a one-off, potentially more significant injection of capital – Asset Finance, a Government Backed Start Up Loan or a Crowdfunding Campaign are possibly more suitable options. Which one a business should choose depends on the size of the business and available assets.

Speak to your accountant for advice on the best option for you. If you are looking for great finance deals, speak to the finance specialists at Evangate Financial Services today. Our team has over 20 years of helping business owners secure finance.

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