In part I of the strategic funding article, we discussed the following sources of funding:
- Bank Operating Line of Credit
- Invoice Discounting (Factoring)
- Asset Financing
Theres are also another variety of funding available for businesses: the Alternative financing.
Alternative finance is a general term to describe a variety of financing options that sit next to traditional bank facilities and factoring and invoice discounting products.
The alternative finance market includes a wide variety of new financing models including peer to peer lending, crowdfunding and specialist finance providers offering products such as selective invoice finance and invoice trading platforms.
Specialist providers have greater flexibility than the traditional sources and can often offer a faster turnaround on the right deals. Crowdfunding, peer to peer lending and invoice trading platforms greatly depend on online platforms bringing many investors and borrowers together.
The section below looks at the main options for the different and emerging alternative financing options:
Selective Invoice Financing
Unlike traditional factoring companies, invoice financing or invoice discounting, selective invoice finance allows businesses to choose which invoices or debtors should be put forward for funding. The business owner can choose when and how much they wish to draw from the selected invoices. The provider agrees upon an ongoing facility for the business. On presentation of a valid invoice, money can be accessed from the facility as soon as the validity of the invoice has been confirmed. For each invoice, an agreed percentage of the value becomes available to draw – typically 70% to 85%.
Selective invoice finance is a great option if you’re looking for flexibility as the business is not tied to any contract and can dip in and out of the facility as needed. Business owners have direct control over costs and the opportunity to repay early if additional funds become available from elsewhere.
Additional security is often required to support the facility. This could include a charge over business assets and a personal guarantee from the directors or owners.
Invoice Trading Platforms
Invoice trading is a short-term finance option where the borrower signs up to an online platform and submits an invoice for sale.
The invoice trading platform will pre-vet the invoice, looking to ensure the debtor is credit worthy. If satisfied with the quality of the debt, full details of the invoice will be posted on the platform and a bidding process begins.
Potential lenders start a reverse auction so the keener they are, the lower the interest rate for the borrower. If there is insufficient appeal, the trade will fail. It is exclusively web based due to the administration efficiencies involved.
When the invoice becomes due the debtor pays directly to the platform but the business remains responsible for making sure the invoice is paid.
On repayment the platform deducts its own charges and repays the capital and interest to the individual lenders. A shortfall in the repayment will mean the business will be asked to make up the difference.
Some trading platforms have now started to take additional security in the form of a charge on the business and a personal guarantee from the directors and/or shareholders.
Peer To Peer Lending
Peer to peer (P2P) lending enables numerous small investors to loan money directly to a business and could be a good solution for longer term funding.
The length of the loan is agreed by all parties upfront and as per a normal commercial loan, the business will have to pay interest, typically quarterly. In order to attract lenders the proposition needs to demonstrate a strong likelihood of both the interest and capital being repaid on agreed terms.
Failure to meet the repayments may result in penalties such as a demand for immediate repayment or an increased rate of interest if the loan remains in default.
The platform provider acts as middleman between lender and borrower and will ultimately enforce whatever security has been taken on behalf of the individual lenders.
Provided a loan has been properly serviced and there is adequate security available, it is often possible to return to the P2P lender for a second or later round of borrowing but each new loan has to be separately posted to the platform and must justify why the new lending is required.
Security will need to be offered, normally in the form of a charge over company assets (a debenture) and a personal guarantee. Investor money is at risk if the loan is defaulted.
Crowdfunding involves a business plan being posted to a specialist website where sufficient small investors offer funding to generate the target amount required by the business.
Crowdfunding is a good option for businesses not wanting ongoing interest costs. However, on completion investors will own shares and have certain rights in the business. For example they may require input such as audited financial statements and will need to be kept informed of how revenue is progressing. No personal security is needed from the current owners.
There are two main types of crowdfunding and the expectations of investors vary according to which they are looking at:
- Special Interest Funding: Often used in the entertainment industry, for instance to pay a musician to produce a new album or to cover the production costs of a new show. In this case, the investor doesn’t necessarily expect a commercial return on the investment but will have some special rights, such as pre-release copies of a CD or discounted tickets to see a show.
- Trade Finance: Money is advanced to enable goods to be purchased (typically from abroad) before they are sold. The lenders security is the goods purchased so these must either be easily saleable or in response to a confirmed order. Generally available to established businesses with good credit. Minimum transaction values and margin on the contract will apply.
Supply Chain Finance
The funder takes control of the supply chain, generally making payments direct to the supplier. Security is taken over goods purchased. There is usually a high degree of involvement and control over the borrower’s business and other security is invariably required.
Private Equity Firms
Private equity firms provide medium to long-term capital in return for an equity stake in companies with high-growth potential.
The investors’ return is dependent on the growth and profitability of the business. As a result, most private equity investors will seek to work with you as a partner to grow the business.
It is most suitable for firms looking for longer term capital to fund their expansion activities.
IPO (Public Offering for Shares)
This is where your business is publicly listed and shares can be bought and traded by the public. Typically this is only used for larger businesses.
In Canada, the Toronto Stock Exchange (TSX) is the senior equity market, while the TSX Venture Exchange is a public venture capital marketplace for emerging companies. The Montreal Exchange or Bourse de Montréal (MX) is a derivative exchange that trades futures contracts and options.
Funding is often the catalyst for taking your business to the next level.
It’s your choice whether you want to take on an equity partner or raise debt to finance the growth of the business. When raising equity, if the right partner can be found, it can make a profound difference to your business. It may be that the investor provides not only funding but also adds significant value to your business in terms of experience, expertise, infrastructure, and channels to market. However, it does mean you will lose partial or complete control in running your business. Something that for many is not appropriate.
Raising debt can be complex and frustrating, and the increasing array of alternative funding doesn’t make that process any easier, but it does mean you keep control as your business grows. However, if you’re like most business owners, you simply want the funds and are less interested in the detail of how to get hold of them!
That’s fine if your company has a full-time chief financial officer (CFO) with substantial experience in raising funds: however, as an SME, you probably don’t have a full-time CFO, or if you have they probably don’t have a vast range of fund raising experience, whether it be raising debt or equity. So what can you do?
You can hire a very experienced part-time CFO to manage the entire process for you. He or she will manage everything from determining your immediate and long-term objectives to finding the right kind of funding partner for the business.
Discover the funding options now
To discover your funding options, book your free one-to-one call with one of our chief financial officers who are funding experts:
email: [email protected]