Whether its a store burning down or the sick leave of multiple staff at the same time, small businesses often find themselves in need of small business loans. There are many ways to about funding, but there are some issues with traditional banks that may pose a problem with small businesses. This article will dig into those issues and solutions – but before that, a brief summary on how and why a company may raise funds in general.
In order to raise funds, a company can either increase its liabilities or its equity, hence the model:
Assets = liabilities + equity
In order to fund an investment through equity, it often means selling part of your own ownership to an angel investor, or perhaps to the public in general through an Initial Public Offering (IPO). In order to do this though, it takes significant amounts of time. Detailing the ins and outs of the business with potential investors is a lengthy process, and can be prolonged through negotiations over the price or value of the business. This is not ideal when the investment necessary is extremely urgent, for example in the instance of a store break in, or interest rate changes causing unforeseen cash flow problems.
On top of this, a huge personal cost to the owner is that it involves relinquishing a part of the business. Small companies that invite angel investors will often be on the receiving end of instructions over the direction of the business, which they may or may not agree on. Angel investors tend to be quite involved, because they have such a large stake in this one entity, often allowing them the time to focus on the company (unlike retail investors’ shareholdings for example).
Small business loans
Therefore, sometimes the only option for small business to take on an investment is to raise funds through debt. Increasing the gearing of a company can be a good idea in general, although the business will be seen as very risky if it is too highly geared. Such a debt-laden capital structure leaves the company at risk to interest rate changes and the macroeconomy in general – highly leveraged companies were more likely to fold during the 2008 mortgage crisis, for example.
Some level of debt is a great way to grow, though. For small business, the refusal to acquire debt is going to be a serious disadvantage. It takes a long time for small businesses to save up enough cash to fund large investments, or have as a cash reserve for disasters. This is because funds are constantly being reinvested through minor means, as well as cash flow being a key reason for failure (82% of small businesses fail because of cash flow).
The problem is though, creditworthiness is automatically hyped up for limited companies, leaving sole traders and many small companies at a disadvantage when applying for a business loan. They can be extremely picky – most banks accept well under half the applications. This includes the companies that have a throughout business plan, and their funds will be used to expand and increase revenue. When cash flow difficulties are the source of the motivation behind a business loan, suddenly the chances of being approved by a traditional bank is even smaller. Additionally, even upon being accepted, many banks APR is extremely high – further punishing you for having an average creditworthiness.
It will often take a week or two for a response on the loan application, too. This is no good for a desperate cash flow emergency. Paying staff on time, completing current orders and meeting other debts is absolutely vital. Whilst the response time isn’t great, the application itself can take just as long. The endless documents, business plan, objectives, finances and other statements required can be a real headache.
There are some ways around this, which is to go to small business lenders that are specifically for solving these business problems. They don’t have vast amounts of other departments, instead, they are relatively focused on having a fast application process. For example taking the time to compare business loans against each other in order to distinguish the requirements of each is going to leave you in the strongest position.
With small business lenders there tends to be far less hoops to jump through, take a few days to respond, yet they still can lend serious money (there are several that can go up to $400,000 in Australia). In fact, they are beginning to dominate this market. Firms like Prospa and Capify have great ratings online (another useful feature that is harder to apply to traditional banks) and are two of the biggest lenders at the moment.
Many have quote estimators, whilst only a few have minimum annual turnover requirements. These have somewhat been a saviour of the Australian economy, with small businesses playing the biggest role. For example, half of employment is derived from small businesses in the private non-financial sector of the economy. Even with somewhat high interest rates, Australian firms have found a new reliable way to leverage their business for the better, and gear their company towards growth.
Last ditch effort
There is another alternative option, peer-to-peer lending, which has been growing fast in Australia ever since its launch in 2012. This is an extremely decentralised way of lending, and is a way to connect individual investors (lenders, but can be any individual with spare cash) to borrowers. Often, P2P platforms are associated with a place of individuals seeking loans – a vastly superior alternative to payday loan companies. However, there are also options for small businesses to acquire loans.
For very high-risk individuals and small businesses, this may be the only way to be accepted for a loan. It may not be preferable for all businesses to use compared to the previously mentioned methods. However, one big reason why high-risk borrowers will receive relatively decent interest rates is because investors can diversify – they can build a portfolio of different borrowers from different demographics and locations to spread their risk.