Banks have continuously reduced their lending activities to small and mid-sized enterprises since the 2008 financial crisis.
According to a study by Harvard University, SME lending by large U.S. banks has decreased by around 20 percent since the financial crisis and, due to regulatory pressure on large banks to reduce balance sheets, SME lending has not really picked up again since.
Fortunately for SMEs however, the recent boom in FinTech has provided SMEs with new alternatives to fund their business.
FinTech, which is short for Financial Technology, refers to new innovative technologies that are disrupting the financial industry by enabling startups to offer new financial products and services that are cheaper and more customer-friendly than those offered by traditional financial institutions.
In this post, I will introduce five ways to fund your business using alternative funding options provided by the FinTech sector.
Related Article: How FinTech Is Changing Business (and Bank Accounts)
Traditionally banks use a credit scoring model to analyze your company’s creditworthiness and, provided you fit into their loan portfolio, then offer you a loan agreement with terms and an interest rate closely tied to your creditworthiness.
However, as banks have reduced SME lending you will likely either have your loan application denied or you will be offered a loan agreement with a very high-interest rate.
Fortunately, however, there are now several SME lending companies, such as Kabbage and Credibly, which offer loans specifically for SMEs. Specialist SME lenders from the FinTech sector will not solely determine your creditworthiness using a credit scoring model.
Instead, real-time business data (such as monthly revenues and profit margins) is taking into account by an algorithm that helps to determine whether you will be awarded a business loan or not, within a much shorter time frame than you would get from a bank.
Alternatively, you could raise funds through a peer-to-peer lending platform. Peer-to-peer lending refers to a method through which you, as a small business, are able to borrow from individual investors without the need of a traditional financial intermediary.
There are numerous platforms, such as LendingClub and Prosper, which allow you to list your peer-to-peer loan online for investors to invest in, once your creditworthiness has been determined. Once your loan is fully funded, the loan amount will be dispersed to you. Peer-to-peer lending is, therefore, an excellent alternative to a bank loan for small businesses.
If you prefer a cash injection via equity, then raising capital through an equity crowdfunding platform would be the right option for your business. Equity crowdfunding refers to the funding of new startups or existing SME business operations through contributions from a large number of individual private investors who in return become a shareholder in your business. Examples of reputable U.S.-based online equity crowdfunding platforms would be OneVest, Crowdfunder and FoundersClub.
Another way to receive funding and keep your cash flows stable is through invoice factoring. Invoice factoring refers to a type of debtor finance where you sell your invoices to a third party at a discount to meet immediate cash flow needs.
While factoring has previously only been available to large multi-national corporations FinTech companies, such as BlueVine, Dealstruck, and Fundbox, now provide the same service to SMEs in the U.S. If you experience regular cash flow shortfalls due to invoices not being paid on time, invoice factoring might be the right financing option for you.
Related Article: Finance, Meet Your New Match: FinTech Trends to Watch in 2016
Merchant Cash Advances
Finally, you could also opt for merchant cash advances as a source of funding. If you opt for a merchant cash advance you will receive a lump sum payment in return for a pre-determined fixed percentage of your daily credit and debit card sales until the full amount is repaid. This allows you to pay back less in months were sales are slower and more in months when business is going well.
This is a useful funding option for companies with bad credit, little business history or little to no collateral, which struggle to receive small business loans.
However, it is important to note that merchant cash advances often come with very high APR rates, so they should only be used if it makes business sense and won’t affect your business’ financial stability further down the road.