8 viable alternatives to a bank loan
Unfortunately, higher interest rates targeted at combating inflation result in collateral damage, and the victims are small businesses looking for cheaper financing options amidst a higher inflationary environment. Whilst, there are no “cheaper” options as such, there are other financing options that do not require that you pay interest rates as a small business.
The Central Bank of Nigeria recently increased its benchmark interest rate to 16.5% making it the 4th consecutive rate increase this year.
The apex bank’s reason for increasing interest rates is geared towards tackling the high inflationary environment that we currently find ourselves in as a country. The inflation rate in Nigeria is about 21% one of the highest levels in over 15 years.
Unfortunately, higher interest rates targeted at combating inflation result in collateral damage, and the victims are small businesses looking for cheaper financing options amidst a higher inflationary environment. Whilst, there are no “cheaper” options as such, there are other financing options that do not require that you pay interest rates as a small business.
Nairametrics has listed eight important alternatives to bank loans that small businesses can tap into when looking for funding for their business.
Angel Financing – This refers to funding by family, friends, or well-wishers who for little or no financial gain decide to meet your funding expectations.
- Companies that rely on this form of funding, are those that have products that are not ready to hit the market. You are still yet to produce a minimum viable product so the capital required is little but often more than what you can bootstrap.
- Angel financing is also a very cheap and effective way of funding projects especially when no one believe in you. It could come in cash or in kind.
- For example, your Dad can give you a car to help with running errands or meeting supplies. It could also come in the form of an office space where you can conduct your business without having to worry about utility bills.
- A lot of us rely on angel financing at some point in our business life but do not recognize that. Properly structured businesses must capture the value even if it isn’t in cash.
So, if there is an aspect of your business that you find difficult to fund, look to see if it is something an “Angel” can help fund.
Crowd Funding – No longer a new phenomenon as it was years ago when we first wrote about it, most small businesses are finding out new ways to take advantage of this alternative financing method.
- Crowd Funding involves sourcing money to finance projects from potential customers who are basically your first point of sales.
- It’s basically receiving money in advance from your customers for a product that hasn’t been manufactured.
- For example, as a startup, you have designed a prototype for a product that you believe consumers will like but don’t have the money to fund its mass production.
- By approaching crowd-sourcing websites such as Kick Starter, consumers who like the product you are launching will pay for it in advance in return for being the earliest to use it and at a cheap price.
- You also make some profit and have proof that your product is indeed marketable giving you better access to banks or venture capitalists.
- Nigeria’s Security and Exchange Commission recently released its crowdfunding regulations which guide how companies can leverage crowdfunding sites to raise money.
Real estate developers also use a form of crowdfunding, and off-plan sales to raise money to fund projects. Here, they enter a contract with buyers of properties that allows the buyers to pay a significant sum upfront in exchange for buying the property cheaply.
Venture Finance – Venture Finance is a form of equity investing used by Venture capitalists (VCs). VCs are experienced risk-takers and will support risky projects which no one may be willing to take on early in a business lifecycle.
- In exchange for that, they get a stake in the ownership of the company/project and then sell when the business has started generating considerable profits.
- The upside for VCs is that when they take a bet on you and it works out well, they sell their equity stake for a higher return.
- For fund seekers, the advantage is that you get interest-free money which is very crucial to the early stages of your business simply by relinquishing some control. In some cases, you can also seek rounds of funding from VCs to fund different stages of your product development.
- Popular businesses like IrokoTv, Paga, and Jumia have all used Venture Financing at some stage in their funding cycle.
It is important to add that venture financing is in stages often termed “series a, b, c, etc. Each stage represents a level of risk and capital that are within the limit of a venture capitalist. Businesses that explore VC funding are those that have a product that has passed the minimum viable product stage and achieved product market fit.
Private Equity – Equity finance they say is the most expensive form of finance because of its risky nature and the fact that you give away a percentage of your business and control in exchange for financing.
- However, it is one of the most effective ways of raising money without having to pay interest to any bank or to anyone.
- Some small businesses are afraid of giving up a percentage of their business because they fear they may lose control. But while that is tenable, it is also a myopic way of building a long-term viable business.
- Very few businesses in this world attain growth and scale without giving away something. It is either you give away interest to banks or you give some equity to new shareholders or a combination of the two.
- Thus, you should consider raising equity for your business when you are very sure the money you raise will significantly increase the scale of your business. The must be sure that the new investment you make will deliver higher sales growth and increased profitability.
In the case of startups, private equity is often sought when a business is mature and mainstream. You must have received some form of equity finance from angel funding and venture capitalist before going for private equity. Typically, VCs hand over to private equity investors(PE), and then the PEs go public by selling equity to the public.
Equipment, asset Sale, and Leaseback – Equipment Sale and leaseback is a form of financing for businesses that offer capital-intensive services.
- It involves your business buying an asset and then selling it to a lessor who then leases it back to you at a fixed periodic rental.
- For example, MTN, one of the largest companies in Nigeria recently sold its base stations to IHS in exchange for funds. They then leased back the base stations from IHS paying them monthly as service charges.
- The money they raised will be better used for investing in its 5G deployments and creating more exciting products for its customers.
- Companies that can explore this option can also be those who generate their own power or own buildings that are very valuable on paper. For example, a cash-strapped company occupying a property worth billions can sell the property to a developer and then enter a long-term lease in the same building.
Asset sale and leaseback are mostly for large corporations that rely on capital-intensive assets to operate but are in constant need of working capital.
Debt Factoring/Invoice Discounting – For a business characterized by a high turnover of sales, it is very likely that you have millions in unpaid sales from customers whom you give credit to.
- This can be a drag on your cash flow especially as you need to replenish sold-out inventory.
- Debt factoring is basically selling the rights to your debtors at a discount in exchange for cash.
- For example, Company A supplies packs of toilet rolls to a multinational organization for N2 million which he will receive payment after 30 days.
- He then sells the right to receive the cash to a debt factor of N1.9 million thereby, getting the benefit of getting the cash immediately while the Debt Factor makes a profit of N100k.
Invoice Discounting is similar to Debt Factoring except that it is mostly offered by banks.
Vendor Financing – This is almost the opposite of debt factoring. In this instance, you rely on your creditors or suppliers to fund your business.
- Vendor financing involves, leveraging your economies of scale and relationship with the supply of your inventory to fund your operations.
- It is a very common way of funding working capital for businesses that are facing liquidity challenges.
- By delaying how quickly you pay your vendors, you unlock cash that you can quickly use to meet other short-term funding needs.
Vendor financing is not a long-term option because when misused, it can be expensive and damaging to reputation. If you promise to pay your vendors over 60 days, then make sure you meet this promise.
Cash Flow Management – The way you manage your cash can also limit the number of times you approach a bank for a loan.
- As mentioned above, Multinationals and Large Corporates manage cash flows very well which is why they issue local purchase orders to vendors with a promise to pay back after 30 days.
- You can also deploy such cash flow techniques but make sure you inculcate the habit of paying as and when due.
- Experience shows companies who make their payments as and when due are able to command better discounts and quality products than those who chronically owe.
- Cash flow management also involves incurring expenses at the right time and front-loading costs when necessary. It means not tying cash down in prepayments or investments that do not yield immediate liquidity.
Remember, cash is king, so manage it well.
Source: norvan reports
