Expectations Vs. Realities Of Securing Alternative Finance As A Small-Business Owner

Payson Johnston is the CEO and Co-Founder of invoice finance marketplace Crowdz, helping SMEs get paid faster and access working capital.

For most enterprising Americans, running a small business isn’t a walk in the park, especially during a pandemic. With the fundamentals of how we conduct business changing seemingly every week, hardworking SMEs have adapted with new strategies to stay afloat, from bodegas and family restaurants introducing online shopping to dance studios offering remote classes. 

With banks tightening lending criteria and government stimulus incentives requiring mountains of paperwork, SME owners have looked to alternative financing methods to fuel their most critical growth cycles and reach new milestones, from expanding product lines to growing their team. 

Alternative financing options like invoice finance (or receivables finance) have emerged as a boon throughout the pandemic, despite existing in various forms, similar to factoring, for decades. Lower barriers to entry and reduced overheads have led to the proliferation of easy-access options and platforms, meaning private funding for communities is increasing as more investors and organizations realize their bottom line can support communities and drive returns.

As a leader in this space, I’ve witnessed some common misconceptions, or expectations, that make it unclear how invoice financing offers an alternative option to secure financing. Invoice financing isn’t new, but it has become more popular, particularly during the pandemic, because this method generally allows businesses to exchange unpaid invoices for instant cash, which is then repaid when the original invoice is settled by the customer. 

However, when we take a legacy system and add a 21st-century spin, there are always misconceptions. Here’s how invoice finance works in business today:

Expectation: I need a high credit score or an established business to access finance.

Reality: If you want to access credit, we all know the bank wants to see that golden 700. In business, it’s mandatory to demonstrate an almost perfect credit score, which is a hard feat for any business impacted by lockdowns — and it’s even harder if you’re a minority. Minority-owned businesses, in particular, are less likely than their white-owned counterparts to access funding, especially for businesses with less than $500,000 in gross receipts.

So what happens if your business is young, hasn’t previously needed credit, or is deemed “riskier” by discriminatory lenders? Though there are many plausible reasons a responsible business may have a credit score in its infancy, it automatically rules out their lending options, right?

Not quite. Invoice financing fast-tracks money you’re already owed, so the risk factor is reduced for the funder and makes highly leveraged credit lines redundant. 

Some providers are also developing new risk assessment models to improve equitable access to finance. Businesses with timely repayment habits or creating positive impacts in their communities are incentivized with better rates. Further, initiatives like the Facebook Receivables Financing Program specifically focus on improving access to finance for diverse and minority-owned businesses for up to $25 million. 

Expectation: Invoice finance is the last resort for failing companies.

Reality: Alternative finance providers have historically been seen as the final hope for businesses with nowhere else to turn other than high-interest, non-bank providers to bail them out. But the tables have turned. With the proliferation of fintech disruptors and the contracting risk appetite of banks, alternative finance options have become a tool for companies who need access to instant and reliable sources of working capital. 

Within five years, 45% of businesses shutter, and for startups, this rate is worse, with over 90 percent eventually biting the dust. A study from U.S. Bank revealed for 82%, the biggest reason for failure is cash flow mismanagement

Expectation: Invoice financing can bankroll my company.

Reality: Theoretically, yes — if you’ve got a healthy stream of invoices, you can auction off for cash advances regularly. However, it’s smart to be strategic about how you leverage working capital, as opposed to frivolous spending. When considering any alternative financing source, whether a traditional bank loan, revenue finance or invoice finance, consider how you’re going to use the capital. Think of alternative finance as a tool to unlock unpaid cash. 

Some common scenarios include:

• Leveling out volatile and unpredictable cash flow cycles: A customer makes a payment, and cash flow suddenly spikes, so you use that money to pay expenses. Then you wait 90 days for another major invoice to settle, but cash flow takes a dip again. Sound familiar?

• An umbrella for rainy days: In 2021, more SMEs than ever are at risk of missing payroll, coming up short on rent, or being threatened with the power being shut off. Instead of using financing to cover expenses, some businesses use it as an emergency resource to stay afloat, whether that be due to a low season or the onset of a global pandemic. 

• Growing and expanding: Scaling is one of the most cash-intensive processes a company can experience. Whether it means laying down cash for new office space, putting in a bulk order to expand a product line or venturing into new markets, receivable financing can be built into growth strategies without having to give away equity or compromising on the speed at which you can move. 

Invoice financing can be a great way to unlock cash tied up in unpaid invoices, but like every financial decision, it’s important to consider the potential limitations and responsibilities. In the same way that you would be responsible for paying down a loan or a credit card, the cost of the invoice must also be repaid once your customer’s payment is processed. Defaulting on an invoice repayment has the potential to impact your credit score. If your score is already low, defaulting could set your score back further. In the event that a customer defaults on your invoice payment, you’d still need to find the funds to cover the cost of the initial finance your provider has granted.

Before you trade an invoice for cash, consider the likelihood of your customer paying their invoice in full. You may want to consider using invoice finance for tried and tested customers before you auction off receivables from a brand new debtor. Invoice finance is not the solution to every financial predicament, but when used strategically and responsibly, can become a powerful resource for cash flow stability and growth.

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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