July 3, 2020

SME finance: the simple guide

SME finance: the simple guide

What is SME finance?

SME finance is basically a product you buy from banks, lenders and finance suppliers that helps you to grow, or in some cases, to save your business.

I think this simple definition is important - you’re buying money from a finance provider to pay back to them at a later date with an additional fee on top.

Unravelling the complicated wording used to sell finance products can be hard. That’s why we put together this guide. So that you don’t get harmed by companies selling you stuff you don’t need or that doesn’t meet your requirements.

This list is comprehensive. Packed full of tips, hints, and the pros and cons of the different types of finance options available to you.

You probably already know about some of these options. So this guide aims to educate you on the things to watch out for and to present some new options you may not have considered before.

Before we dive into the details, let’s take a quick look at some SME owners most commonly asked questions.

We believe that most SME finance sucks. But there is a solution.

What SME owners wanted to know before using business finance

Are they giving me more money than I need?
It benefits the lender if you take a large loan. And more money may seem like a good problem to have. But in this case it isn’t. Because you’ve got to pay back all of the interest on money that you didn’t even need in the first place. Be careful when taking out a loan or selling your invoices to a factoring company. If they want to buy all of your invoices and lock you into a long contract, it might be worth looking for an alternative option.

What about my credit score?
Finance providers selling lines of credit, factoring and loans often want to know your personal credit score. Sometimes your credit score will get affected when you apply. Plus, if you don’t pay them back on time, the credit bureaus will find out and may penalize you. This seems unfair considering that the business you own is a separate legal entity to yourself. Nevertheless, it’s the way it’s done. Well, until now at least. New financial products have entered the market that don’t care about your credit score, and some like Fellow Pay (which we’ll talk more about later) that don’t care about your company's credit score. The sky is looking clearer every day.

What about hidden fees?
Often lurking amongst the finest of fine print in many finance agreements you’ll find the dreaded hidden fees. And when these are added to your interest, fees can cause serious repayment issues that you’d not budgeted for. Watch out for origination fees, subscription fees, prepayment penalties and maintenance fees.

Will they contact my customers?
Invoice factoring will give you money for unpaid invoices paid upfront. But require your customers to pay them back, directly. Which might not be a good option for you. If you don’t want a third party interfering with your business relationships, then invoice finance could work better. Or what we do at Fellow Pay, gives 60 days extra to your buyer to pay , so you get paid right away. It benefits both parties and should help to better your business relationships.

Will it be easy to pay back the debt?
You can ask for a longer payment plan. But it’ll cost you more money. Your best option is to select a provider that lets you choose which invoices you want to sell. If the finance company wants a long contract and access to all of your invoices, it’s perhaps best to look elsewhere.

The problem with traditional bank loans.

Getting a bank loan for many companies, especially those without near perfect credit ratings, seems to be something of a bygone era.

Long gone are the days when you could walk into the local bank and sign a loan agreement within a day, or so. Gone also are the days of getting a long term, low interest loan. You can thank the financial crisis of 2008 for that.

In the old days, you and your bank manager would have had a great relationship. So when you needed the money, you got it. But now things have changed.

In Denmark today, big banks only sign off on 25% of loan applications according to research by SMVDanmark. Out of the 75% that get rejected, another 3 out of 4 of them give up finding other finance options altogether.

And the companies that do get a loan will have a shiny, perfect credit score and a perfect financial record.

Let’s say you want to get a loan to cover your next quarter of expenses. It’s likely that you’ll go to the bank, discuss your needs with an agent, go through the entire application process - including loads of paperwork and jumping through many other hoops - before finding out guessed it, you’re not (actually) eligible.

- Low interest rates
- Bigger loan amounts
- Fixed monthly payments
- Develop a strong relationship with the bank

- Strict credit requirements
- Time-consuming process
- May require collateral
- Banks lend to established businesses (not new ones)

So, getting a bank loan in 2020, seems like a non-starter then?

Fair enough. But what’s sad is that 75% of those Danish companies whose application was rejected stopped looking for finance altogether.

And that really is a shame, because there are many other options.

So let’s take a look.

A Line of Credit

A line of credit is like having rolling access to money that can be used when you need it. Unlike a traditional bank loan where you get €100,000 all at one, a line of credit gives you the chance to withdraw, up to €100,000, when you (actually) need it.

Most lines of credit come with high interest rates. And if your credit rating is poor, expect to pay seriously high fees!

There’s a chance you’ll be charged with additional fees - watch out for those! But often you’ll only pay interest on the part you spend, not the whole credit line. If you’re looking for a massive credit line, be expected to put up some collateral first.

Lines of credit can be risky. If you use it all and can’t repay it, you will be personally liable for the debt.

- Revolving credit
- Some vendors only charge interest on what you spend (be careful - this isn’t always the case)

- Very high interest rates
- Very often requires a personal guarantee
- Often requires a hard pull of your personal credit, which may lower your credit score
- Significant risks if you can’t repay

Loans from an SME Administration

Across Europe, many Small Business Administrations will guarantee loans, issued by banks and alternative finance lenders.

These loans are often easy to apply for. After a few days you’ll find out if you’re eligible. If you are, it takes another few weeks for investors to choose to offer the loan.

The fastest examples see SMEs getting money after just two weeks.

That’s pretty good!

Expect a loan between: 200.000 - 5.000.000 DKK (or €26,500 - €670,000)
With a fixed Interest of 4,25 - 9,70% p.a.

Search for your local, or national, SME administration and search for business loans.

Crowdfunding (like Kickstarter & Indiegogo)

If you have a new and exciting idea. And you’re really good at marketing. Crowdfunding sites like Kickstarter and Indiegogo could be great options for you.

Unlike traditional finance, crowdfunding gives your customers the option to invest small amounts into your company in exchange for rewards. The more money they pledge the bigger the reward.

This is a great route for you if you want to raise money without too much risk - paying for materials upfront or giving away equity to investors.

But there are other risks. You’re basically giving away your business idea and blueprints upfront, for the world to see. That includes companies with greater resources that you could steal your idea.

Plus, you really do need to be good at marketing. You need to sell your idea to hundreds (perhaps thousands) of people because the amount each person will invest is typically very small.

Also, there are several fees to take into consideration. So yes, if you have an innovative idea and you’re good at telling people about it, crowdfunding is great. But, if you’re a little more conservative, perhaps our next option is better for you.

- Pre-fund new products with pledged money
- Don’t have to sell equity
- Don’t have to take on long-term debt
- Your campaign could go viral

- Most campaigns are very time-consuming
- Potential for plagiarism or intellectual property issues
- Several fees

Fast loans

Fast business loans are the payday lending of the business world. Which should be enough to put you off.

There’s very little good we can say about this type of finance. Avoid it with all of your might. These are often used by companies who are very desperate and often come with a whopping AOR of over 700%.

- Fast - around 24 hours

- VERY expensive - often over 700% AOR
- Higher repayments than other finance options
- Very risky - you could lose your house
- Could have misleading, unfair and unaffordable terms
- Watch out for hidden fees (there’ll be a lot)
- Lenders may charge a fee if you pay off your loan before the end of your loan term

Business Grants

We are co-funded by the EU and Innovation Fund Denmark. These funds are in the form of grants - loans you don’t need to pay back or give away any equity for.

Almost every business has the chance to get some grant money - not just nonprofits and charities. If you start a business, or are growing a business and that business of yours is going to add to your countries’ GDP in some way, no matter how small, there is value in the government giving out grants to help you succeed.

Sounds amazing!! What do I have to lose??

Well, not so fast there.

Applying for grants, as we can testify, takes immense time and focus. If you’re already strapped for time, growing your thriving business, then proceed down this route with caution. Plus, there’s no guarantee you’ll get the money this time. Meaning you’ll have to start the application process again if unsuccessful.

For more information about EU grants, visit the small business finance site for the EU.

- Not a loan so no need to repay
- No risk to apply
- The only cost is your time

- Large grants are very competitive so you can’t count on winning
- Time consuming research and application process
- Restrictions and rules about how you may use the funds

Sell an equity stake in your company

Many SMEs benefit from selling a percentage of their company to an outside investor. Ideally, that investor comes with great experience and a large number of contacts that you can access when you need them.

Giving up some ownership of your company can be hard, especially if you’ve built this yourself, but having an experienced partner onboard could be hugely advantageous.
Except for when it’s not.

Before you take an investor's money, make sure that their values and vision are exactly aligned with yours.

Please promise me that!

There are many horror stories, especially in the venture capital world, of companies being destroyed by investors who “thought they knew best” without taking into consideration that, actually, the SME owner is often the expert in this industry.

So, it could be a good option - but please proceed with caution.

- No debt
- No monthly repayments
- Knowledgeable business partners

- Time-consuming process
- Profit-sharingLess control of your company
- Risk of losing complete control if you have to give away too much equity

Invoice finance

Did you know that you can borrow some, or all, of the amount of your unpaid invoices? So when a client decides they’re not going to pay you for 30 days or more, and you need the money now, you can get hold of it faster?!

It’s a good option for SMEs that want more control over their finances. And to use that money to grow now, instead of later.

The total amount of unpaid invoices at any one time, in the UK alone, is around £67.4bn, and this amount has been rising year on year for some time. What’s more shocking - 22% of those unpaid invoices are from large companies!

If you’ve got cash flow trouble and unpaid invoices, invoice finance sounds like a good option then, right?

Well, yes and no.

Invoice financing can be very risky. If you borrow money against an invoice, that you still have to pay back with interest, and then your client doesn’t pay the invoice you’ll be left in a very bad position. If you’ve got cash flow issues, this is going to double your pain.

If your client doesn’t pay, you can extend your terms. But that’s going to incur several extra fees - just for extending, on top of the additional interest.

And then, if you end up not being able to pay it back it’s highly likely that it’ll affect your personal credit score.

So, before using invoice finance, you better be certain that your client is going to pay you and that you can pay back the financing, with interest, on time.

- Fast business funding
- Solve cash flow problems
- Get the most of the value of your invoices

- Often many hidden fees
- Can be expensive if you’re a smaller business
- Very risky
- Could affect your personal credit score
- They won’t lend to you if you’re registered as a bad payer (RKI/Schufa)
- Must have a good invoicing history
- Must have a certain level of annual revenue

Invoice factoring

Invoice factoring is the process of selling your invoices to a third party. In return, you’ll get cash.
Some companies claim that you’ll get this cash immediately, but the first time you use it it’s likely to take several days to weeks before you’re even approved. Plus, Factoring is a manual process. So it takes longer and costs more than it should.

Nevertheless, it’s still much faster than going into a bank or getting a line of credit.

And you don’t have to chase invoices anymore. Which is a good thing!

Well, perhaps not.

Do you want a factoring company chasing your customers to pay their invoice? In the worst case, this could lead to losing the relationship with your customers.

The next time your customer is deciding between you and your competitor for a project, are they going to be turned off by the possibility of dealing with your factoring company instead of you?
It’s an important question to ask yourself before you take the factoring route.

Also, factoring companies often want a long term agreement where they buy most of your invoices. Our customer Freddy left a factoring company and came to Fellow Pay because they wanted to buy ALL of his invoices. He just wanted an option that was on his own terms.

With factoring, you’re liable for the invoice even after you’ve sold it. If your customer objects to work he feels you’ve not completed, you’ll be liable, not your factoring company.

Factoring can work. But many SME owners view factoring as the payday loans of the business world. So if you choose this route, tread carefully.

- Fast money
- No collateral
- Reclaimed time

- High hidden fees
- High interest payments
- Potential long term agreements
- Potential embarrassment
- Highly risky

Financing with Fellow Pay

Fellow Pay exists to give SMEs the fastest, easiest and fairest finance.

Fellow Pay allows you to be paid immediately by us and your buyers get 60 days to pay us back without interest.

If your customer chooses to, they can extend that payment term to 90 days for just 1% of the invoice amount (between you and them).

Unlike bank loans, a line of credit, invoice financing and factoring; Fellow Pay benefits both the buyer and the seller (the invoice issuer and the invoice receiver).

Invoice issuers are suffocating under the pressure of long payment terms. In many cases acting as a lender to their larger and more liquid customers. They need money now.

Invoice receivers want to reduce the risk of long production cycles and minimize the need for expensive project financing. They want to pay later for free.

Fellow Pay is also very fast. Less than 5 minutes to set up an account. Once set up on the system, getting the money happens immediately after you and your customer sign the agreement.

So you won’t be waiting six months (bank loan), a few months (line of credit), or even days (invoice finance and factoring). With Fellow Pay, you’ll get your money instantly.
Fellow Pay avoids the issue of harming your customer relationships, like factoring, by offering great value (in the form of extra days to pay) to your customers.

If your client doesn’t pay their invoice it doesn’t affect your credit rating or ability to borrow money again.

There’s no physical meeting, no financial interrogation and no paperwork.
Uniquely to Fellow Pay, you will get finance even if you’re not deemed creditworthy. We’re only interested in the creditworthiness of your customer.

And it costs just 3% of the invoice amount as a one time price. That’s it. No hidden costs. No unexpected additional fees. Instant invoice payments, credit rating, bank transfer fee and invoice insurance all included in one set price.

Pros for buyers:
- No lengthy application process
- Ease your cash flow worries
- 60 days extra to pay invoices.
- Increase to 90 days for just 1% of the invoice amount.
- Access to the supplies and materials you need.
- Stay current with industry news and developments
- Keep your suppliers happy

Cons for buyers:
If you’re not creditworthy, you won’t get it
- If you don’t pay on time you can end up owing late fees

What are the pros and cons of using Fellow Pay to extend your credit?

Pros for sellers:
Increase sales from cash-strapped customers
- Gain an edge on competitors that don’t offer using Fellow Pay
- Helps establish trust and build customer loyalty
- May gain additional customers via word-of-mouth recommendations

Cons for sellers:
You may have to convince your buyers to agree to sign the agreement. But we can help you with that.

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