Small business owners still use ‘alternate financing’ when hard to borrow

Dubai: Ask most business owners where they would go for a loan, and the answer is usually their bank. But what about when the banks can’t - or won’t – lend to particularly small business owners who have limited financial history or business experience?

“The disruption and consequent financial ramifications of Covid-19 has led to pivotal changes in banking and borrowing appetite among small business owners ever since,” explained Dr Rashid Hammad, a UAE-based serial business investor and entrepreneurship mentor.

“While loans are no longer difficult to secure, what do you do when banks can’t lend to you regardless of the reason? In an ideal world, you'd be able to turn to your business credit card to borrow money any time you needed it for your business.

“But not everyone has a long enough credit history or a high enough credit score. If traditional sources are not working out for you, it may be worth considering alternative financing. The interest rates and fees can be significantly higher than for a traditional bank loan or on a great business credit card deal, but they can come in handy in a cash crunch.”

Moreover, small business owners generally find it tough to secure bank loans due to their size and lack of financial history. Zahid Majid, a Dubai-based serial entrepreneur, offers a quick tip sheet to help you determine the right type for you:

- Take stock of industry-specific options

If you work in a field such as ecommerce, look into lending programs tailored to your industry or the platforms where you sell your products or services.

Often such programs are tailored to the cash-flow quirks of particular industries. If you're not aware of lending programs specific to your industry, seek advice from your accountant or financial planner.

- Consider ‘factoring’ financing

In factoring — a type of financing that is often used by small businesses that sell merchandise through big retailers — you sell your accounts receivable to a company called a ‘factor’, at a discount.

In one common type of factoring, the factor buys your invoices and purchases the right to collect the money owed from your customers.

Once your customers pay their invoices, you get the face value of the invoice, with a small discount subtracted, often in the neighbourhood of 2 to 6 per cent. The factor will give you 70 to 90 per cent of the value of the invoice up front, and the rest when the customer pays it.

One reason some small business owners like this type of financing is the ‘factor’ bases the decision to buy the invoices on their customer's credit, not the business owner's.

For instance, if you make a household gadget that a big retailer has stocked on its shelves, the factoring company would decide whether or not to buy the invoice based on the retailer's credit, not yours. This could be a plus if your credit profile is not strong.

Added perk of alternative financing: Securitisation

“Another dominant feature of the alternative financing market in the UAE is securitisation. Securitisation, while a common feature of alternative financing in the US market, is becoming more prevalent in the UAE,“ added Hammad.

What is Securitisation? Securitisation provides a controlled opportunity to invite people to invest in a structure. Securitisation in the UAE commonly involves transferring an asset into a special purpose vehicle (SPV), which then raises the desired capital by issuing securities, such as shares and bonds.

These securitisation SPVs can be structured to be either Shari'ah or non-Shari'ah compliant. So essentially, a securitisation is a legal structure which enables business owners to transform their assets to working capital.

“A growing concern for small business owners is managing their balance sheets and a key feature of securitisation is to remove the relevant asset being securitised from the business’ balance sheet and to allocate the receivables as income (also known as a true sale).”

How does a small business owner borrow against his or her receivables?

Another type of financing that may come in handy is borrowing against your receivables, particularly if you run a professional services firm.

“Since late last year, companies in the UAE, especially small and medium businesses, have been able to secure bank loans by using their moveable properties as collateral in order to help them meet their cash-flow needs,” added Majid.

“This allowed the use of your ‘tangible and intangible’ moveable properties such as equipment and tools, receivables, cash flows, crops and others as collateral against obtaining loans.

“You don't need a credit check or personal guarantee, approvals can happen in a matter of hours, and you can get the loan as soon as the next business day once approved.”

The challenge with this type of financing, Hammad added, is that the money you owe is automatically deducted from your business bank account. “If money is flowing into the business slowly, you could end up in a period where you have very little cash on hand until you repay the loan.

“If you're going to go this route and aren't sure if you'll have enough free cash to run the business during the repayment period, do a cash-flow projection with your accountant to be sure.”

Both Hammad and Majid agree that schools, insurers, developers and landlords are now increasingly recognising the benefits of receivables financing and it is becoming commonplace in the UAE for such institutions to use receivables such as school fees, rent, sales proceeds and insurances proceeds as collateral for obtaining short-term financing.

“This is an emerging trend across the UAE and an example of how receivables financing is being adapted to suit the cash flow needs of businesses,” added Majid.

Quick ‘alternate financing’ options as a small business owner

• Try an alternative loan

A working capital line of credit from a lender is another option that might help you in a pinch. Small business owners can often apply for a credit line starting from Dh100,000, and are commonly offered six-month and 36-month repayment terms.

Each month, you'll pay a fee of 1.5 per cent to 10 per cent, based on your business's performance. For example, if you borrowed Dh10,000 for six months with a 4 per cent monthly fee, you would pay Dh1,667 each month for the loan repayment, plus Dh400 a month in fees.

Peer-to-peer lending (aka, P2P lending) is also an option. You can borrow money from investors, who may be institutional funds or private individuals, instead of going to a bank.

Among the providers are UAE-based Beehive, Eureeca, Ziina and Humming Crowd Realty (HBR). Generally with peer-to-peer lenders, your interest rate will be based on your credit profile, so the stronger your credit, the better your options.

• Get an advance

In the past few years, more companies have been offering small businesses and individuals advances on the money they expect to receive in a given month from certain sources of business.

They can be helpful when you're in a jam, but make sure you understand what you're actually paying for the money, because some providers charge quite a bit for this type of financing.

Once you're out of your cash crunch, turn some attention to doing what you can to add to your revenue and profits.

Your business will be a lot healthier if you can finance most of your growth out of cash flow. And the stronger it is, the easier it will be to find financing at great rates in the future.