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A bank in Dubai. Picture used for illustrative purposes. Image Credit: Ahmed Ramzan/Gulf News Archives

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, first of the financial crisis and now more dramatically COVID-19, has led to pivotal changes in banking and borrowing appetite among small business owners.

What did this mean for those who sought to borrow funds for their businesses? Loans were more difficult to secure, requirements on collateral became stricter and other terms and conditions became more restrictive.

Now as pandemic-induced implications ease and the economy bounces back to pre-pandemic levels, so have the banking-related restrictions and borrowing appetite among UAE business owners.

However, like mentioned above, what about when the banks can’t lend to you? In an ideal world, you'd be able to turn to your banker or 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.

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If traditional sources are not working out for you, it may be worth considering alternative financing.

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.

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Moreover, small business owners generally find it tough to secure bank loans due to their size and lack of financial history. Here's a quick crib 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.

What is receivables?
Receivables, also referred to as accounts receivable, are debts owed to a company by its customers for goods or services that have been delivered or used but not yet paid for.
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Image Credit: Maxpic

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 neighborhood of 2 to 6 per cent. The factor will give you 70-90 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.

A key feature 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, have been becoming more prevalent in the UAE.

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).

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Picture used for illustrative purposes only. Image Credit: Gulf News archives

Where a transfer occurs on a true sale basis assets to be transferred should be ring-fenced (guarantee that funds allocated for a particular purpose will not be spent on anything else) in a special purpose vehicle established solely for the purpose of holding the assets.

Such ring-fencing of assets seeks to ensure that the bankruptcy of the originator of the assets does not have an impact on the transferred asset.

Further, structuring the securitisation on a non-recourse basis (explained below) is beneficial to small business owners to ensure that it (as the originator) has no obligation to repurchase the transferred assets on enforcement.

It is also beneficial to small business owners to ensure that it (as the originator) has no obligation to restrict the investor’s recourse solely to the assets that the special purpose vehicle holds and over which the investor has taken security.

What is non-recourse financing?
Non-recourse finance is a type of commercial lending that entitles the lender to repayment only from the profits of the project the loan is funding and not from any other assets of the borrower. In case of default, the lender may not seize any assets of the borrower beyond the collateral.

Whilst the UAE market is seeing an increase in traditional securitisation as an alternative funding source, a wave of Islamic finance securitisation has also gathered pace across the GCC as a result of the market becoming more sophisticated in understanding and structuring Islamic securitisation.

Islamic finance securitisation seeks to rely on the principles of a traditional securitisation structures but have been developed in such a way so as to ensure compliance with the main principles of Islamic finance.

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Picture used for illustrative purposes only. Image Credit: Gulf News archives

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 amidst tough situation due to the pandemic.

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 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.

Schools, insurers, developers and landlords are 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.

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Key takeaways

• Try an alternative loan

A working capital line of credit from an alternative 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.