Finding and choosing the best financing for your SME can be challenging. Here, we lay out the factors that you should consider before making a decision to fund your business.
- Identify Your Financing Needs
- Bank Loans vs. P2P/Crowdfunding
- How to Think About the Cost of A Loan
Identify Your Financing Needs
SMEs require financing for a variety of reasons. To make a good decision about funding your business, it is important to ask yourself why you need the funds. Do you need cash to cover short-term cash flow problems? Or do you need funding to acquire equipment or inventory? Perhaps you're planning to expand your business over the next few years? Before you can choose between lenders or products, you'll need to identify the purpose of the funding.
Short-Term Financing Options
Your business may simply need cash to maintain daily operations (e.g. payroll, rent, utilities). This might be the case for businesses that have slow-paying accounts receivable. It might also be the case for new businesses that are growing very quickly. Whatever the reason, there are many different short-term financing options that can help companies get through difficult times. A downside of short-term financing is the significantly increased interest rate charged for these loans.
Working Capital Loans
SMEs with short-term cash needs for day-to-day operations, including payroll, rent, or utility bills, might consider working capital loans. Interest rates tend to be higher for working capital loans than invoice financing or longer-term business loans because short-term working capital loans are considered to be riskier. For example, compared to working capital loans, invoice financing provides investors with some security that loans will be repaid due to the invoices and specific purpose of the financing. Despite higher interest rates, working capital loans can be crucial for businesses that need funding quickly for a short period of time, while they wait to collect revenue from their customers.
SMEs that require funding and have already issued a significant amount of invoices for completed work may be a good fit for invoice financing. Invoice financing is a type of working capital financing that allows businesses to receive a loan based on invoices that are owed from customers. Because goods or services are already delivered, and the business has a reasonable expectation to be repaid, invoice financing is considered to be less risky and its interest rates are generally lower than other short-term loans. Invoice financing is generally restricted by the size of an SME's invoices to customers, which can be prohibitive for SMEs with limited invoices.
Perhaps you expect to have frequent needs for short-term financing over the course of a year, or your businesses financing needs vary over time. In this case, you might want access to flexible financing without the hassle and delay of application process and strict repayment schedule of a regular loan. A revolving credit agreement might be a good fit for your needs. These agreements allow businesses to draw up to an agreed upon amount anytime. Revolving credit agreements, which work similarly to credit cards, only charge interest based on borrowed amounts. While there is generally an initiation fee, this type of financing does not charge early repayment fees. Additionally, they do not require additional application processes each time an SME draws more funding nor do they typical require collateral.
In some cases, businesses simply need cash immediately to grow. Micro loans (also known as short-term business loans) offer financing in smaller amounts (S$5,000 - S$100,000) and shorter durations than traditional business loans. Additionally, because immediacy is essential for some businesses, some P2P/Crowdfunding loans are available within one business day. Typically, as short-term loans, micro loans feature higher interest rates than long-term loans. This is because investors demand higher returns to make the short-term investment worthwhile compared to a long-term investment that generates returns over a long period of time. Also, compared to invoice financing, micro loans tend not to be designed for a specific use, which makes them more risky from the investors' perspective. If the need for immediate cash for your SME outweighs higher interest rates, a micro loan might be the right type of financing for your business.
Long-Term Financing Options
While short-term financing might work for some companies, others might seek long-term financing to facilitate their growth. There are a variety of options of long-term financing that vary in attractiveness depending on a business's preferences.
Business Term Loans
Business loans take a range of forms. With one type, business term loans, businesses receive a lump sum payment and repay this principal plus interest over a set period of time. Business term loans generally offer SMEs more funding, over a longer duration, with lower interest rates than short-term loans. In some cases, businesses are required to provide collateral; if not, directors are generally required to provide personal guarantee of repayment. The advantage of business term loans is that they can be used for any number of purposes, like business expansion. However, business term loans generally offer stricter payment profiles than other loans (as they are long-term) interest is charged based on the principal amount (rather than the amount a business needs at any one point in time), and cash disbursement tends to be slower. Also, equity financing may offer greater financing amounts than most business loans; however, business loans allow SMEs to retain ownership of their business. Business term loans make sense for SMEs that need significant funding over a longer period of time and do not want to dilute ownership.
Asset Purchase Agreements
In some cases, businesses need to purchase equipment, inventory, or real estate, to continue or expand their operations. Asset purchasing financing offers financing tailored to a business's required purchase. Typically, asset purchase financing offers lower interest rates than general business loans because the asset can be used as a collateral to secure the loan. Asset purchase financing varies in duration based on the cost of the asset. Interest rates, too, vary depending on the specific asset. For example, an expensive asset, such as a vehicle or a factory may be paid off over a longer period at lower interest rates, while a cheaper asset (such as IT equipment) may be repaid over a shorter time period with higher interest rates.
Some SMEs may not be eligible for business loans. These companies might be interested in equity financing, which allows the business to sell shares of itself to investors. Advantages of equity financing are that it does not require regular interest payments and that it can provide the greatest financing amounts. A downside is that the ownership of the business becomes diluted. Businesses that succeed may end up giving more to investors through equity financing than they would have through interest payments of a business loan. However, businesses that fail do not owe equity investors anything. Equity financing is the best option for young SMEs that are not eligible for business loans with affordable rates, or businesses that require huge amounts of funding.
Typical Ranges of Characteristics of Various Loans
|Banks||Working Capital||Asset Purchase||Business Loan||Equity|
|Financing Amount||S$70,000 - S$300,000||up to 90% of purchase price||up to S$5 million||N/A|
|Tenure||up to 5 years||3 months - 8 years||up to 6 years||N/A|
|Annualised Interest Rates||from 6.75%||from 2.5% - 12.8%||4% - 10%||N/A|
|P2P/Crowdfunding Platforms||Working Capital||Asset Purchase||Business Loan||Equity|
|Financing Amount||S$10,000 - S$5 million||up to S$150,000||S$50,000 - S$5 million+||S$100,000 - S$25 million|
|Tenure||1 month - 1 year||1 - 12 months||3 months - 3 years||Indefinite|
|Annualised Interest Rates||10 - 20%||Unknown||9 - 15%||N/A|
Bank Loans vs. P2P/Crowdfunding Platform
Until recently, small and medium sized businesses have only been able to obtain loans from traditional banks. With the advent of P2P/Crowdfunding loans, SMEs have more options and increased access to financing.
Banks offer a great variety of loans and the most competitive interest rates. Bank loans make the most sense for businesses with strong financial track records and an operational history of a at least a few years. These businesses will be eligible for larger loan amounts and better interest rates compared to crowdsourced financing. Newer businesses, especially those that are not yet generating a significant amount of revenue, tend to not be eligible for financing from banks.
Thanks to SPRING Singapore's government-backed SME loans, in which the government takes on a percentage of the default risk to encourage banks to offer financing to SMEs, small businesses have more opportunities to receive traditional business loans. The program supports short and long-term loans at several local banks. These loans are restricted to companies registered in Singapore with 30% local shareholding and most require that applicants have Group annual sales of S$100m or less or group employment size of 200 or fewer. While the requirements of these loans are intended to ensure the availability of financing for SMEs, meeting the requirements alone does not guarantee funding. Ultimately, banks decide whether or not an applicant will receive funding.
Due to the decentralised risk of crowdfunding, P2P/crowdfunding platforms are able to offer loans to businesses that may not qualify for traditional bank loans. These platforms generally have less stringent financial and operational requirements. Younger SMEs that might not meet banks' eligibility requirements are often well-suited for at least some form of P2P/Crowdfunding. Interest rates tend to be more expensive through crowdfunding platforms, as financing for newer companies presents more risk for investors.
Assess Your Own Eligibility
|Typical Criteria||Banks||P2P/Crowdfunding Platforms|
|Revenue Requirement||S$500,000 - S$1 million||S$0 - S$300,000|
|Operating history||2 - 4+ years||0 - 2 years|
How to Think About the Cost of A Loan
Before making any business decision, a wise SME director will always consider the decision's costs and benefits. Obtaining financing can be vital for the future of a company. However, it is important to consider the costs of each financing option before diving in in order to find the best small business loan
Lenders generally charge interest rates and various fees. Fees charged include: application, success/issuer, and early repayment fees. It is important to read and understand the description of the fees for each loan. For example, make sure you understand the basis for each fee (e.g. total loan amount, monthly payment, principal outstanding). It is also important to understand if each fee is applicable to your small business. For instance, if you expect to be able to repay a loan back quickly, keep an eye out for early repayment fees. Similarly, if you plan to apply for several loans, make sure you're on top of application fees.
Interest rates charged depend on the lender, the borrower, and the type of loan. In general, banks offer lower rates than crowdfunding platforms. That being said, younger SMEs may not be eligible for loans from banks. Some loans require collateral, an asset to sell to repay lenders in case of default; loans backed by collateral are called secured loans. Secured loans generally require lower interest rates, due to their lower risk compared to unsecured loans. Similarly, loans with a specific use (e.g. invoice financing, asset purchase financing) are considered to be less risky and have lower interest rates than loans that can be used for general purposes. Finally, short-term loans generally have higher interest rates than long-term loans. This is because investors will receive returns for a longer time with long-term loans, and demand higher rates to make short-term loans worthwhile.
|Fee Type||Typical Range||Who Charges This Fee?|
|Application Fee||S$500 - S$750 one-time fee, S$500 - S$1,000 annually, 1 - 2% of loan amount||Most lenders|
|Processing Fee||1%-7% of loan amount||Some lenders|
|Success/Issuer Fee||2 - 8% of loan amount||Nearly all lenders|
|Early Repayment Fee||1.5%-3.5%% of outstanding loan||Some lenders|