Small businesses are not always considered traditional banks’ top customers of choice. A lack of banking history, struggles with cash flow and general inexperience make SMEs a high-risk segment for the banks.
But according to lobby group the Association for Financial Markets in Europe, banks are still the leading source for working capital aid for small businesses – whether that aid comes in the form of a loan, or in the form of financial guidance.
The AFME recently published its guide for small business owners in need of financing in Europe. “Raising Finance for Europe’s Small & Medium-Sized Businesses” breaks down the multitude of options SMEs have when in need of a loan. The report offers a hand to small businesses unsure of where to turn when seeking working capital, and what, exactly, to ask for.
Narrowing It Down
Sometimes, the toughest hurdle isn’t accessing finance from a bank. Once a bank is willing to service a small business, the challenge can come in choosing the right type of financing.
The types of loans available go way beyond straight-forward factoring, invoice discounting, trade finance and other increasingly common types of lending products for businesses, the AFME said. For example, when it comes to trade finance, a small business may need to obtain a pre-shipment loan, a way to ease cash flow concerns “at the beginning of a contract when goods are being manufactured or purchased to be sold,” the report reads.
Or, businesses may seek out a trade loan, generally a short-term loan provided to an importer to fund their purchase, a tactic that the report notes can be particularly useful to manage cash flow between the time an order has been made and paid for, and the time that revenue has been received once those procured goods have been sold.
Easing The Risk
There are ways banks can facilitate B2B trade and ease working capital struggles without providing a small business loan, however. With small businesses considered such high-risk, the AFME points to ways trading partners and banks can lessen the anxiety of financing small business operations. The report highlights payment documents and contracts, which, just as with loans, come in a multitude of types depending on a small business’s needs.
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A letter of credit is a guarantee to a supplier or seller that a purchase will be paid for. A guaranteed letter of credit has been approved by a buyer’s bank; transferrable letters of credit can be passed between businesses, a service particularly useful for the multiple players involved in a single supply chain; meanwhile, a revolving letter of credit can be used for multiple transactions between two businesses.
Then there’s the documentary collection, a means by which exporters can submit payment documents like invoices to their bank, and then have the bank pass those documents on to the buyer once payment is received. Exporters can use these documents to ensure they receive payment, whereas importers can use them to ensure they get the shipment they’ve paid for.
And even still, there is the international guarantee, which acts as a contract for advance payment (for the exporter) or performance (for the buyer).
The Lending Tree
Europe is among the world’s strongest alternative lending markets, and it comes as no surprise, the AFME said.
“Most banks and non-banks would rather lend to an established business with a stable and positive cash flow history, particularly if it can provide collateral or a personal guarantee,” the report concluded.
While analysts at the agency noted that getting denied by a bank for a business loan is not necessarily a recipe for failure, the report offered the SME Finance Decision Tree to help small businesses decide which source of financing they should turn to first – and it’s not always a bank.
The tree begins with a single question: “What is the size of my firm measured by annual turnover?”
The AFME then moves on to ask SMEs whether the financing they need is for a low-risk investment, and whether the business needs a small or large amount of funding. These factors can guide businesses to the right source of working capital.
For example, SMEs with annual turnover of between £4 million and £20 million with the need for a small amount of funding for an investment that cannot be considered low-risk would be wise to turn to crowdfunding, the AFME said.
Businesses with less than £4 million in annual turnover with the same financing needs, however, can turn to family and friends. If these small businesses need a larger loan, they can turn to a business angel.
The fact that banks are weary of lending to high-risk SMEs makes alternative lenders, crowdfunding, and other sources of working capital more “appropriate” for small companies, the AFME wrote. Still, traditional banking services should not be dismissed – small business owners need merely to pursue these services in the correct way, the guide says.
[bctt tweet="In most cases, your bank will be able to help."]
“Your accountant is an invaluable source of advice about suitable sources of finance,” the AFME wrote. “In most cases, your bank will be able to help. Banks are the chief source of finance for SMEs in Europe. Even if they cannot lend themselves, they will often give information about alternative sources and will sometimes guide you during the funding process.”