Cash flow is the lifeblood of your business, so when your bank has let you down and you don’t know how you’re going to pay wages and expenses, it can be quite scary. Your business may be perfectly credit-worthy, yet still be rejected for a business overdraft or a business overdraft extension.
A main consideration for any lender is security – how they get their money back if you can no longer pay your debts. Recent changes brought in by the government, giving HMRC preferential creditor status, mean that in the event your business becomes insolvent, any unsecured lender would rank behind HMRC and be one of the last creditors to be paid.
This change means that banks are going to be even more unwilling to provide unsecured lending, going forwards. All is not lost though, and there are alternatives out there which could be even more appropriate and cost-effective.
Here are a few options when your bank rejects your business overdraft application or declines your request to increase your business overdraft.
This type of lending solves the problem of lenders not having adequate security, as the borrowing is secured on your book debts.
For example, if a business client of yours owes you money for products or services you’ve provided and has agreed to pay you in 60 days, a lender would take a fixed and floating charge over this debt that your client owes you and advance you most of this money straight away, freeing up cash to spend on your expenses. The borrowing is then repaid when the client pays you the money that they owe.
This type of lending is only suitable for businesses trading with other businesses on credit terms. Lenders also like to know your terms of trade and don’t like contractual debt, staged payments or clawbacks.
For example, lenders providing invoice discounting love temporary recruitment companies – the service is provided (the temporary staff) and your client agrees to pay in a certain number of days after the temporary staff attended their placement. There is no dispute as to whether the service has been provided in full. The invoice discounter is happy to advance funds straight away, enabling the temporary recruitment company to pay staff in a timely manner, rather than waiting for their client to pay them.
Permanent recruitment is much more difficult for invoice discounters, as staged payments and clawbacks may be involved – for example, payment from the client may only become due once the member of staff placed has passed a probation period. So, in the event you become insolvent, the invoice discounter is unable to collect on the debt or it may be disputed by your client.
The high street banks all provide invoice discounting at various levels of turnover and service. The likes of Close Brothers, Skipton and Hitachi provide a personal, sometimes more flexible service whilst also being competitive on price with the high street banks.
There are two main costs involved – a service charge and a discount margin. The service charge is charged as a percentage of your invoice turnover put through the facility, which can be as low as 0.1% for businesses turning over £15m. The discount margin is charged on funds you draw down on and can be as low as <2%.
At the lower end of the market, service charge and discount margin can vary widely, and it really pays to shop around and understand the fees and interest payable.
It doesn’t necessarily matter if your business has poor credit – the invoice discounters are more interested in your debtor book – the quality and spread of the debts owed to you by clients and your terms of trade. Even if your business is insolvent and has entered into a Company Voluntary Arrangement (CVA) some invoice discounters may still advance you the funds your business needs to trade.
Invoice factoring (where the lender collects the debt on your behalf) and/or bad debt protection (where insurance pays out on unpaid debts) can also be added to these facilities at extra expense.
Hybrid facilities such as Natwest Rapidcash have emerged which may offer a cheaper alternative to under-utilised or expensive invoice discounting facilities, especially those with a minimum service charge. There is no service charge or renewal fees with this facility and rates for borrowing up to £300k range from 4.5% - 8.5% over base rate. There’s a simple calculator on their website here showing how much the lending might cost your business.
If you’re a retailer, serving the general public, you’re unfortunately not eligible for this type of lending. However, if you take card payments, you may be eligible for a merchant cash advance.
Merchant Cash Advance (MCA)
A Merchant Cash Advance allows your business to borrow money for short term purposes (e.g. to buy stock), with repayments taken directly from an agreed percentage of future card payments.
To be eligible, a business must take at least £1,500 per month in card payments. Up to 2x your monthly card payments can be funded.
Common industries served are retailers, pubs, restaurants, hairdressers and MOT garages. Businesses with lumpy, unpredictable revenue streams or ones where deposits are taken, such as car sales, high end jewellers and travel agents are usually ineligible for this type of lending.
Some of the leading Merchant Cash Advance providers are 365 Business Finance, Liberis, Merchant Money and Youlend. Lenders charge a factor rate, whereby they add a fee at the start the facility, which is then repaid directly from your future card sales. Most merchant revenue streams can be lent against, including Stripe and Just Eat. Rates can be as low as 1.06 but typically range from 1.15 – 1.3.
So, for example, if you are a restaurant that wants to borrow £10,000, and the factor rate is 1.2, the total amount repayable will be £12,000. The lender might agree for 15% of your daily card payments to be taken as repayment. The lender retains this percentage of your card takings and uses it to reduce their balance.
In a busy December month, your restaurant might take £20,000 in card payments, meaning your repayments that month would total £3,000 (15% of £20,000), whilst in a quiet January month where you take £5,000 in card payments, your total repayment on the merchant cash advance would be only £750 that month – the facility flexes with your card turnover and is typically repaid within 12 months.
Once you're set up with a lender, most clients tend to use the facility again.
This type of facility isn’t suitable for start-up businesses because lenders want to know the history of your card turnover, so at least 4 months card payment history is required, and card statements provided to show this.
If you’re not eligible for either of the above facilities, then you have the option of a revolving credit facility.
Revolving Credit Facility
Iwoca, Just Cashflow, Credit4 are some of the lenders that provide flexible revolving facilities – just like an overdraft, these facilities give you the flexibility to draw down funds and repay as and when your cash flow dictates.
They aren’t cheap though – typically 2% per month. These lenders will want to see you use the facility too. Non-utilisation fees may be charged or, if you don’t use the facility for a certain number of months, the facility may be cancelled – so it’s generally not something you can have sat there just in case.
Unlike some of the invoice discounting and merchant cash advance lenders, you must provide a personal guarantee and you must be a homeowner. Additional security may be required too.
Unsecured Business Loans
I’m mentioning these last as, strictly speaking, business loans aren’t cash flow facilities. Business loans are designed for investment, not working capital. They don’t revolve and flex through your trade cycle – monthly repayments can be a drag on your business, especially through quieter months of trading.
However, they can be much cheaper overall than some of the revolving credit facilities mentioned above and don’t always require a personal guarantee.
Outside of the banks, Funding Circle is the market leader.
Under the government-backed Recovery Loan Scheme (RLS), under which the lender receives an 80% part guarantee from the government, no personal guarantee is required (although you are still liable for the full loan amount) and the annual effective rate of interest, upfront fee and other fees cannot be more than 14.99% under the Scheme (it can be lower than this).
However, if a lender can offer you the same amount on better commercial terms without requiring the guarantee provided by the Recovery Loan Scheme, they will do so; meaning a lot of the time, lenders will require a personal guarantee.
Because these business loans are unsecured and repayable over a number of years, the primary concern of the lender is your creditworthiness and ability to generate the earnings and free cash flow to repay the lending in the years to come. Loss making businesses and businesses with previous defaults on lending will find it difficult to obtain an unsecured business loan.
Lenders such as Nucleus are expected to be accredited onto the Recovery Loan Scheme in the coming weeks and it remains to be seen how relaxed their underwriting is.
Often your first port of call, when looking for a working capital facility, should be your bank. They are best placed to assess your creditworthiness, they can see the cash flow through your business account and can spot early warning signs of financial distress. They have a major advantage over other lenders. What’s more, some of the best high street deals available are only available to existing bank customers.
If you’ve been declined an overdraft or overdraft extension from your bank, please speak to me. There are a number of options available that may surprise you. Some I’ve not mentioned above too (such as refinancing of investment property or pension-led funding).
I often see businesses struggle to get the funds and service they need to thrive, or overpay for expensive facilities when there are more appropriate, cost-effective options. That needn’t be the case.
It’s my job to keep up to date on developments to find you the best deal, while you focus on your business.
The views expressed above are my own. Lenders are always updating their pricing and criteria and there may be other options available, in addition to those outlined above. Please contact me before entering an agreement with any of the lenders mentioned. I do not charge an appraisal fee or broker fee but may receive commission from the lender.