Why alternative financing could address financial needs of SMEs

Small and medium enterprises (SMEs) are viewed as the foundation of every economy. The scale of the small and medium enterprises and the number of individuals engaged in this sector demonstrate their critical significance in the growth of an economy. This significance is also acknowledged by policymakers, who are working to create a business-friendly climate for SMEs to boost their financial development and growth.

Even though the significance and contribution of SMEs to the economy are widely acknowledged, there are many small businesses and startups that face a myriad of challenges. Among the most significant impediments is a lack of financial resources to sustain its competitiveness and grow the business.

If the SME sector is unable to secure the necessary cash to operate optimally, it will be unable to fund its investment and day-to-day operations. As a result, the expansion of SMEs is largely constrained. 

Technological advancements have created a possibility for the growth of a new industry, financial technology. Using the advancements in technology, this industry provides a much-needed service. New alternative finance channels have emerged with the goal of servicing the economy’s underserved segments.

The SME sector has understood the importance of alternative financing. Because of the digitisation of their operations, fintech businesses may provide easily-accessible, lower-cost loans, significantly lower-cost transactions, speedier application processes, and so on. The biggest limitation for SMEs in regards to their expansion and scaling is the fact that most of them don’t have access to capital. Due to inadequate collateral, smaller asset size, and a limited previous track record, commercial banks often regard SMEs to be high default risk – an unfortunate factor that has, in turn, hampered the growth of SMEs globally and especially in developing markets.

Measures in place

To enhance institutional credit flow to SMEs, legislatures in various countries have implemented a variety of measures including subsidised interest rates, collateral-free loans, partial credit guarantees, credit insurance, matching grants, and so on. Many nations have also established separate stock markets for SMEs further simplifying the much-needed access to capital market resources. However, the institutional credit route remains inefficient, preventing many SMEs from expanding their operations.

Many measures taken by the government during the pandemic – such as tax deferrals and state loans – have helped SMEs survive (some maintaining to trade at lower levels, others furloughed), but cash flow issues will persist as enterprises strive to return to ‘normal’ trading volumes.

Alternative funding is accessible through the fintech industry and can provide a lifeline for enterprises in desperate need –and businesses must enlighten themselves about the possibilities available.

Alternative finance is a developing channel in financial intermediation and is technology-driven. Crowdfunding and peer-to-peer (P2P) lending are two examples of the same. Crowdfunding is a digital platform that has three moving parts — the SME business seeking financing, the donors willing to support the project, and the regulating organisation that promotes interaction between the donors and the originator.

Creating financing options

The moderating organisation provides participants with information on various programmes and financing possibilities for product/service development. Organisations and owners alike can lend and borrow from each other via the P2P platform. Thanks to their foothold in IT Design, P2P platforms often offer cheap interest rates and an enhanced lending procedure to both lenders and borrowers.

Furthermore, because they have automated onboarding, ID verification, and immediate bank account openings, fintech companies like these have been able to disburse cash with government programmes faster than banks. However, these initiatives are coming to an end, and SMEs will soon need to seek capital from non-government sources.

These options have assisted thousands of enterprises not just in staying afloat during the pandemic, but also in getting access to the finances required for the production of goods, hiring new talent, and penetrating new markets. The goal is to empower owners to embrace a new era of corporate financing.

Usually, small businesses benefit when seeking finance from an unconventional source. These alternatives help the owner collaborate with a powerful, invested partner who may expose businesses to qualified leads, analysts, the media, and other partnerships.

Some advantages of partnering with an atypical lender include:

Market credibility 

The business may loan some of the strategic partner’s goodwill, and cooperating with an experienced investor adds weight to the brand.

Infrastructure assistance 

The bigger partner is likely to have groups for marketing, IT, finance, and human resources – all of which a startup may use at a discounted rate.

Overall business advice 

As part of this deal, the strategic partner is likely to join your board. Understand that they will have a plethora of business expertise, so their opinion and perspectives will be useful.

Market access and longer payment terms 

Businesses can access the world’s most cost-effective markets where the factoring solution provider has a presence. Factoring also allows for longer payment terms giving businesses a better chance to compete effectively in the marketplace.

In a nutshell, factoring is largely a type of financing that is based on the creditworthiness of a company’s buyers, rather than on the financials of their own business. Also, since it’s not a loan, it will not appear on the balance sheet as debt. It also allows businesses to closely monitor the creditworthiness of their customers and covers the risk of shortfall of payment in the case these customers become insolvent. Lastly, it allows businesses to offer longer payment terms and, therefore, attract larger buyers.

When circumstances are tough, it isn’t just about bringing money in, but also about keeping money in; SMEs must consider cash flow preservation. P2P lending and crowdsourcing help businesses with short-term financial loans.

To promote alternative funding sources for SMEs, regulations that support a variety of financial mechanisms for SMEs while preserving monetary sustainability and investor protection, as well as tax incentives to stimulate investment in SMEs, are the need of the hour. 

While there have been ongoing discussions about the emergence of alternative financing in recent years, knowledge among company owners remains low. We must alter this after the epidemic, not just for the sake of these businesses, but also for the sake of our economy. 

Peter Maerevoet is the global CFO and CEO Asia, Tradewind Finance