Working Capital Options for SMBs: Navigating Traditional and Alternative Funding

Traditional funding has been hard to come by for small-and-medium sized businesses (SMBs). Unlike larger entities, SMBs can lack the assets or credit history to access enough working capital through traditional means. However, the modern SMB still requires access to working capital in order to fill existing orders and cover overhead costs — since many of these businesses are also trying to expand, boost their online presence, and acquire new customers. 

In the past, access to working capital was possible through methods like SBA loans, financed equipment purchases, or via traditional lending. In each of these cases, the founder usually needed to provide a personal guarantee. While traditional methods of accessing capital are preferable in certain scenarios, they aren’t always the solution founders need. Neither is selling equity always a possibility: many founders prefer to hold onto their equity interest in the business until the business sees growth. However, without access to capital this growth is difficult to achieve. 

Traditional Financing for Businesses

Traditional lending makes up some of the most commonly considered funding options considered by SMBs. These options include:

• Revenue based financing: Revenue based financing (RBF) is an alternative to selling equity for many businesses. In RBF, businesses receive a set amount of funds, and repay the amount via a portion of future sales. These future sales can be debited daily or weekly, depending on the terms. Shopify Capital and similar methods of funding tend to operate on this RBF model. 
• SBA loans: the US Small Business Administration (SBA) offers SBA loans in partnership with banks to businesses who want capital but don’t have the assets or credit history. These loans offer funding that is still backed by personal guarantee, but are often with more favorable terms than the business would otherwise receive. 
• Bank Loans: traditional bank loans are best for large purchases like vehicles or warehouses. They are either secured or unsecured by the value of an asset (for example, using your vehicle as collateral) and can be either revolving or non revolving (for example, a term loan for a set amount versus a line of credit where you only borrow what you need). Terms and amounts will depend on the borrower's assets and credit history. 
• Credit cards: businesses can take out credit cards to cover costs such as inventory. While these forms of credit come with slightly better terms for smaller purchases such as inventory (since the borrower can borrow only what they need), they do often still require a personal guarantee. In addition, credit cards usually come at a higher rate than a bank loan, or with a smaller credit facility.

Small and medium sized business owners might have personal loans or lines of credit, use vehicle financing, or take out mortgages for their own properties — so it makes sense that these founders look at the same funding methods for their companies. However, depending on how the funds will be used, these options aren’t always the best terms. 

Why? Short term inventory costs will be invested into the finished goods and repaid when the goods are sold. In the meantime, the business will need to order more inventory. If a founder uses a loan to cover initial inventory expenses, they can end up footing the cost of inventory for much longer than they realistically need. This leaves them repaying inventory at the same time they set out to purchase new inventory. Combined with the impact of a personal guarantee (leaving each founder on the hook for the borrowed funds), these options aren’t a good fit for many businesses' needs.

Alternative Finance Solutions for Businesses

Since traditional funding has struggled to meet the capital needs for SMBs, the industry has seen a number of alternative options for funding emerge. These include:

• Invoice Funding: Invoice Funding is an alternative method of meeting business’ working capital needs. As opposed to invoice financing or invoice factoring, Invoice Funding allows the business to directly fund the invoices they need. For example, Invoice Funding can be used to cover marketing costs or run ads on social media. It can also be used to make orders for inventory. Funding these invoices frees up working capital for other needs. 

Newer forms of funding working capital can all be part of the solution for SMBs. Whether or not these alternative means of accessing capital make sense will depend on the business model and the method of financing. However, in almost all cases, there are at least a few funding possibilities that SMBs can use to fuel growth and meet the business’ needs.

By choosing the right option for working capital, SMBs set themselves up for a positive trajectory – making it easier to sell the business, make a founder exit, or buy a new business in the future.

Contributor Bio

Audrianna Frey, Demand Generation Specialist, Clearco 

Audrianna is an experienced marketer with a diverse background in digital marketing, content creation, social media, and brand management. She specializes in developing and executing comprehensive marketing strategies that drive top-of-funnel growth.

Opinions expressed here by contributors are their own.

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