Financial constraints and the need for financing is something almost every business encounters at some point. These are probably 3 of the most common financing sources first time entrepreneurs will lean on for their seed financing.
If you need capital as soon as possible, you can apply for a business loan in Singapore from banks or financial institutions. There are numerous banks and loan products and you need to make a comparison of the banking facilities available to source for the most suitable ones.
You will need to consider the maximum amount that you can borrow, interest rate, tenure, fees, and the effective interest rate (EIR). What is effective interest rate? This is the true cost of your loan, and it can be much higher than the rate advertised.
Government financing schemes
The Singaporean government support SMEs with government assisted financing programmes. SMEs can access a number of government-backed loan schemes and grants that will allow them to borrow money to finance their enterprise.
The Temporary Bridging Loan was launched in 2020 to help SMEs access financing during Covid-19 . Then there’s SME Working Capital Loan, which offers up to SGD 300,000 per borrower and a 5-year repayment period.
Bootstrapping is to finance your business initially using only your existing resource. This can mean using your own savings or even getting a loan from your family members to kick-start your company.
The main benefit of bootstrapping is having 100 per cent control over all business decisions and direction.
On the other hand, you have to accept that there’s a good chance that your company will not grow as quickly as those that have access to external financing such as SME loans or venture capital funding.
Your financing options are not limited to only banks and investment institutions. Other than traditional bank loans or bootstrapping, there are many other creative options to get funding.
Below are 8 creative alternative funding options which provide companies with ample financing options.
1. Finance leasing
A finance lease is usually used to finance acquisition of equipment or machinery. There are commonly two types of finance leasing: Direct financing lease and sale-leaseback.
Lessee applies for a finance leasing to the lessor:
After due diligence and credit underwriting based on the lessee’s equipment purchasing plan, the lessor approves the application, signs the finance lease with lessee, sets up contract terms and clauses such as instalment plans, interests, duration, as well as default clause.
After the lease agreement is signed, the equipment seller delivers the equipment, installation and completes commissioning (if required). Lessor will make remaining payment after the lessee confirms the delivery.
Lessee will service the installment according to lease agreement and has all rights to use and operate the asset for the discharge of it's business. The lessor holds the ownership of the equipment until lease installments are fully paid.
Once all installments are fully paid and the lease expires, the lessor transfer the ownership of the equipment to the lessee and terminate the lease. In certain lease arrangement, the lessor might still retain ownership of the equipment after end of lease.
A sale-leaseback is an arrangement where the lessee sells an asset to the lessor, and then lease it from the lessor. Once the lease expires, the ownership of the asset would be transferred back to the lessee.
Comparing to direct financing lease, the advantage of a sale-leaseback is that the lessee will have access to cash flow without affecting the production or operation of the company.
Finance leasing provides lessees with faster financing than bank loans, with typically less stringent requirements on credit assessment and guarantees for the lesser, which is ideal for SMEs.
2. Credit card financing/personal loans
Yes, most business owners would not link the use of credit card as a form of alternative business financing. This used to be true as most business expenses are not payable via credit cards.
However, there are now solution that allows credit cards to be used for payments of business expenses. Fintech startups like Cardup allows businesses to use underutilized credit limit on either personal or corporate credit cards to pay for business expenses such as rental, suppliers payments and even staff salaries.
Payments to suppliers can be paid using credit cards even if suppliers don’t accept credit card payments. Cardup has an unique proposition that business users can tap on by charging your credit card upfront on the invoiced amount of purchases from suppliers.
They will then pay direct to your listed suppliers and you are billed the payable amount only when you receive your credit card statement.
SMEs whom use Cardup’s solution can tap onto the underutilized limit in personal or corporate credit cards to make payments for business costs like payroll and rental which are usually not able to be financed via traditional revolving bank credit facilities like trade financing.
It’s also a smart way to book company expenses under credit cards to earn card issuing bank’s reward points, cash back or miles. With up to 55 days interest free period from point of card debiting to statement due date, companies can enjoy some credit terms from such payment arrangement.
3. Equity Pledge
If a company is faced with a situation where it has no assets to pledge as collateral to lenders, but requires capital for CAPEX to expand production. When a company can’t obtain a loan with asset nor credit, but doesn’t want to sell equities, stock pledge is an option worth considering.
Stock pledge refers to the transfer of stocks against a debt, in order to obtain funds from lenders. This type of financing has a higher requirement for the liquidity and pricing level of equity, therefore is more commonly used by public companies.
However, SMEs can also copy the model, using equity as a guarantee to obtain a loan or production equipment to expand the business and overcome capital shortage.
Company A lacks the production equipment or cashflow for the operation of the company, so it proposes a stock pledge financing plan to capital provider, company B, asking for funding to purchase production equipment for production;
After a negotiation, it is agreed upon that company A pledges a certain portion of stock (15%, for example), company B provides company A with 10 sets of production equipment, each set of equipment costs $500,000, the total amount of the loan is $5 million, inclusive of interest.
Company A pledges 15% of its equity to company B, and it is agreed upon that company A will repay the loan in two instalments, $250,000 each, redeeming 5% of the equity.
After a two-year term, the loan is paid off in full, company A redeems 10% of its equity back, and company B continues to hold 5% of company A as a shareholder.
The implementation of this type of financing requires specific conditions. For example, company B must be confident in company A’s outlook and it’s business valuation. Through careful design and negotiation, equity pledge could be a brilliant financing method for more mature and larger companies with proven track record to overcome a company’s capital shortage.
4. Mezzanine Financing: A hybrid of Debt and Equity Financing
Mezzanine financing is an innovation in the capital market, with characteristics similar to both debt and equity financing, its risk and return level is between equity financing and preferred debt.
A mezzanine financing plan can be customized based on the needs of the company seeking capital, the ratio of debt and equity is very flexible, which helps companies restructure their capital. Common mezzanine financing includes preferred stock and convertible bond. Mezzanine Financing is a popular financing option in pre-IPO financing.
There is an average of 20-month wait after a company files for IPO; during which, many events may take place, such as a bear market, drop in valuation of the company, or a less-than-ideal IPO price.
The company can choose to conduct a financing round first, and mezzanine financing would be a good choice. On one hand, it fixes the problem of a capital shortage, on another, it can improve the financial structure of the company. Furthermore, the fund raised can also prove that the company’s outlook is optimistic, and therefore be valued higher.
5. Project financing
Project finance is the financing that is backed by the assets from a specific project, and paid back from the cash flow generated by the project. Both BOT (Build–operate–transfer) and PPP (public-private partnerships) are forms of project financing.
The advantage is that it can attract investors with the stable, estimated future cashflow with no need to pledge assets as collateral.
Project financing is generally used for financing large-scale infrastructure projects such as highways, airports and power plants. Certain banks do offer project financing to SMEs as well for smaller scale construction and real estate projects.
Larger scale project financing can also be funded by several financial institutions as a syndicated loan.
6. Advance Payments
Structuring your business model such that advance payments options from your customers can be made upfront is another creative method to obtain funding without credit.
This is common in the service and telecom industry, such as pre-paid cards SIM cards, annual membership programs for online streaming services, membership packages with gyms and yoga classes etc.
These form of prepayment financing are in fact a form of compensation trade, only it doesn’t pay back the advance payments with physical products, but with services that the customer can “draw down” on over a period of time.
Developers in the real estate industry frequently finance their construction costs of property development with pre-sale of the development’s units to buyers. Before even spending a single cent to break ground, it’s common that the developers could have already collected 80% to even 100% of the development’s sales proceeds from preview sales.
7. Business Incubation
Statistically, most startups tend to fail within the first few years of operations.
This is a fragile stage of a company, there is usually not much asset to be pledged as collateral, and it’s almost impossible to get a SME loan from the banks. Additionally, equity financing would mean losing a substantial portion of the company. And this is when a SME can consider Business Incubation as a mean to resolve the cashflow problem.
A government agency or professional investment firms usually leads the way with its resources and reputation to create a business incubator.
Company A has made viable a new technology, but have yet to develop its market. The business incubator can provide support for business development and R&D phases.
The government or investment company provides Company A with seed capital, affordable office, product promotion, guarantee for loans, networking introductions and general advice to help Company A develop its market and product.
After successful commercialization, Company A will pay incubation management fees that was previously agreed upon, which could be structured as a form of profit-sharing or equity.
This type of funding requires strong backers and is suitable for companies that already have a MVP (minimal value proposition) in place with an initial small pool of paying customers, but lacks working capital.
Through the integration of resources, this creates a win-win situation for both the startup and the business incubator.
8. Supply Chain Financing
Supply chain financing links various parties in a transaction together using technology-based platform and financing processes. Through linking the buyer, seller, and financing institutions together, the financing costs are reduced and business efficiency is improved.
Financing usually comes in the form of short-term credit from the participating bank to the buyer that optimizes working capital for both the seller and the buyer. Supply Chain Finance (SCF) might also involve a technology platform where the entire process takes place, from automating transactions, invoicing, and settlement process.
The increasingly complicated supply chain and globalization have been the main driver for SCF’s popularity, namely in the automotive, manufacturing, and retail sectors.
SCF transactions includes extension of buyer’s account payable terms, inventory finance, and payables discounting. SCF connects financial transactions to value as the transactions move through supply chain, and encourages collaboration between the buyer and seller.
Through these, SCF enhances working capital by reverse factoring and payment discounting.
Here’s how a typical extended payables transaction works:
Buyer (usually known as the anchor in SCF) purchases goods from Supplier. Supplier delivers the goods and invoices Buyer, which Buyer approves on standard credit term, 30-day.
If Supplier requires the payment before the 30-day credit term, it can request immediate payment at a discount from the financial institution in this SCF chain, given that the invoice was approved by Buyer.
The financial institutions engaged in this type of financing typically has a pre-screened approved list of suppliers.
Seek financing with a strategic purpose
If you’ve not been keeping a close eye on your working capital running into a cash flow crunch and have to scramble for a loan to tie up loose ends, this is for a tactical purpose.
If you’re anticipating a large project to be awarded to you and start planning months ahead by priming your cash flow and financial reports to be in the best financial shape when applying for loans, this is a strategic purpose.
When seeking external shareholder or equity funding, the type of investors you’re reaching out to also reflect your financing purpose.
If only the price of funding is considered, the financing purpose is only tactical.
If you consider intangible benefits the investor can bring to the table including industry expertise, network and prior experience, this is strategic financing.
In addition to the different financing options mentioned above, companies can also choose credit guarantee, P2P crowdfunding, profit sharing, and many other types of creative financing methods.
The risks tolerance and costs determine the financing method, but fundamentally, every financing option involves equity and/or debt. Companies should be flexible and smart about the financing options to select the most suitable financing option to inject cash-flow into the company.