Small business owners can face a tough decision when it comes to finance: with so many options for funding, it can be hard to know where to turn. In 2015, around 100,000 UK SMEs were refused a bank loan, and 40% of small businesses chose not to try another source of funding after rejection. But the banks aren’t the only way to raise funds for your business; alternative finance is growing in the UK and has generated many different kinds of finance options for consumers and businesses alike. Invoice financing, invoice trading, and peer-to-peer lending are great possibilities to consider. Let’s take a look at these forms of finance to help you decide which might be right for your business.
There are two kinds of invoice finance: factoring and invoice discounting.
Factoring, or debt factoring, is typically managed by an invoice financier who buys debt owed to you by your customer. The financier provides you with a percentage of the debt in advance (around 85%), and when they have collected the debt in full, they send you the outstanding balance. The cost of this service depends on the invoice financier you use, but you can expect to pay a discount charge or interest and fees. As the invoice financier is collecting debt from your customers directly, your customers will know that you are using invoice finance.
If you prefer to manage your customers’ debts internally, you might prefer invoice discounting. In this process, an invoice financier lends you a percentage of the value of your unpaid invoices. As payments come in for these debts, you send them on to the invoice financier, reducing the total amount that you owe. If you like, you can borrow more money on new invoices, up to the percentage you initially agreed on with the invoice financier. You can expect to be charged a fee, but customers will not be aware that you’re using invoice discounting, unlike with factoring. It does require more involvement in managing these debts, however.
Invoice trading takes the principles of factoring and invoice discounting, and brings them online. With this method of raising finance, you can raise finance by auctioning your invoices online to a group of buyers for a fee. Selling your invoices online removes the need for long, fixed term agreements with an exclusive financier that can come with the invoice finance models. Some platforms even offer you the ability to keep your company name private.
Peer-to-peer (P2P) lending is a way to raise finance that isn’t based on your customers’ debt. P2P lending, a type of alternative finance, involves raising funds for your loan through a group of investors. There are a few different models, but in general, your loan will either be offered to investors at a fixed rate or in a loan auction where they can bid at different interest rates. Like invoice financing, you can expect to pay a fee to the peer-to-peer lender.
There are quite a few benefits to this approach; you have more control over the amount of finance you need, the term of the loan, and how you use the funds. Depending on how much you request a loan for, you could potentially raise more finance upfront than you might through invoice financing.
What you should consider
In choosing between invoice finance and P2P lending, it is important to consider the pros and cons of each method:
- In factoring, the responsibility for chasing debt is left to the invoice financier, giving you more time to spend on other aspects of your business. You risk, however, a potentially negative interaction between the invoice financier and your customer, which could damage your own relationship with your customer.
- With invoice discounting, your customer won’t know that you’re using invoice financing, but you are responsible for collecting payment.
- Selling your invoices on a platform is a more flexible approach, but how much you can raise depends on how well your invoices fare in the auction process.
- Invoice financiers may place a charge over your invoices, which will potentially restrict funding from other sources.
- Finally, with P2P lending, you could potentially raise more finance than you would against your invoices, but as with invoice trading above, your interest rate may depend on the bidding process.
Invoice finance and trading are sometimes a stopgap solution that can limit your business’s growth. Find out how you can plan a future for your business with a LendingCrowd loan.