Business overdrafts used to be the most common form of funding used by firms all over the country. They’d be included as part of your standard bank account, and you could use the extra cash for a few days or a few weeks as a buffer against cashflow issues.
But then the credit crunch happened, and the banks were forced to start reducing or removing the overdrafts they extended to small businesses. Suddenly, companies who had relied on their overdrafts no longer had a safety net. Luckily, the growth of the alternative finance market since then means there are lots of business overdraft alternatives available.
Merchant cash advances
If you accept payment using a card machine, a merchant cash advance might be a good alternative to your old business overdraft. Although they work in a similar way to loans, they’re based specifically on your future card sales. The lender works with your card payments provider and uses this data to agree an advance amount, for example one month’s average revenue.
So the advance is a fixed amount, and you’ll know the total cost up front — but the important detail is that the repayments are flexible. They’re taken as a percentage of your future sales, so each transaction repays a small amount of the advance.
For example, if your agreement states that repayments will be 20% of sales, a transaction of £50 would automatically repay £10 to the lender, while the other £40 would go to your bank account as normal. That means it’s a good fit for businesses with unpredictable revenues, as you’re not committed to a fixed monthly payment.
Revolving credit facilities
Revolving credit facilities are perhaps the closest equivalent to traditional bank overdrafts. You still get a pre-approved credit limit, and you can draw funds as and when you need them up to that limit. But since a revolving credit facility isn’t tied to your bank account, when you want to draw funds you can log in to your account and decide where to direct them.
Most of these facilities will have an initial setup fee, but after that the interest is only calculated on outstanding cash — in other words, once you’re up and running you only pay for what you use.
Revolving credit facilities are a type of unsecured loan, so lenders will be looking at your trading history and monthly revenues to determine affordability. However, provided they satisfy the basic criteria, a wide variety of businesses can use revolving credit facilities because they’re not tied to a particular sector or asset.
If your customers pay you on terms, invoice finance can be a good alternative to a business overdraft. The basic concept is that instead of waiting for your payment terms, you effectively get paid earlier — the lender advances you a percentage of the face value, then you get the rest (minus fees) once your customer has paid.
While the ‘full’ facilities of factoring or invoice discounting can certainly be useful, the best overdraft replacement is probably the selective products such as spot factoring.
The key difference is that instead of putting all of your invoices through the facility, you can choose specific customers or specific invoices to finance. For example, if you offer different terms to different customers, you could finance the invoices that take longer to be satisfied, while treating all the others as normal.
On the other hand, spot factoring focuses on individual invoices, regardless of the customer. Lots of modern providers offer online spot factoring, where you upload the invoice when it’s raised and get an advance within hours. Many will also offer an all-in fee, so you know the cost up front.
If you’re lucky enough to still have a business overdraft, you may not need another form of business finance. However, many smaller businesses are finding them increasingly difficult to come by, and if yours is taken away there are still lots of options that could help — whether you issue invoices, take card machine payments, or just need an occasional cash injection.
Conrad Ford is Chief Executive of Funding Options, recently described by the Telegraph as “the matchmaking website for small businesses and lenders”. Funding Options has been selected by HM Treasury to help businesses find finance when they’re unsuccessful with the major banks, as part of the Bank Referral Scheme that launched in November 2016.