Unsecured Business Loans for SME’s: How They Work

Very few businesses can achieve any kind of growth without external funding of some kind. If you’ve reached the point where you need financial help, it’s probably a good sign that your business is growing.

The problem is that traditional lending institutions, like banks, don't view it that way. They often decline small and medium-sized businesses any sort of finance because it does not suit their traditional secured lending model. This is because most banks ignore the business and look at you as the individual to secure any debt personally.

No matter how upbeat you are about your business, your family’s home and children’s education may be more than you’re prepared to risk. That’s where the alternative finance industry is changing the face of business finance.

But before getting into that, let’s understand a little bit more about business funding in general.

Secured vs. Unsecured Business Loans – What’s the Difference?

A secured business loan incorporates something of value as collateral that the lender can attach if the business defaults on payments. This reduces the risk to the lender, so interest rates on secured loans are generally lower.

However, it can take a long time for secured loans to be put in place because the collateral must be agreed to and formally contracted into the loan agreement. With immovable property like houses, there is a strict legal process to be followed.

With unsecured business loans, the lender relies on alternative sources of data to make a decision on whether to extend the company a loan. Some data points they draw on include:

Business turnover
How consistent is your turnover month on month
How diverse is your turnover (does it come from multiple customers or only a few customers)
How seasonal is your turnover (Holidays, etc.)
Business trading history
How long have you been in business
How long have you been earning revenue

Because there is no security or collateral involved in the transaction, unsecured business loans are more expensive than secured loans. However, most small business owners are willing to accept the higher cost of finance because it means they are able to grow their business at a rate that is higher than the cost of the funding.

Because unsecured loans are made largely on data that is retrieved from your accounting records, it is extremely important to keep up to date accounting records if you’re a small business.

Features of Unsecured Loans

Some features of unsecured loans include:

Speed. You can usually get funding within 48 hours of your application being submitted if you have all the required documentation.
No security required. Perfect for small businesses without assets.
Tailored product. Small business lenders work with owners to create tailored products suited to the business’s needs. This means you are getting a product that works for your needs, and will be paying the lowest amount possible.

The Alternate Finance Industry

Commercial banks in South Africa (and elsewhere) are highly regulated and have conservative mandates. They are not set up to respond quickly or to offer flexible, unsecured business loans. This is especially true for small businesses with less than two years of trading history and negligible assets.

Fortunately, the growing alternative finance industry is coming to the rescue of small businesses.

Utilizing technology, alternate finance companies can speed up and streamline processes, enabling them to offer a greater variety of products (including unsecured business loans). Offering smaller loans with shorter terms, and generally with higher interest rates, allows them to service businesses who might not qualify for traditional business loans or need funds on short notice.

Different Types of Unsecured Funding for Small Businesses

Some examples of alternative financing activities include online lending, crowdfunding platforms, revenue-based financing, peer-to-peer consumer and business lending, and invoice trading.

Knowing who to approach and what to apply for can be overwhelming, though. That’s where FundingHub, steps in. We are the experts in the small business finance space so that you don’t have to be. We do all the hard work of understanding your financial needs and then finding you the most appropriate partner who will offer you the best deal.

These are some of the most popular SME funding options available in South Africa today.

Revolving loans (or a line of credit)

These give you ongoing access to credit up to an agreed limit. Typically, you only pay for what you use, but there might be fixed fees for availability, and transaction-based charges. Credit cards are a form of unsecured revolving credit.

Unsecured term loans (or non-revolving loans)

These are fixed-term loans with fixed repayment terms. Once you have made a payment, you can't "drawdown" that money again. Non-revolving credit gives the lender predictable income flows and is cheaper to administer, so rates for this type of loan tend to be more reasonable. Unsecured term loans will generally have much shorter terms than secured term loans – anything from 3 months to 3 years. (Secured term loans are typically a minimum of 3 years and more likely five or more.)

Asset leasing

With leasing, the lessor retains ownership of the asset, and you just pay monthly for the use of it. No security is required of you. Sometimes there is an option to acquire the asset for a nominal fee at the end of the lease.

Merchant cash advance (new in South Africa)

This is for businesses where clients pay via credit card. The loan is advanced based on average monthly revenue and repaid over an agreed term. Repayments are linked to monthly revenue. In good months you’ll pay more and in bad months, less.

Invoice discounting and factoring

These are both forms of short-term borrowing that use the business’s debtors’ book as collateral. They are generally used to improve working capital, i.e. cash flow. The business borrows a percentage of its book (usually about 80%) to get cash from sales earlier than it otherwise would. The lender charges interest on the amount loaned. With invoice discounting the business retains credit control, while with factoring the lender takes over debt collecting.

Trade finance

This facilitates import and export transactions. It is estimated that 80% of international trade is financed. Neither sellers (exporters) nor buyers (importers) can afford to have cash tied up in goods that sit on the water for months. Lenders will work with all the parties involved, including export credit agencies and insurers. And they will cover all necessary activities which could include issuing letters of credit, lending, export credit and financing, and factoring.

Purchase Order Finance

Purchase order finance is a great way for small businesses to access finance to complete projects and tenders that they have been awarded.

Because there is a project or tender that has been awarded to the business owner, the contract serves as a form of ‘security’ for the lender. This means that if you have a purchase order or tender contract with a reputable organization (like a government entity, or large corporate) you can probably get finance to fund the purchase order.

What Documents do You Need When Applying for Unsecured Business Finance?

Alternative lenders are more flexible than banks but are still regulated, so you’re going to need all your standard FICA documentation. Plus, proceeding without security means they will need detailed access to your business trading history and forecasts.

Some standard documents include:

All directors’ ID documents
All directors’ proof of residence
Business proof of address
6 to 12 months bank statements
Latest set of management accounts or annual financial statements

Depending on what kind of funding you're applying for, your debtors' book or credit card takings reports will be requested. If you're requesting trade finance, full details of the goods and sales contract must be available.

It would be best if you made every effort to have your business credit score rating as high as possible because lenders will look at that too. Business credit reports are a good way for you to get a quick snapshot overview of what information your business has on file with the bureau.

When Should I Consider a Short Term Business Loan?

There is a commonly held view that short-term, unsecured business loans are a sign of an unhealthy business. And it is true that an ongoing dependence on expensive short-term funding can be an indication that the business is not sufficiently profitable. Or, that management is not understanding and planning for regular business cycles.

But short-term funding always has a place when the opportunity cost or Rand-cost of a traditional loan makes it unfeasible. Or when tying up credit longer term will harm the business. The following are some examples of instances where businesses can benefit from short-term business loans;

Inventory on special

If you have an opportunity to buy extra stock at a discount, for example, when a supplier goes out of business. Your day-to-day cashflow might not cover the transaction. A traditional loan would take too long to get approval and cost too much over the loan term. Presuming you expect to quickly sell the inventory, a short-term loan that still allows you to realize a profit would be a good option.

Unplanned repairs to essential equipment

Where your operations are halted due to broken equipment, every minute of downtime costs money. Short-term loans can be obtained quickly and can be repaid once operations have resumed.

Short-term or seasonal cash flow shortages

Seasonal businesses hit periods where they might need working capital to continue to cover operational costs like rent and payroll. A short-term loan with a term that matches the shortage means you don’t pay for money when you don’t need it.

Kicking off a project

The nature of some projects means cash is required proportionately more at the start of the project. Short-term loans can provide additional cash flow when needed.

Establishing or improving credit scores

Some short-term lenders report payment behaviour to business credit bureaus. Successfully servicing short-term loans can improve your credit score, making you eligible for more and cheaper credit from traditional lenders.

Traditional term loans are still usually the best option for real estate transactions and acquisitions of other assets with long lifespans.

In conclusion, if you’ve approached your bank for business finance, but feel like you’re bashing your head against a brick wall, relax, there are other options. SME funding is all about finding the right partners for your particular situation. There will be other lenders who are happy to deal with small businesses and will welcome the opportunity to work with you.

If you’re looking for business finance for your company, we’re here to help. FundingHub takes all the effort out of applying for business finance for your business.

You fill in one application form, and we do the hard work of finding the right lender and comparing products and offers from across the industry for you. Our service is free to use, and takes roughly 5 minutes to apply.