Six Alternative Financing Models You May Not Have Thought About

Provided by the International Finance Corporation

Good news, financing is now becoming more flexible and available through a variety of sources! Traditional financing models, which rely on a well-established banking and financial sector, physical value and the ability of companies to trade in that value are now expanded to many countries. In complement, other financing models have emerged in the internet era and are more flexible both in terms of access and availability. Find out more about at least six alternative financing models below and expand your options:

  • Warehouse receipts financing provides a confirmation and valuation of goods or materials held in a warehouse, which can be used as collateral for loans. This system is often used for agricultural produce and allows producers of crops to obtain investment funds for next year’s crop on the strength of the value of the current crop, even though you haven’t yet received the cash from selling the current harvest. Typically, the crops will be held in a participating warehouse operated by a third party which is linked to the commodity trading system in that country. Great for: short term financing (6-12 months). Industry types: agriculture, commodities, trading.
  • Factoring is a type of trading system that treats invoices as commodities to be traded. It works where a business needs cash and has made sales on credit. The value of your credit sales (measured by your sales invoices) is adjusted for risk and processing costs before the factoring agent makes an offer to buy the invoices from you at the agreed price. The agreement sometimes includes a protection clause whereby the value of the invoice has to be refunded by you to the factoring agent if the invoice is never paid. Otherwise, the value of the invoice is discounted enough for the full risks of non-payment to be taken on by the factor. Great for: short term financing (3-6 months). Industry types: any business with credit sales and a good sales history
  • Asset based financing is a broader term covering all situations where something owned by a business is either sold outright (as with factoring above) or is used as evidence of ability to repay the funds borrowed. This type of financing is usually used as a last resort, often where more structured overdraft facilities or loans are not available from the formal banking sector. Great for: medium term financing (12-36 months). Industry types: Any business with ownership of high value assets.
  • Microfinance. You will probably have heard of microfinance. Many people think that is only for very small businesses who need very small amounts of money to start a very small business. However, the model has evolved and now represents an important opportunity for SMEs in many countries to get funding at reasonable interest rates. Microfinance is a very broad term used to describe everything from micro loans for disadvantaged groups to efforts to redesign the financial services infrastructure in developing economies. Many micro finance institutions support entrepreneurs at different stages in their growth through loans, advice, and consultancy services. Others target more established businesses and support them to gain access to new markets and encourage their engagement with commodity value chains (the series of people, businesses and transactions that moves raw materials (e.g. crops) from growing to final consumer). More information about opportunities in your country or region can be found at the website of the World Bank’s Microfinance Gateway https://www.microfinancegateway.org/ . Great for: start-ups, small, and growing businesses short and medium term financing (3-36 months). Industry types: Any

The internet has created many new financing possibilities. By allowing businesses in one country to gain direct access to millions of individuals around the world, it is now possible to bypass the ‘middle man’ role usually performed by banks who would accept the savings of individuals and companies who had more cash than they needed and use it lend to individuals and companies who need funds.

Common approaches include:

  • In Crowd funding, a business presents a case for a product or service, and invites individuals to provide a small amount of funding to bring it to market. Often the funder is offered a discount on the price of the finished product if the venture succeeds. The key is to convince as many people as possible to invest small amounts. There have been some quite spectacular crowd funding success stories in recent years and there are now many web based companies offering to host these offers for a small cut of the proceeds, of course.
  • Peer-to-peer financing uses the efficiency of the internet to bring together investors with individuals and businesses looking for funds. The business in the middle that operates the web based service takes a fee, and makes sure the investor’s risk tolerance is respected. The application process is quick and a response could be available immediately. There might be restrictions on certain countries meaning that loans will not be available, and it is likely to be more difficult or expensive to obtain finance for more speculative ventures. However, this could be a viable option for some businesses looking for funds to grow or consolidate their market position, quickly and without the usual stress and complications of dealing with traditional banks.

Both of these approaches can be used to raise equity finance, particularly for start-ups. Equity financing is discussed in another article, but these approaches are designed to work best as loan funding, where the investor is looking for a steady financial return on their investment rather than to have any control over the running of the business.

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