These days, Small to Medium Enterprises (SMEs) must contend with rising geopolitical tensions and increased competition from both local and foreign players.
The effects of the trade war between the US and China, along with the resulting slump in demand from both countries’ manufacturing sectors, have affected large and small businesses alike across the region.
While the development of e-commerce services and initiatives like free trade pacts have boosted Hong Kong SMEs’ ability to expand to overseas markets, they also mean foreign businesses can come and compete for a slice of the local pie.
All these challenges make it essential for SMEs to grow their products, services and markets, as well as to adopt digitalization—strategies that both require access to fast, accessible financing.
However, the lack of financing has been a longstanding issue facing SMEs, particularly in Asia. The Asian Development Bank reports that 74 percent of trade finance rejections involve SMEs and mid-cap firms. In China, for example, banks have been reluctant to lend to SMEs due to perceived risk.
Amid the tight credit environment, alternative options are emerging for SMEs, spurred by fintech startups and government support for financial innovation and business growth. This has opened up new options for SMEs, and even regulators and traditional financial institutions have supported fintech lending.
So today, owners of SMEs and midcap businesses in Hong Kong can opt to obtain financing from banks and alternative financing platforms, depending on their needs and financial situation. The most common financing solutions for these businesses apart from raising equity capital can be traditional loans, trade finance or asset financing.
Simple business term loan
The most frequent type of business loan is the business term loan. The funds are set for a specific amount and a set repayment period.
This may be an unsecured loan, which does not require collateral, or a secured loan, which requires your business to put up some form of collateral. This collateral may come in the form of a deposit with the issuing bank, property owned by your company or the firm’s owner house.
The maximum loan amount varies based on the bank’s credit assessment of your business. It is uncommon to find business term loan tenures of more than five years.
An advantage of the business term loan is that if the repayment is made according to the terms, the bank can’t call-back the money when they wish. This is different from the following funding solution.
An overdraft facility provided by a bank lets you withdraw more money than you actually have in your account. This functions similarly to the way a credit card works for consumers, except that it applies to companies instead. Once your application is approved, your business can tap in the overdraft facility at any time. Like a business term loan, an overdraft facility may be secured or unsecured.
The maximum overdraft facility amount can vary, depending on the value and nature of your collateral and the bank’s credit assessment of your business. For instance, using a stock portfolio as collateral can result in a lower facility amount than using a deposit left with the bank.
Keep in mind that overdraft facilities are maintained at the discretion of your bank, making them risky to depend on. If your bank believes your business isn’t doing well, it can lower your credit ceiling, increase the interest rate, or simply close the facility at a moment’s notice. This can hurt your business at the time when it’s most in need of financing.
Trade finance is the financing of a transaction of goods or services between a buyer and a seller. Some key financial tools include:
Letter of Credit
A Letter of Credit (LC) is a guarantee provided by the banks on each side of a transaction that payment will be received under specific conditions. For example, your business is selling a large volume of product to an overseas buyer with whom you have not worked with before. It can be risky to deliver the product before getting paid, as the buyer may fail to complete the payment after receiving the goods.
You and the buyer could then agree to make the transaction using a standby LC with your respective banks, guaranteeing that you’ll receive payment. If the buyer fails to pay you, the bank issuing the LC will compensate you for the full amount.
When applying for an LC, you need to prove your creditworthiness to your bank. For SMEs with poor cash flow or insufficient funds, this can be a problem. Certain LCs may also require collateral that SMEs cannot provide.
The application process is cumbersome as the banks ask for a lot of justification documents and if there is a tiny anomaly, the LC could be stuck or refused and the fund blocked or even not provided. In addition, banks take time to verify all the documents, thus the funds will take more time to be released than other funding solutions.
Invoice Financing and Factoring
Invoice discounting—also called accounts receivables financing—allows your business to sell accounts receivables to a lending platform or factoring house for a slight discount. This helps raise your company’s cash flow, allowing you to continue operations even when you have longer payment terms with your buyers.
For example, you have sold a large volume of product to an overseas retail chain. The lowest payment term you were able to negotiate is 90 days; but in the meantime, you still need to pay your own suppliers, workforce, and sub-contractors.
You could sell the accounts receivable for a small discount to the lending platform or factoring house and receive the funds immediately. Your buyer now owes the factoring house instead of you.
Once the buyer pays the lending platform or factoring house, your business will receive the remaining balance, minus a small interest rate.
A main advantage of invoice financing is the scalability of the facility. As you are raising the invoice size, the facility can grow with your business with little restrictions compare to a loan or an overdraft.
One type of invoice financing is selective invoice financing, which lets you choose which individual invoices to assign to the lending platform or factoring agent. This helps you retain control over your sales ledger instead of discounting all accounts receivable collectively.
For SMEs and mid-cap businesses, accounts receivables financing is a funding option that involves a far less complex application process compared to other type of financing. Businesses do not need to provide collateral or have a pre-existing line of credit or borrowing history with the lending platform.
Supply Chain Finance
Supply Chain Finance is used to fund specific goods by optimising cash flow through the supply chain for both buyers and sellers. It allows you, as a buyer, to stagger payments to your suppliers, while still ensuring they receive payment early. This is done through the help of an intermediary, such as a factoring house or lending platform, which pays your suppliers first.
For example, say your business has a supplier from which it buys parts or raw materials. Through Supply Chain Finance, you can organise for the third-party lender to immediately pay your supplier. You will then pay back the lender at an agreed-upon rate.
This benefits both sides. Your supplier receives payment earlier, which might also mean a smoother flow of materials to your business. At the same time, you can get payment terms that suit your financial position.
Interest rates for supply chain financing can vary significantly based on the bank or lending platform’s assessment of the borrower.
Asset financing is useful for businesses that need funds to purchase assets, such as equipment, machinery, heavy vehicles, and computers. There are two main types of asset financing: hire purchase and leasing.
Hire purchase allows you to acquire the asset by paying in instalments over a period of time. Depending on your agreement with the lender and accounting rules, you may or may not include the asset in your balance sheet before you’ve completed the payment. The business legally owns the asset once all the payments have been made.
Leasing, on the other hand, allows you to simply rent the equipment while the ownership of the assets remain with the lender. This is useful in situations when you need the asset for a single project instead of for the longer term, or when the technology is constantly and rapidly changing.
Governments, banks and tech start-ups have taken the initiative in raising liquidity for businesses.
Gone are the days when business financing was a choice between stringent bank loans and unregulated lenders. There are many types of financing options out there, including those offered by alternative but accredited lending platforms and fintech companies. The key is to determine the loan and terms that best suit your business and financial position.
With governments and traditional financial institutions recognising that SMEs are the backbone of Asian economies, more support is being poured into business models and technology that help businesses obtain the funds they need.