Small and medium-sized businesses make up 97.3% of all businesses in Australia. They employ around 44% of the private sector workforce and contribute to GDP. Most SMEs require funding at some point to stock up before a peak season, bridge a cash flow gap, hire ahead of demand, or enter into a new market.
This is where SME finance plays a key role. It refers to a wide range of funding solutions built for businesses that are unable to access capital markets and do not want to sell equity. These options include traditional bank loans, revenue-based financing, invoice financing, and more. Each has its own structure and is ideal for different business needs.
The following is a guide that will help you analyse your choices, evaluate them objectively and use them effectively to improve your chances.
SME finance refers to any financial product, arrangement or mechanism that helps a small or medium-sized enterprise access funding for their business purpose. The purpose may range from day-to-day operations, growth investment, to financial stability during a difficult period.
In Australia, the term "SME" does not have a fixed definition. According to the Australian Bureau of Statistics (ABS), a small business employs fewer than 20 people, while according to the Australian Taxation Office (ATO), a small business earns less than $10 million per year. For lending purposes, the Australian Prudential Regulation Authority (APRA) defines SMEs as companies with an annual income below $75 million.
The difference between SME finance and general corporate finance is the context. For large companies, capital markets may be used to raise funds or institutional equity with relative ease, while most SMEs cannot. They depend on credit history, business revenue, assets and lender relationships, which determine what they can buy and the cost involved.
The two main categories of SMEs finance include debt funding (borrowing capital with an obligation to repay it, with or without interest) and equity financing (exchanging ownership in the business for capital). There have been more product variations in these two categories than ever before, especially in Australia, which has seen growth in the non-bank lending sector.
Not every SME finance product operates the same way. Choosing the wrong product can cost you more than not financing at all. Here are 6 main types of SME finance products available for Australian businesses.
A business term loan is a lump sum borrowed from a bank or financial institution and paid back within a fixed period, typically from 1 to 7 years, through regular instalments. The interest may be fixed or variable, depending on the outstanding balance.
Term loans are ideal for businesses that have a strong credit history and assets that can be used to secure the loan. They are commonly used for purchasing equipment, funding a fitout, refinancing existing debt, or financing expansion into a new location. However, the main drawback is accessibility. The application procedure involves lots of paperwork and it takes weeks to get approved. Meanwhile, the lender may require collateral, often property.
A line of credit gives a business an allocation of funds that can be drawn down, repaid, and reused as needed. Interest is charged on the amount withdrawn, not the total limit.
Lines of credit are effective for businesses with stable but fluctuating cash flow since they need flexible working capital to cover short-term gaps between income and expenses. Lines of credit are more flexible compared to term loans, but have higher interest charges and may still require a strong credit profile to access through a bank.
Invoice financing, also referred to as accounts receivable financing, helps businesses access funds that are tied up in unpaid customer invoices. Instead of waiting over 30 days for clients to pay, you advance a percentage of the invoice value, typically 70–90%, from a lender immediately. When the customer pays the invoice, you receive the remaining balance minus the lender's fee.
This is especially applicable to B2B businesses or any business that operates on long-term payment schedules. It does not need any physical asset-based collateral because the invoices themselves will serve as collateral. The amount charged will be a percentage of the invoice amount, not a traditional interest rate.
A merchant cash advance (MCA) provides a lump sum of capital in exchange for a percentage of future card or payment terminal sales until the advance and fee are repaid. The repayment fluctuates according to the daily turnover of the business.
A merchant cash advance is fast to access and does not need any collateral. Hence, they are more common among retailers and hospitality businesses with high card transaction volumes. However, the total cost can be high and the structure indicates that businesses with fluctuating revenue can find the repayment period unpredictable.
Revenue-based financing (RBF) is a non-dilutive funding. Businesses get a fixed amount of capital and pay back the total amount, along with a fixed fee, as a fixed percentage of monthly revenue. The repayments vary depending on whether revenues are high or low. There is no fixed repayment period because it will depend on when the total repayment amount is reached.
Revenue-based financing is suitable for digital or asset-light business models such as e-commerce brands, SaaS businesses and subscription businesses, as most of these business models lack physical collateral but have steady cash flows. Since the lender considers revenue as an evaluation factor instead of collateral, the loan application process is faster and requires fewer documents than traditional financial solutions.
Equity financing involves the sale of an ownership interest in the business to raise funds. The sources of funds may include angel investors, venture capital and private equity.
Equity finance is suitable for high-growth businesses that need significant capital for expansion and are willing to accept outside investors or share board control. It is dilutive since you give up a part of your business and a portion of future profits.
Here are two differences to consider when evaluating your choices:
The right option depends on why you require the funds, how your revenue behaves, what you have to offer a lender and what the funding costs.
The purpose of the funds is important because different products are suited for different objectives. For instance, funding to be used for stock purchase before a peak season has a different purpose compared to funding a new retail fitout or solving a short-term cash flow problem. Working capital gaps are well-served by invoice financing, lines of credit or revenue-based financing. Capital expenditure on fixed assets suits a term loan or equipment finance. If capital for long-term growth is necessary, then equity financing should be considered.
Before comparing products, it is important to know about your capacity to service in monthly payments and what happens in a slow month. Monthly fixed payments on a term loan affect cash flow whether revenue performance is good or not. If the repayment depends on revenue levels, it reduces the risk of defaulting during a difficult period.
The best way to access your repayment capacity is to review your last 12 months of cash flow and identify the 3 worst months. Ask yourself if your business can still meet repayments at that level of revenue. If not, a fixed-repayment loan has risks for you.
Many Australian SMEs, including e-commerce, service-based or digital businesses, do not have significant physical assets. These businesses are not able to provide property as collateral, leading to unable to access secured loans. If your business is in this scenario, unsecured products will be your best choice. However, if you have property or equipment, you can get higher amounts and better rates through a secured loan, but your assets are at risk if the business cannot service the debt.
Interest rates are not the same as total cost. For example, a bank term loan at an interest rate of 8% per year for 3 years does not cost the same as a revenue-based funding facility, which has a flat fee of 6% to be paid back within 6 months. This comparison depends on the total repayment against capital received.
Key Factors to Consider:
There are several types of businesses, such as seasonal, project-oriented and those that have long invoice cycles, which do not match up with the monthly payments. For instance, if your revenue is highest in December and lowest in February, a fixed instalment loan will be most challenging when your operations slow down.
Revenue-based repayments, revolving credit, and invoice financing are more suitable for businesses with unstable cash flow. Term loans and fixed facilities are ideal for businesses with stable cash flow.
There is no single financial product available to all businesses. Your decision depends on your stage in business, your cash flow patterns and how you will use the funds. The most important step is understanding your options before you need them urgently.
If you need funding without collateral and with a fast processing time, Choco Up offers different financing options, including merchant cash advance and invoice financing that flex with your business. You can get an indicative offer in hours and skip the long approval process. Check your eligibility now.
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