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SMEs typically find it challenging to obtain financing and SMEs lucky enough to obtain loans under acceptable terms must still put-up valuable collateral.
While providing collateral is a mainstay of banking and lending the fear of potentially losing a valuable asset drives SMEs away from traditional finance.
That said, SMEs looking for collateral-free financing have several avenues that they can turn to.
Some banks offer unsecured working capital loans for SMEs with favorable interest rates and durations of up to five years. These include the UAE’s RAK Bank, which can provide business loans of up to AED 3 mn.
However, while the number of collateral-free loans issued by banks is rising, their availability is still not as widespread as collateralized debt, with many of those institutions that do provide them requiring higher interest rates.
Furthermore, those that do provide unsecured loans tend to reject loan requests at a higher rate than other banks, with SMEs reporting rejection rates of up to 77% for unsecured loans, according to the UAE central bank’s 2020 MSMEs business survey.
These institutions also come with hefty paperwork and other requirements that make it hard for MSMEs to meet, including bank statements going back significant periods of time. This would preclude recently-founded SMEs.
One of the most common forms of collateral-free financing is selling ownership stakes in the company. For SMEs looking to grow into startups and then full-fledged companies,
that would mean looking for angel investors, VCs and other institutions in the startup ecosystem such as incubators and accelerators. Financing from these institutions usually comes in the form of investment, with no loans involved and no collateral.
As investors, these institutions also provide connections, mentorship and other resources to help nascent businesses grow and succeed.
The primary disadvantage of this form of funding is that it is dilutive, requiring founders to give up an ownership stake in the.
Furthermore, the startup ecosystem is geared towards businesses looking to scale up and grow into startups and large businesses. SMEs that can’t scale will find it difficult to tap into this ecosystem.
Read more about: All You Need to Know About Angel Investment For Start-ups
Crowdfunding allows businesses to raise funding for a project from a large group of people through online platforms. This type of funding comes in a variety of forms, including:
· -Soliciting donations from those eager to help the business.
· -Obtaining funding in exchange for rewards and benefits offered by the business.
· -Offering ownership stakes or profit-sharing schemes for those who invest.
· - Borrowing through peer-to-peer lending, whereby the business borrows from a large pool of individual lenders at an agreed upon rate or a fixed rate offered by the platform.
Whether it is peer-to-peer lending or other forms of crowdsourcing, collateral is typically not required. However, by its nature, this form of collateral-free financing opens the business up to public scrutiny, so any obligations offered by the business must be met.
Know more about: The Different Types of Crowdfunding Platforms in The UAE
Microfinance institutions provide SMEs with small loans. These institutions provide credit to businesses who have been traditionally shut out of the finance sector.
Apart from requiring no collateral, these institutions typically forego other requirements demanded by banks, including extensive business records.
That said, the loan sizes are very small and may be unable to meet the needs of businesses looking for extensive funding. Also, some of these institutions provide funding at higher interest rates.
This form of funding sees suppliers provide SMEs with goods on credit and receive their payments at a later date – usually after the business has managed to sell off a portion of its inventory.
This is a very common form of financing, especially for typical mom and pop stores, with much of their inventory having been secured through this.
However, defaults can be costly, as suppliers may cut off the business if they fail to pay for their product and may force them into litigation.
This is a form of business financing sees businesses borrow in exchange for a percentage of their gross revenues. This form of funding provides businesses without access to the banking sector with collateral-free credit that is solely contingent on their ability to secure revenues, allowing entrepreneurs to focus on their topline growth.
This model aligns the priorities of the borrowers and the lenders as both benefit from the business achieving revenue growth.
That said, this type of financing is available solely to revenue-generating businesses, which is very difficult for newly-founded businesses.
This model typically shouldn’t be considered by businesses looking for long-term loans, as they may prove to be very expensive in a high interest rate environment.
Unlike private-sector lenders who provide financing to SMEs with the motivation of profit, government-backed programs by government-backed institutions are designed to provide loans at favorable terms and grants to SMEs as a means of national economic development with the mandate of helping SMEs succeed.
These include programs such as the Emirates Development Bank’s Credit Guarantee Scheme, whose five-year strategy will see it provide AED 813 mn in funding to SMEs and MSMEs through banking and fintech partners.
The main downside to these types of programs is they’re competitiveness, with a limited number of SMEs benefiting from them.
Read more about: Collateral Assessment: How Lenders Evaluate And Determine Loan Eligibility For SMEs
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
