People often speak of ‘traditional finance’ – usually opposed to alternative finance, which is growing in popularity in the UK.
Although the phrase is used regularly, it isn’t necessarily clear what traditional finance is and where its role in business finance lies.
In our guide, we explore precisely what is meant by ‘traditional finance’ and the options it provides your business – even as alternative options take the spotlight.
- What is traditional finance?
- Types of traditional finance
- Should you use traditional finance?
- Alternative options
What is traditional finance?
Traditional finance refers to various funding solutions that have been used for many years, with proven results for businesses. It is often synonymous with conventional finance, which uses traditional mechanisms to deliver funding.
It is also often used to refer to traditional lenders, such as banks, credit unions and other high street names that have been established for many years and are relatively well-known in the financial market.
Types of traditional finance
The term traditional finance covers many options which allow businesses to raise funding. We have listed the most prominent types.
- Loans – particularly those offered by banks or other well-known lenders
- Overdrafts – associated with your business bank account
- Mortgages – relating to your premises or the exit for a property development project
- Lines of credits and credit cards – allowing you to access funds up to a set limit to borrow as you need
- Invoice factoring – unlocking capital from your unpaid invoice
- Trade finance – funding your overseas trade
- Investment – selling equity in exchange for investor funding
Each type has specific characteristics that make them more suitable for some companies than others. If you are considering traditional finance, you should research to determine the best fit for your business and eligibility criteria. A commercial finance broker can also take you through the options and pinpoint the ideal solution.
Should you use traditional finance?
Traditional finance has many benefits. Firstly, the solutions it encompasses are tried and tested, having delivered results for businesses across the years. They will appeal to companies who want to replicate the same results.
More people will be aware of traditional funding options and understand the process. This may make it more inviting to businesses, especially those unfamiliar with alternative options.
It also typically comes from known, trusted lenders that give applicants peace of mind that the solutions offered work.
Most traditional financers will be able to offer funds to eligible businesses. They usually provide competitive terms, including low-interest rates, minimal fees and affordable repayment instalments.
Traditional solutions are ideal for businesses with funding needs looking for a cost-effective option – provided they meet the lender’s criteria. This brings us to the primary problem with traditional finance.
Lenders and financiers in the traditional sphere tend to be risk averse and have restrictive criteria that businesses need to meet. If you don’t, you will struggle to raise funding, especially at higher levels. As a result, many SMEs report a fear of rejection when applying for bank loans.
Some lenders will insist on security to reduce the risk before they provide finance, such as utilising assets as collateral or signing a personal guarantee. You may be locked out of funding if you don’t have sufficient assets and are unwilling to sign a guarantee.
Even if you are eligible, traditional options won’t necessarily suit your needs. They often have set terms with little room for negotiation. If you are looking for a more flexible solution, it’s likely not for you.
Another disadvantage of traditional finance is that they are often complex and lengthy application processes. You will need to apply (sometimes with a paper application, though many lenders now accept online versions) and present your business favourably to be accepted. You will then have to wait for the lender to review your application and release the funds, which may take some time.
If you are willing to wait for funding, find terms that match your goals and successfully meet the lender’s criteria, traditional finance may well provide value in the form of competitive and substantial funding.
However, if your needs are more complex or you are perceived to be a higher risk, you will fare better from other options. Developments are constantly occurring in the traditional market to make it more agile, so it is still worth checking what’s available.
Alternative options
Many SMEs pursue alternative options in place of traditional finance. They are often seen as more accessible, suitable for broader needs and offering unique benefits.
Here are some examples of alternative solutions:
- Peer-to-peer lending – where funding from individuals and institutions is pooled to fund commercial loans for SMEs
- Crowdfunding – giving individuals a chance to contribute to your business cause, usually in exchange for equity or other incentives
- Venture capital – where investors seek high-risk, early-stage businesses to maximise growth potential and get a return on investment
Some alternative lenders will also offer conventional finance types, such as loans and invoice discounting. These typically offer more flexible options, including unsecured or short-term funding.
They tend to be less well-known or online-based. Remember to check if the lender is regulated by the Financial Conduct Authority, as this will give you confidence, but a number of alternative lenders choose not be regulated as they do not deal with consumers.
In summary
Traditional finance still has its place in the market. It offers a variety of solutions that provide substantial funding at competitive rates from trusted names. However, it will only work for a limited number of businesses that meet the eligibility criteria.
When many businesses require financing, including those with complex needs or high risk profiles, alternative finance may fill the gap. With both traditional and alternative methods on the market, more companies will obtain the support they need.
There is also the opportunity for traditional lenders to adapt their offering to be more flexible and accessible, though only time will tell if this happens.
Whether you are seeking a traditional or alternative funding route, we will help you to find the right solution.