While debt finance might not sound like a topic that gets the heart racing in the same way as a trilogy of romantic bestsellers, I’m here to argue that it’s more interesting (or at least more important) than it might first sound. And at the outset I’d like to flag that this will be the only reference to 50 shades - it’s very difficult to shoehorn this metaphor into an article on debt finance any further…

The reason why SME debt funding is important is because the problem, as anyone who owns or manages an SME in the UK will tell you, is enormous. As banks increasingly pull up the drawbridge to small business lending, even those with solid fundamentals struggle to access funding. The Bank of England estimates that the funding gap in the UK amounts to an astonishing £22 billion. Beyond the banks, the range of options and lenders in the SME market is fairly mind-boggling to say the least. 

This week’s Lenkie blog provides an overview of some of the different debt funding options available to UK SMEs. The hope is that we can save you some time and headspace when deciding what works best for your specific requirements. In particular, we’d highlight how opting for the most ‘obvious’ solution (read: the cheapest) on paper may not always work out to be the most suitable.

What do you need the funding for?

At a high level, you need to understand whether the funding is required to cover operational expenses (opex) or capital expenses (capex).

Opex refers to the day-to-day operational costs that keep a business running. This includes expenses like payroll, rent, utilities, inventory, and routine maintenance. Capex, on the other hand, refers to investments made in long-term assets that improve or grow the business, such as equipment, machinery, vehicles, or property.

We’ll go into these in more detail below, but some of the most common products used to support capex are:

1. Asset Finance

2. Term Loans/Bank Loans

Opex, on the other hand, is typically best supported by:

• Short-Term Loans

• Invoice Factoring

• Invoice Discounting

• Merchant Cash Advance

• Business overdrafts and credit cards

• Revolving Credit facilities

  
  

1. Asset finance

Asset finance allows businesses to fund the purchase of equipment, vehicles, or machinery without large upfront costs by spreading payments over time, making it ideal for SMEs that need costly assets for growth. Some of the most common forms of asset finance include hire purchase (where ownership transfers after payments) and finance leasing (long-term rentals with the option to buy).

• Costs: Interest rates typically between 3–15%

• Pros: preserving cash flow and avoiding large upfront payments. Lower cost of financing given underlying security.

• Cons: limited to the purchase of assets. Risk of repossession in the event of default.

2. Term Loans/Bank Loans

Perhaps the most common and best understood form of SME debt funding, term loans provide SMEs with a lump sum, repaid over 1-10+ years, for significant investments like physical expansion or equipment purchase. The fact loans are well understood is a problem in itself. Businesses that need cash automatically gravitate towards loans, assuming that a lump sum of cash will solve any funding requirement. However, if your need is short-term, for example hiring staff or buying equipment and stock, having funds sitting on your balance sheet will make the cost of funding more expensive overall, even though the rate may be cheaper on paper.

• Costs: Interest rates range from 5–40% annually.

• Pros: Predictable payments; good for long-term growth. Often come with cheaper monthly rates compared to short-term facilities.

• Cons: Requires solid credit; possible early repayment fees. Having cash sitting on the balance sheet can create unnecessary costs if the funding requirement is short term in nature.

3. Short-Term Loans

Short-term loans, as the name suggests, are designed for SMEs needing quick cash, typically for 3 to 18 months. Unlike term loans, they are typically targeted at businesses looking to cover cash flow gaps. They have fast approval but often come with hefty interest rates, and can strain cash flow if not managed well.

• Costs: Interest rates range from 8–60% annually.

• Pros: Quick funding decisions; lower underwriting qualification criteria.

• Cons: Higher costs; potential cash flow pressure.

4. Invoice Factoring

Invoice factoring allows SMEs to sell their unpaid invoices to a factoring company (i.e. a lender), receiving a percentage of the invoice value upfront. This effectively means businesses are able to get cash into the business without having to wait for 30, 60 or 90-day terms. While this offers quick access to working capital, factoring companies will generally take control over the businesses' accounts receivable process. Having a third party chasing your customers can jeopardise hard-won relationships, and mean that borrowers can run into difficulties if payments are disputed or delayed beyond the agreed terms.

• Costs: 1–6% of invoice value.

• Pros: Quick cash flow; debt collection handled externally.

• Cons: Invasive credit management process, involving contacting customers and suppliers; higher fees than invoice discounting.

5. Invoice Discounting

Invoice discounting, like invoice factoring, lets SMEs borrow against their unpaid invoices. The main distinction is that the business is able to retain control of their sales ledger and collections. This means that it’s confidential, but typically approval comes with more stringent credit requirements. Typically it’s harder for many SMEs to access this sort of facility.

• Costs: 0.5–4% of invoice value + monthly fees.

• Pros: Confidential; control over customer relationships.

• Cons: Requires solid credit management.

6. Merchant Cash Advances

One other facility we’ve not really spoken about so far are Merchant Cash Advances (MCA). These have grown in popularity over the past couple of years with the growth of online marketplaces and eCommerce more broadly - however, it also works well in brick-and-mortar retail. MCA facilities allow businesses to access a lump sum in exchange for a percentage of future sales, making them ideal for businesses with high credit card transactions.

• Costs: interest ranges from 20-50%.

• Pros: Fast access to capital, flexible repayment tied to sales.

• Cons: High overall costs (often lenders have to pay high commission to the platform partners which leads to higher pricing, on top of the up to 3.5% card processing fee the SME already pays). Frequent repayments can put a strain on cashflow.

7. Business Overdrafts & Credit Cards

Overdrafts and business credit cards are one of the most established routes to short term credit to help businesses managing cash flow. They are easy to access but can lead to high costs if balances aren’t paid off quickly. Another challenge is that limits are often lower than with other products.

• Pros: Quick access to funds, rewards for cards.

• Cons: High interest rates and potential for accumulating debt, relatively low limits.

8. Revolving credit facilities

Perhaps the most flexible option of all, a revolving credit facility is a form of financing that provides businesses with access to a set amount of credit that can be drawn upon as and when the funding is needed. This product is particularly useful for managing short-term cash flow needs and adapting to fluctuating business requirements. Maximum limits are typically much higher than overdrafts and credit cards. In some cases, businesses can be caught out with hidden costs - particularly when subscriptions are involved. These can make prices look cheaper on paper, but generally mean the cost of funding will be higher in the longer term (particularly when the funding requirement is harder to predict).

Conclusion

As with many things in life, there’s no silver bullet when it comes to determining which funding option is right for your business. And in every case when considering options, your particular business context will ultimately determine what you prioritise most.

Alongside the various pros and cons outlined above it’s important to bear in mind that lenders within each category vary significantly.

Often it may be tempting to place the most attractive headline rates at a premium, though this may often come with significant trade-offs in terms of poor product experience, customer service or inflexible collections processes should you miss a repayment.

In other cases, the ability to save time through best-in-class customer or product experience may mean you’re able to invest more of your time and energy into the business.