Growth credit vs traditional loans: Which is right for you?
Choosing the right funding option is a crucial decision for any business leader looking to scale.
While traditional bank loans come with familiarity and lower interest rates for established businesses, growth credit provides a more flexible and forward-looking approach that is well-matched to fast-growing companies.
This article explores the key differences between the two, helping you determine which option best aligns with your business goals.
What is growth credit?
As the name suggests, growth credit is a financial instrument used by businesses to support their growth.
More commonly provided by alternative lenders than traditional banks, growth credit providers will focus on a business’ projected success, rather than relying solely on past performance. This makes it an attractive proposition for earlier-stage, or rapidly-growing businesses that need a cash injection to support their continued growth, but do not necessarily have the strong financial track record required by banks.
As it is a form of debt, growth credit is usually structured as a loan, set over a pre-agreed term, with the capital and interest repaid in regular instalments during this term. Growth credit from Growth Lending is structured in the form of a term loan, where the term is a period of three to five years.
You can find out more about growth credit here.
What is a traditional loan?
In the context of businesses raising funds, a traditional loan usually refers to those that are provided by high street banks and institutions.
The process is not dissimilar to that of a personal loan, with the bank assessing the business’ credit history, financial records and any assets that might be used as collateral. Because high street lenders are usually looking at ways to de-risk their investments, they tend to focus on businesses with strong track records and several years’ financial performance data. For the businesses that can provide this, alongside collateral, traditional lenders can usually offer competitive interest rates and loan terms.
However, rapidly scaling businesses do not usually fall into this category, leaving a gap in the funding ecosystem for fast growth businesses. This is where alternative lenders offering products such as growth capital become an essential part of UK SME growth, offering much-needed financial support to firms that would otherwise struggle to access it.
What are the advantages of growth credit?
1. Forward-looking approach
Growth credit providers understand the profile of fast-growing businesses. They therefore understand the value in looking at a business’ potential, rather than past perfomance.
Instead of relying solely on historical financial data, they will consider future revenue forecasts, the experience of the management team and how robust growth assumptions are – as well as the role that an investment would play in fuelling this growth.
This approach is particularly helpful for businesses that are growing quickly, since their past performance may not reflect their true potential, or for sectors that require significant cash injections for R&D purposes.
2. More creative funding structures
The experience in lending to these types of businesses means that growth credit providers can also be more creative in their approach to structuring deals. Lenders such as Growth Lending will assess each deal individually and consider how they can tailor a solution to the unique needs of the business.
This might mean a blended approach, where growth credit is provided alongside equity. Or tranching a facility so that capital can be drawn down at the right time for specific growth initiatives. Or providing interest-only periods at the beginning of the loan, so that the business can really hit the ground running with their growth plans.
Ultimately, growth credit providers are usually able to offer more options and flexibility than their traditional counterparts.
3. Flexible use of funds
Adding to this flexibility is the approach to use of funds. Because growth is an implied part of a growth credit facility, lenders are usually supportive of business leaders using the funding to achieve growth in the way that they see fit.
This means that growth credit can be used for a wide variety of initiatives including investing in R&D, expansion, M&A, MBOs and even refinancing if this would strengthen the business’ growth trajectory.
Such flexibility enables businesses to remain agile and react quickly to market changes and emerging opportunities.
4. Specialist lenders for specialist sectors
Businesses in high-growth sectors such as technology and professional services have unique characteristics that it is important their lenders understand.
Those that offer digital solutions for example, usually face signficant upfront development costs, but lack the traditional tangible assets required to provide leverage for a loan.
Professional services firms with a buy-and-build growth strategy need to be able to move quickly when they identify a suitable acquisition target.
The nature of growth credit means that growth credit lenders have prior experience of working with these sectors; they understand their unique challenges and can structure funding accordingly.
5.Borrow more, earlier in the business lifecycle
All of this knowledge and experience also gives growth credit providers the confidence to lend where traditional banks will not.
This means that less-established, or fast growing businesses, which lack the qualities preferred by traditional banks, are often able to access more capital, earlier in the business lifecycle than if they went to their high street bank.
What are the disadvantages of growth credit?
While all of the above is true, the profile of fast-growing and rapidly scaling businesses means that they are a riskier investment for lenders – and riskier investments tend to be priced accordingly.
This means growth credit can be a more expensive form of debt than an equivalent loan from a high street bank, but business leaders should take a long term view when assessing the cost of borrowing. Growth credit may be more expensive than a loan from a bank, but the opportunities lost during the time it takes the business to meet a bank’s eligibility criteria could cost the business a lot more.
Access to funding enables significant investment in areas such as sales and marketing, product development, or hiring the best talent. In the lon run, these investments could lead to bigger returns than the extra cost of borrowing money.
To make the right choice, businesses should conduct a detailed cost-benefit analysis. This means looking at the cost of debt and comparing it to the potential return on investment from initiatives that can drive growth.
What are the advantages of traditional bank loans?
1. Lower interest rates for qualified borrowers
Loans from traditional banks usually – though not always – have much lower interest rates than alternative funding options.
This is because large and well-known financial institutions have a lower cost of capital in the first place and they see businesses with good credit histories as safe investments to place this money.
The challenge of course, is whether a business fits this “safe investment” criteria – many disruptive and fast-growing businesses do not.
2. Familiarity
Traditional banks also feel more familiar to borrowers than alternative lenders. Most businesses will already have an account with a high street bank and so a loan from the same provider feels like a natural extension of the existing relationship.
Alternative lenders and alternative funding products require a little more research and exploring unfamiliar options can be particularly uncomfortable for business leaders who are undergoing the fundraising process for the first time.
What are the disadvantages of traditional bank loans?
1. Eligibility
The most obvious disadvantage of a traditional bank loan is the rigid eligibility criteria. The appetite for bank lending to SMEs has retrenched in recent years, meaning that any business unable to meet the strict list of requirements is unlikely to be eligible for a loan.
Extensive financial records, long performance track records and the ability to provide security for the loan are usually basic requirements of high street banks and simultaneously, significant obstacles to fast-growing businesses.
2. Extensive documentation and longer approval times
This approach means that application processes with traditional lenders also tend to take much longer. While borrowers will need to collate and submit a range of financial and operational documents regardless of whether they work with a traditional or alternative lenders, the latter have the ability to process things quickly once the documents have been received.
Size of organisation is often a factor that holds traditional banks back; less agility and lengthier processes are not companions of a swift transaction.
3. Strict use of funds
Usually, businesses have to be clear from the outset about how they intend to use a traditional loan. If they change their planned use, they might need to secure extra approvals or risk breaching the terms of the loan.
But this can be problematic for businesses in fast-moving, disruptive industries. They need to be able to react quickly to changing market dynamics and adjust their growth plans – and therefore their growth investment – accordingly.
4. Favouring core sectors only
Traditional bank financing usually focuses on businesses in the industries that these lenders consider “safe”. Banks tend to lend money to companies that have extensive performance histories and stable income, which can make it difficult for businesses in emerging and fast-growing sectors.
Technology-driven firms, or those with unique revenue models are likely to face difficulties because there is not enough historic data to give banks a clear indication of the trends in these sectors.
What is the main difference between growth credit and traditional loans?
The primary difference between growth credit and traditional loans lies in their flexibility, approval processes, and the criteria lenders use to evaluate borrowers.
Growth credit prioritises speed, adaptability and a business’s growth potential, while traditional loans focus on minimising risk through stringent underwriting and a preference for established businesses with strong financials.
What type of business is best suited to growth credit?
Growth credit is a great option for smaller and less-established businesses that are growing quickly and need fast access to funds. These businesses may not have a long performance history or any tangible assets to leverage, but they have a clear vision for growth and just need the capital to help them get there.
What next?
Deciding between growth credit and traditional loans will centre on where your business is at in its lifecycle, the type of business it is and your anticipated plans for growth.
If you operate in a disruptive or fast-growing sector and are looking for capital to accelerate your growth trajectory, then it is likely growth credit would be a good fit.
