Financing Options for SMEs During a Recession

Explore various financing options for SMEs during a recession.

Canadians have experienced six recessions over the last five decades but despite their frequency in economic cycles, financial slumps affect all businesses differently, with many exploring external financing options.

Below, we'll discuss some basic financing options for SMEs during a recession and how they can help you navigate an economic downturn.

Key Takeaways

• Financial institutions have historically offered lower interest rates on business loans during recessions. However, there have also been situations where interest rates did not decrease, despite expectations.

• Financing during a recession has its advantages and drawbacks for SMEs. While interest rates are usually lower, qualifying criteria can often be stricter, due to the uncertainty surrounding the economy and the decline in risk appetite of some financial institutions.

• Banks, credit unions (or caisses populaires in Quebec), and other institutions set their rates competitively using the Bank of Canada's (BoC) target for the overnight rate as a reference.

• Recessions are unpredictable and difficult to forecast, meaning things can worsen before they recover and improve.

Financing Options for SMEs in a Recession

Borrowing money during a recession isn't always ideal, but it can benefit business owners weathering financial uncertainty.

Many small businesses witness a decline in profit during a recession, which affects how they operate, making external financing an appealing resource.

Generally, SMEs in Canada have the option of applying for financing through online or physical banks and selecting between term loans and revolving credit.

Here are some basic business financing methods and the types of institutions that provide them to small and medium-sized businesses in Canada.

Physical Branches vs. Online Lenders

There are two channels to receive business financing during a recession, which include physical bank branches and online lenders.

Physical Branches

Obtaining financing for your business through a financial institution is an option many business owners choose when seeking financing for their business during a recession.

Banks and credit unions tend to have a more intricate process, often requiring various application requirements and, in some cases, a visit to a physical branch to speak with a loan manager.

Receiving financing from institutions with physical branches should be prepared to provide financial statements and financial projections.

The loan process through a traditional bank or credit union is a professional one, but can be time costly, especially if the loan application is declined. Generally, these institutions tend to have stricter requirements when providing customers with business financing.

Online Lenders

Applying for a loan through online business lenders may be a suitable fallback if major banks do not approve your application.

Online lenders can offer a quicker application process for applicants. access to smaller loan sums, without collateral requirements.

Interest rates and applicable fees tend to be higher from alternative financing providers in contrast to traditional banks.

With the rising popularity of these digital financial institutions, many options are available, creating a competitive landscape for lenders and their customers alike.

The requirement for financing during a recession is a time-sensitive matter, which makes the promptness of online lenders an attractive method for receiving funding.

Revolving Credit vs. Term Loans

When it comes to financing for SMEs during a recession, revolving credit and term loans are two viable options. Let’s look at different types of credit products and if they’re suited for your type of business.

Business Loans

Securing a fixed interest rate on a business loan during a recession is ideal for SMEs, as interest rates can fluctuate abruptly.

With a fixed interest rate, the loan rate remains the same until it reaches maturity. Alternatively, variable-rate business loans can fluctuate according to the prime rate.

It's important to know that qualification terms on borrowing products may come with stricter approval criteria during a recession, with low rates typically reserved for businesses with strong credit history.

Business Lines of Credit

One word comes to mind when describing a business line of credit: flexibility.

Classified as a revolving loan, a business line of credit is ideal for SMEs during a recession as it allows business owners to borrow capital and pay it back on an ongoing basis. It also charges interest on the borrowed sum instead of the entire amount.

Using a business line of credit is most suitable when addressing short-term expenses, such as purchasing inventory, paying your employees, repairing equipment, or addressing cash flow gaps, among other expenses.

Business Credit Cards

Business credit cards are among the most straightforward forms of revolving credit methods that SMEs can use.

Credit cards for businesses aren't usually the best option for larger business expenses. They're more suitable for minor, reoccurring expenses that you can pay in full at the end of your billing cycle.

Business credit cards come with a higher interest rate but grant the business owner a grace period to repay their balance in full at the end of their billing cycle without interest.

After the period indicated in the terms and conditions, interest is charged only on the unpaid balance.

During a recession, business credit cards can provide quick access to financing in contrast to the lengthy process of applying for business loans.

Additionally, business credit cards offer sign-up incentives and bonuses, including a waiver on the annual fee and bonus points.

And, like other borrowing products mentioned in this article, business credit cards can come with variable or fixed rates. It’s up to the borrow whether they want to take the risk securing either during times of economic uncertainty, such as a recession.

Final Thoughts: Financing for Businesses During Recessions

According to Forbes, the average recession lasts approximately ten months, while a sluggish economy's ripple effect can last for a few years after.

Job growth and subsequent spending can take longer to stabilize to pre-recession standards, meaning your business may also feel these effects.

If possible, business owners should avoid creating new debt during a recession. However, in unavoidable circumstances, borrowed capital might serve as a necessary lifeline.

Be sure to consider debt repayments in relation to your forecasted revenue and keep unnecessary expenses to a minimum.

Recessions certainly aren't easy on Canada's small and medium-sized businesses, but no recession lasts forever.

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