During an economic downturn, traditional sources of funding may be more challenging to secure. To keep your business going, you may want to look at alternative sources of capital, as well as ways to manage your cash flow effectively so that when you are in a position to apply for a loan, your business is as attractive as possible.
Here’s a look at some strategies to consider to keep your business moving ahead when the economy turns south.
Key Points
• Cash flow management involves tracking balances, sending invoices promptly, and offering early payment discounts.
• Government-backed loans and alternative financing, such as revenue-based, support business funding.
• Trade credit and vendor financing enable delayed payments, improving immediate cash flow.
• Angel investors and private equity offer equity or debt financing, crucial for startup growth.
• Cost reduction through energy efficiency and business pivots, like online expansion, enhance financial stability.
Signs of an Economic Downturn
There are several indicators to watch that may signal an economic downturn.
• Volatility: First, be on the lookout for increased volatility, which suggests that investors are more afraid. Keep your eye on the CBOE Volatility Index, or VIX. A reading above 30 suggests there’s a lot of volatility in the market.
• Growing unemployment: The Sahm Recession Indicator is based on unemployment data published monthly by the Bureau of Labor Statistics. According to this indicator, a recession begins when the three-month moving average of the national unemployment rate increases by 0.50% relative to its low during the previous 12 months. Higher unemployment may be tied to declining demand and decreased consumer spending.
• Inflation: A certain amount of inflation is expected and doesn’t necessarily signal an economic downturn. However, high inflation can decrease demand. What’s more, central banks will often raise interest rates to curb inflation, which can make borrowing more expensive.
• Declining stock market: When the stock market declines 20% or more, it falls into bear market territory, which can signal a downturn.
• GDP contraction: The country’s gross domestic product, or GDP, is a measure of its economic output. A shrinking GDP can signal an economic downturn or even a recession. In fact, some experts define a recession as two consecutive quarters with declining GDP.
How Lending Standards Change During Downturns
During an economic downturn, lenders tend to become more cautious. Banks focus on ways to reduce risk and their potential losses. Unfortunately, that can mean that it is more difficult to get a small business loan to fund operations or invest in expansion.
What’s more, in a period of high inflation, interest rates may be high, which can make traditional business loans more expensive.
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How to Fund Your Business During a Downturn
During an economic downturn, if funding your business through traditional methods proves challenging, there are several strategies you may consider.
1. Optimize Your Cash Flow Management
First things first, you’ll want to ensure that you are managing your current cash flow efficiently. This helps ensure you’re making the most of the resources you have and nothing is going to waste.
Ensure that you have a way of tracking cash balances, income, and spending. Send invoices out promptly, and consider offering incentives to clients who pay earlier. Take stock of your inventory and make a note of items that aren’t selling well. Stop buying these and eliminate back stock, which may mean selling at a steep discount.
Ask your suppliers if there are ways you can reduce how much you are spending with them, and consider increasing your prices if the market will support it.
2. Explore Government-Backed Loan Programs
Consider Small Business Administration (SBA) loans. These are backed by the federal government and may be easier for businesses to secure. The SBA also offers loan programs that target specific groups, such as women, veterans, and minorities.
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3. Consider Alternative Lending Options
Consider raising capital for your business through alternative funding methods, such as revenue-based financing. This strategy allows businesses to receive capital from investors in return for a percentage of the company’s future revenue. This type of financing generally works well for companies that are already generating a steady stream of revenue.
4. Leverage Trade Credit and Vendor Financing
If your business does not have enough cash on hand to buy the goods or services it needs during an economic downturn, you may consider trade credits. This type of agreement allows you to receive goods or services from a vendor and pay for them later.
Consider vendor financing in which the vendor lends you money, which you can then use to purchase their goods and services. This type of loan may have a relatively high interest rate compared to traditional business loans. Vendor financing may involve debt financing in which a business receives goods and services at a sales price with an agreed upon interest rate. Or a business might exchange shares for the goods and services.
5. Pursue Angel Investment and Private Equity
Angel funding often comes from a private individual who invests money in a business in exchange for equity or convertible debt, which is a loan that can be converted to shares at a later date. Angel funders usually step in during the startup phase of a company, and the funding they provide may be a good stepping stone to help a new business get to a professional round of funding.
Private equity firms pool investor money and then use it to invest in companies that aren’t publicly traded. Private equity companies often invest in businesses that they expect will be sold later at a profit.
6. Explore Crowdfunding and Community Capital
You may also consider leaning on your community to help raise capital for your business. Crowdfunding platforms allow you to tap a large number of individuals near and far who may contribute small amounts of money to your business.
Other community capital options include community investment funds designed specifically to invest in local business, as well as community lending, in which lenders provide loans to local businesses.
7. Utilize Business Credit Cards Strategically
Business credit cards may offer rewards and perks as well as an easy way to track expenses. What’s more, responsible use of business credit cards can help your business build credit, which can make it easier to secure loans in the future at better rates.
That said, credit cards tend to have relatively high interest rates. If you carry a balance, the debt you rack up on them can get expensive quickly. So they are best used when you have the cash flow to pay them off each month.
Business lines of credit are another form of revolving credit you may consider, allowing you to borrow and repay up to a certain limit.
8. Implement Cost-Cutting Measures That Preserve Value
Finding ways to cut costs can help you free up cash to be used for other purposes. However, you don’t want cutting costs to turn into cutting corners and doing things that could hurt the value of your business.
Areas to consider when cutting costs include investing in energy-efficient tools, such as smart thermometers, low-flow plumbing, and LED lights. You might also consider tasks that are handled by third parties that you might be able to bring in-house, such as marketing. Consider technology that can help automate repetitive tasks, or cloud technologies that can reduce the amount of infrastructure and maintenance needed for IT management.
9. Consider Asset-Based Lending
Traditional business financing typically looks at a business’s cash flow. Yet, some companies may be eligible to borrow based on the assets they own. Asset-based lending can use a broad range of business assets, such as real estate or accounts receivable, as collateral for a loan. These assets may be seized if the loan is not repaid.
10. Explore Business Pivots and New Revenue Streams
During a downturn, customers’ needs may change quickly, and businesses that are nimble enough to change with them may capture a greater market share. For instance, you might consider offering more basic services at a lower price point to attract more customers.
Consider other cost-effective ways to gain market share, such as expanding your online presence.
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Creating Downturn-Adjusted Financial Projections
A financial forecast is a projection of your company’s future financial performance. It can help you budget, and it helps determine the value of a company. During an economic downturn, it’s important to adjust these projections. In doing so, make your assumptions more conservative. Reduce growth projections and increase your expense forecasts.
Continue to monitor economic conditions, and as they change, adjust your financial projections as needed.
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The Takeaway
Economic downturns do happen. Arm yourself with an understanding of the options available to you to keep your business funded—and even growing—when the economy is struggling. You will be in a strong position when the climate is more favorable for applying for a small business loan.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How early should I secure funding before an economic downturn hits?
Economic downturns are not easy to predict. However, if you know your business will need funding and conditions are favorable now, it may make sense to secure funding as soon as possible. Take into account that some forms of funding may have significant lead times, so you’ll want to give yourself ample time.
Which industries typically have better funding access during recessions?
During downturns, companies that provide essential goods and services, such as health care companies and companies that provide consumer staples, tend to fare better. As a result, they may have better access to funding during recessions.
How can I improve my business credit score during challenging economic times?
To improve your business credit score at any time, prioritize paying your bills on time. You may also try to keep your credit utilization as low as possible.
What financial metrics do lenders focus on most during economic downturns?
Lenders will likely focus on your credit score, credit utilization, and a cash flow analysis.
Should I consider taking on investors instead of loans during a recession?
Whether or not you decide to take on investors has a lot to do with your business’s goals. Taking on investors means that you will lose a portion of your ownership and control when it comes to making decisions. It may also put pressure on your business to grow quickly. If these circumstances work for your business plan and goals, investor funding may be an option.
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