Money doesn't grow on trees: alternative business funding for SMEs

Concept of money growing on trees
By Martin Morris, CA Magazine

7 July 2017

Whilst money doesn’t grow on trees, finance options for growth are abundant. Martin Morris picks some non-traditional sources of funding

Late payments are a perennial problem for business, especially smaller enterprises. Economic uncertainty as the UK prepares to disengage from the EU, as well as potentially higher import costs thanks to sterling’s recent depreciation, will not help matters. All this has implications for cash flow and ultimately for growth.

Traditional methods of financing growth, such as bank loans and overdrafts are – in the post credit crunch world – no longer necessarily the default option. Alternative sources of financing, including invoice finance and asset based finance, continue to make inroads. And now, they are increasingly being linked to online solutions to make them cheaper, more flexible and more appealing to small business owners.

What is the aim for alternative funding?

Irrespective of the type of financing employed, however, the primary aim is to improve cash flow by getting money to the business more quickly. Interest rates on these loans are typically less than those on an unsecured facility.

Invoice financing is arguably quicker and easier to manage than other sources of financing such as peer-to-peer lending or crowdfunding.

According to Melinda Purdy, head of asset based finance at the Royal Bank of Scotland, these products can suit a wide range of businesses from SMEs to large corporates, both privately owned and sponsor-backed companies – irrespective of sector.

“Where the business has tangible assets – receivables, inventory, plant and machinery to property – an ABL lender can support a single asset class, such as receivables or can provide funding against a multi-asset based business,” Melinda said.

What are the alternative negatives?

Disadvantages for asset finance contracts include inflexibility, since they are usually arranged over a fixed term. It may not be possible to end them prematurely or could prove costly if you do. The lessor of an asset may also require additional security depending on the company’s financial standing. That could affect its credit rating.

Invoice finance is most suited to businesses forecasting credit sales of at least £1m per year, which sell goods or services on normal credit terms with no stage payments and a spread of debtors. This tends to be in industries like manufacturing, wholesale, transportation, business services and recruitment.

Research from the Asset Based Finance Association (ABFA) shows that asset based finance accounted for a growing proportion of funding among UK SMEs last year, as an alternative to bank overdrafts.

The ABFA reported average lending to SMEs rising 3% in 2016 to £9.5bn compared to 2015. This contrasted with a 2 per cent decline – to an average £12.4bn – in outstanding bank overdrafts, according to Bank of England data.

Long term trends show a clear knowledge gap

Yet if the long-term trends are moving in favour of alternative sources of finance, a major knowledge gap still exists as far as SMEs are concerned. 

A survey from Close Brothers found 72% of SMEs polled were unaware they could secure funding based on their turnover, rather than their credit rating. And while almost 44 per cent stated they would consider ABL over a loan or overdraft, this willingness has so far failed to translate into substantive action; just 16% of them saying it was their current ideal form of business finance. Indeed, two-thirds indicated a bank loan or overdraft was their preferred solution.

Noting that asset-backed lending could be the key to unlocking liquidity for very significant numbers of SMEs the Close Brothers research also found 69% of firms with an annual turnover of £10m or more still have cash tied up in business assets such as plant, machinery, property and stock.

Engagement between lender and business is self evidently important. And as Neil Davies, CEO of Close Brothers Asset Finance and Leasing, puts it: “Customer service and sector knowledge is key to our offering, and that will never change. These will always be supplemented with various online offerings, but we know our customers value the advice and partnerships we forge with them.”

He adds: “We hire directly from the sectors we serve, which means we speak our customers’ language and understand first-hand the issues and opportunities they face.”

If SMEs were better informed about how invoice financing and ABL works it is likely that significantly more firms would pursue such a funding strategy.

What is the government doing to help?

Against this backdrop the Government-mandated (and much delayed) Bank Referral Scheme (Designated Platforms) was launched last November – the facility essentially being a matchmaking service for SMEs and finance platforms.

Under the scheme, nine of the UK’s biggest banks (RBS, Lloyds, HSBC, Barclays, Santander, Clydesdale and Yorkshire Bank, Bank of Ireland, Danske Bank and First Trust Bank) will pass on the details of those small businesses they have turned down financing proposals for, to three finance platforms – Funding Xchange, Business Finance Compared and Funding Options.

These platforms will share those details with alternative finance providers and then facilitate a conversation between the business and any provider expressing an interest in supplying finance to them.

In theory, these new rules should make it easier for businesses to access finance when they have been turned down by traditional lenders. The major banks will all have to offer access to these finance platforms, but with small businesses needing to give their permission before any details are shared.

Tellingly, the Government’s own research shows that 71 per cent of businesses seeking finance only ask one lender and, if rejected for finance, simply give up on investment rather than seek alternatives.

In 2015, 324,000 SMEs sought a loan or overdraft, but 26 per cent of them were initially declined by their bank. Only 3 per cent of those declined were subsequently referred to other sources of help.

Big data is encouraging innovation

While the Bank Referral Scheme should improve such poor metrics, the overall market will still require further innovation.

Key to innovation is better use of big data, according to Anthony Persse, group director of risk at Ultimate Finance. The problem, however, is that it has not been utilised particularly well across the financial services market to date.

How the market develops, however, will ultimately be down to how nimble it is and how well it can bridge the current “awareness gap” when it comes to many business owners.

If major traditional lenders prove insufficiently agile to offer flexible solutions, there is every likelihood that independent players with their online platforms/offerings will eventually become more mainstream.    

This article appears in full in the May 2017 edition of CA magazine

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