SMEs are increasingly looking to non-bank financing sources as traditional funds become harder to secure, and growth in new lending slows.
Research from American Express and Oxford Economics has found that, even though 68% of SMEs understand the importance of cashflow to their business, a third of those surveyed have trouble accessing the finance they need. This represents an increase of 6% year-on year, in line with the global average.
The result is that SMEs are increasingly moving away from traditional sources of finance such as bank loans - expected use of bank loans was down 22% (82% to 60%) between 2017 and 2018. Whereas the use of alternative finance such as asset lending is expected to be used by 37% of SMEs, up from 25% in 2017.
The total value of the alternative finance market in the UK grew 35 per cent to £6.2bn during 2017 according to data compiled by the Cambridge Centre for Alternative Finance. That compared to a total of £4.6bn over the previous 12 months.
In 2017 alone, £4.2 billion of business funding, which represents 68% of the total market volume for alternative finance was raised via online platforms and directly channeled to start-ups and SMEs.
As traditional lenders continue to withdraw from this segment of the market, and alternative finance cements is position as a serious alternative, we look at a few of the alternative financing options available to SMEs, and dispel some of the common jargon that can make it difficult to understand.
Invoice Factoring / Discounting
Invoice factoring and discounting can provide much needed growth capital. They both refer to the same process, an asset based working capital product that allows companies to receive an advance on money owed by customers, rather than waiting for them to pay – typically between 60% and 80% of the value of the invoice. This method of financing is particularly attractive to lenders as it is secured by invoice due from the debtor. Post-recession capital regulations have resulted in banks moving customers away from traditional overdrafts and unsecured loans to this method of lending.
Business to Business Lending (B2B)
Similar to peer to peer lending but directed at businesses. Typically managed through online platforms, B2B lending enables SME’s to access debt funding from a group of investors (both individuals and institutions). The major advantage of this method of financing is time. It cuts out intermediaries like brokers and banks, and reduces time spent on complex paper applications. Decisions are quick, typically within 48 hours and interest rates are based on credit scoring and available security. The lenders platforms are easy to use and mostly transparent on pricing and terms.
R&D Tax Credit Loans
This is a relatively new form of financing. The process allows businesses to access their future R&D tax credit in advance, in the form of a loan. The R&D credit is treated as a future receivable and borrowers are provided with a receivables funding facility. It is typically short-term (3-6 months) and the money advanced can be used for working capital or other uses. The loan is then re-paid when the credit is received from HMRC. Generally businesses can borrow around 80% of a future R&D tax credit up to 9 months before the company is due to claim the funds from HMRC.
Equity Crowdfunding
Originally a way for more unique and less traditional businesses to secure funding, crowdfunding for SMEs has grown exponentially over the past 5 years. The model is simple and works by allowing large numbers of people (the crowd in crowdfunding) to investment small sums of money into a business. With many investors contributing, these small amounts add up to a large pooled investments. Investment raised by a business can be used for a wide range of purposes including developing a prototype, right through to more established businesses using the money to invest in international expansion.
SpringRock opinion
Alternative finance has stepped into the shoes of traditional lending institutions, plugging a much needed investment and lending gap.
The alternative finance market has grown at a rapid rate over the last few years, with SMEs turning to these innovative funding sources to meet their growth objectives.
Compared with traditional lending institutions, alternative finance providers are more nimble. This means quicker decision making and the avoids the pain of a 'slow no' that has become the hallmark of the high-street banks.
Whilst alternative finance providers pride themselves on the transparency of their pricing models, this form of financing is generally more expensive to account for the increased risk.
It is important that SMEs fully understand the product and overall costs of borrowing, as well as the implications of any security provided.
Sources: Oxford Economics, American Express, smallbusiness.co.uk, Market Invoice, Cambridge Centre for Alternative Finance