The past decade or so has been a rollercoaster for lending to small and medium-sized enterprises (SMEs). When banks needed to rebuild their capital in the wake of the 2008 global financial crisis, one of the first lending pipelines to be shut down was the SME market. The Government’s figures show that bank lending to SMEs contracted in the years following the crisis.
2020, by contrast, saw record-breaking levels of lending to SMEs. According to UK Finance, gross lending to SMEs in the first three quarters of 2020 reached £54bn, more than double the total amount lent in 2019 – but almost all of this was the result of COVID-19-related government support.
Borrowing from banks – the first port of call for most businesses when they need finance – has become increasingly challenging in recent years. This is partly due to extensive customer checks required by regulators. Funding a startup with no track record can be particularly difficult.
Open Banking regulations introduced by the Competition and Markets Authority in 2018 effectively threw open the market for SME lending by requiring banks to share account information securely with other third party providers. This has allowed lenders to decide if an SME is a good credit bet and monitor the affordability of repayments.
As a result, many SMEs are exploring alternative finance options. These include:
Private investors
Angel investors and informal networks of high net worth individuals willing to support a business on a no-equity basis are an important source of funding for SMEs. Most are matched through existing contacts or word of mouth, but a good business adviser can also help.
Crowdfunding campaigns and peer-to-peer lending
Online platforms allow investors and businesses to be matched with ease, and a multitude of crowdfunding and peer-to-peer lending sites have emerged in recent years.
Crowdfunding, as the name suggests, raises contributions from a large group of people. Crowdfunding for business finance and can be equity-based (contributors receive shares in the company in return) or reward-based (contributors receive some kind of reward, often exclusive to the campaign).
Peer-to-peer lending platforms match together borrowers and lenders, with the lender receiving interest on the loan.
Asset finance
This falls into two broad categories:
- Refinance, under which assets in the business are used as security against a loan
- Leasing or hire purchase, used to fund sizeable new and used assets such as vehicles and machinery
Invoice finance
Invoice discounting – the lending against outstanding or future invoices – has been a mainstay for many smaller businesses for years. Invoice trading is a relatively new variation on the idea, where invoices are sold at an online auction to institutional investors at a discount, with the company receiving a cash advance based on the invoice value.
Merchant cash advance
This is one of the newest forms of alternative finance and only suitable for businesses that accept most of their payments through a card terminal (such as retail businesses, cafés or restaurants).
Under the arrangement, a loan is paid back at source through a percentage of the business’s card payment receipts. The finance amount available, though, is linked to turnover.
Venture capital and private equity
Private equity houses have built up a considerable store of capital during the pandemic and are looking for promising investment targets. In particular, these investors are looking for the potential for a good, relatively quick return on their investment and mostly focus on the tech sector – but business owners should be prepared to give up some element of control over their future in exchange.
Pros, cons and preparation
There are instances where an alternative finance will be the best option for a business – perhaps, for example, because investors have a better understanding of the sector or market than a high street bank might have.
But there are risks involved; if a lender goes bust, it is possible that the liquidator will seek to recover money from borrowers.
As with any financing arrangement, caution, detailed research, and planning are essential. Does a lender place a time limit on repaying a loan? Can a loan term be extended for any reason?
A business plan is a must – this will be a basic requirement for reputable alternative lenders, but writing a plan is also an important exercise for business owners, as we explained in our earlier article.
For more information about how we can help you, including advice about alternative sources of funding for your business, please get in touch with your usual BKL contact or use our enquiry form.