There were several important repercussions of the financial crisis that directly impacted businesses, in particular SMEs, looking for funding.
The most notable of these was that the lending practices of banks came under enormous scrutiny. There is an argument that banks were always aware of the impact of irresponsible lending practices however with the spotlight firmly on them, they had to make public statements of intent. This resulted in them tightening up their lending criteria and even withdrawing totally from sectors that they deemed too high risk.
SMEs felt the impact of this shift and even as the recovery continues, many are finding that they are being greeted by closed doors when approaching their banks for funding.
The Government has tried to help; in conjunction with the Bank of England, in 2012 the Funding for Lending Scheme (FLS) was introduced to help boost the economy by providing banks and other lenders with a route to obtain cheaper cash in the wholesale financial markets to pass onto SMEs.
The question is: has this worked? Not as the Government would have wanted it seems. As an example, the third quarter of 2015 saw Nationwide Building Society with a negative net lending figure of -£216m while Lloyds Banking Group had positive net lending of £275m.
While banks are slowly lending more, this is still not fast enough for the smaller, entrepreneurial business who remain frozen out. Initially due to be scrapped in January 2016, the FLS has now been extended to January 2018 in a bid to try and resolve this problem.
SMEs are not prepared to wait and the market for alternative funding has grown rapidly since 2008.
The alternative funding market has seen an increase in peer-to-peer lending or crowdfunding. These work by SMEs promoted themselves through online platforms which are accessed by a large number of potential investors.
Kickstarter, one of the longer established online platforms, was launched in 2009 in the wake of the financial crisis. It claims that since its inception, over $2.1 billion has been pledged to over 97,000 projects, mostly in the creative space of music, art, design and photography. Crowdcube, another familiar brand in the peer-to-peer lending world states that it has over 235,000 registered investors while Funding Circle boast that they have raised over $300m of equity capital since 2010 from “some of the most largest and most sophisticated investors in the world”.
While this sounds like an exciting and viable alternative fundraising method, it is not without its problems. Kickstarter itself admits that most of its projects raise less than $10,000 which for most SMEs would not go very far. Additionally, a number of less reputable copycat sites have sprung up, some of whom do not even vet any potential fund raisers.
Factoring and Invoice Discounting
These two more traditional methods of raising finance for SMEs still have their place. Factoring involves an SME assigning certain monies owing to it (such as book debts) to the factoring company in return for almost immediate cash which is usually at a discount of 75%-85% of the gross invoice value.
The factoring company then collects the debt from the SME’s customer directly and repays it back to the SME less the initial advance. While the access to immediate cash is a big positive for this method of borrowing, the factoring company can sometimes use harsher debt collection methods than the SME itself, which has the potential consequence of harming reputation. That's why it's important to research the company before using their invoice factoring services.
Invoice discounting is very similar to factoring other than the SME retains control of the sales ledger and can chase its customers for payment in the usual way. This has the added advantage that an SME’s clients would not necessarily know about the invoice discounting arrangements it has in place.
Many business owners, through their own networks are finding access to high net worth individuals, experienced in investing who are able to invest in their companies. These could range from unrelated third parties to family and friends who assist in establishing start-ups in their infancy.
The added advantage of using this type of arrangement is that a private investor is likely to be familiar with all the issues an SME is likely to encounter during its life and can provide invaluable advice on how to overcome any problems. It can also provide the financial backing an SME needs to expand into a new territory or develop a new product line.
SMEs will need to take into account that a private investor is going to want certain checks and balances in place to ensure that certain key decisions cannot be taken without their consent. These will usually be incorporated in a shareholders’ agreement and the company’s articles of association.
The benefits of alternative funding can be very appealing to SMEs; access to cash can be quicker than any usual bank application for a loan which can sometimes take months. This is of course ideal for businesses that need cash in the short term, perhaps to negate the effects of seasonal fluctuations in their businesses. This type of funding is often unsecured which means a business owner’s assets are not at risk.
Alternative avenues such as crowdfunding provide an environment where any investors are more likely to understand your business and product. Banks simply may not “get” what the business is about, particularly if it is in a market which the bank has little to no exposure or experience.
End of Government assistance?
Not quite yet. There are a number of schemes provided by the Government that many SMEs could benefit from.
These include the British Business Bank which came into operation in 2014, a Government owned enterprise which works with a number of venture capital funds and banks to try and increase lending to the SME sector (rather than lending itself, as its name suggests). Another avenue is the Enterprise Finance Guarantee Scheme under which the Government gives a 75% guarantee on individual loans of between £1,000 and approximately £1m repayable over a period up to 10 years made by lenders participating in the scheme.
There is no doubt that banks are increasing their lending, but the question that remains is whether this is benefiting UK SMEs or simply a small number of corporate borrowers who have ticked all the banks’ lending criteria boxes.
It is clear that there are a myriad of viable alternative funding solutions which are specifically targeted at SMEs and which in most cases can provide quick access to funds with little risk attached. So perhaps the more important question is whether SMEs actually need the banks at all.
Maung Aye is a partner in our Corporate and Commercial department. He joined Mackrell Turner Garrett following corporate law positions in London and in a leading regional firm in Essex. Maung read European Legal Studies at Lancaster University and the Università degli Studi di Trento and is a fluent Italian speaker.
His expertise covers company and business acquisitions and disposals, MBOs and MBIs, joint ventures and corporate finance transactions. He frequently also advises on shareholder and partnership agreements, company reorganisations and general corporate governance issues.
On the commercial side, Maung also advises on aircraft financing and lease arrangements, IT distribution and reseller agreements and international data transfer issues.
Maung can be contacted on 00 44 (0) 20 7240 0521 or by email at email@example.com