The UK’s lending landscape has been under fierce scrutiny since the start of the economic downturn some eight years ago, with banks particularly in the spotlight. Yet while the availability of finance has fluctuated, so too it seems has the desire of small businesses in particular to borrow money.
According to BDRC Continental’s SME Finance Monitor, released in September, 49% of small firms now meet the definition of “permanent non-borrowers” – those with little appetite for borrowing in the past or plans to in the future – and this has increased from 34% in 2011. And 73% of SMEs say they intend to pay down existing debt and remain debt-free.
This may in part reflect either a reality or a perception that finance is hard to find, but could also indicate a more fundamental shift among the priorities of entrepreneurs and business owners. “We know from our own surveys that quite a few businesses have a cash pile and some of them are quite happy not to be thinking of spending it,” says Clive Lewis, head of enterprise at ICAEW. “Others say they’re just waiting for the right opportunity.”
Crowdfunding and peer-to-peer lending have given the market a jolt...that's forcing the banks to sharpen up their practices
This is particularly the case among smaller businesses, typically those where the owner is still involved in running the organisation, suggests Jonathan Russell, a partner at ReesRussell, and member of the UK200 Group. “A majority of these are lifestyle businesses where the purpose of the business is to provide a family income,” he says. “They are less aggressive and more risk averse than true entrepreneurial businesses. They are very pro-risk, they will spend anybody’s money who will give it to them, so it’s a different scenario.”
In fact, if the permanent non-borrowers are excluded, some 70% of small businesses have accessed some form of external finance so far in 2015, according to the BDRC study; a slight increase on the 2012-14 period where the figure fluctuated between 65% and 68%. Bank finance remains a source for many, and there is evidence that this is more readily available than realised. The study found 96% of small firms applying to renew borrowing in the form of loans or overdrafts were successful in the 18 months to the middle of 2015, compared to 57% who were confident they would get the money.
“Banks are still the first port of call for borrowing and that is then used to benchmark other possibilities,” contends Duncan Montgomery, a tax partner at Whittingham Riddell. “There are certain banks that have come into the sector which tend to have a good reputation for looking at things pragmatically, and some banks that are very clearly open for business and will lend.” However, there is also a perception that applications for finance will be tortuous, which puts off those who aren’t in desperate need of the funds, he adds.
New applications for funding, however, fare less well, with a success rate of 67%, although this has risen steadily since the second quarter of 2013, while 62% of overdraft applications from first-time borrowers were successful, up from 36% in 2013, and 53% of loans were granted (up from 40%). “There is a slight improvement but it’s still a problem,” says Lewis. “Roughly half of first-time applicants are not getting the funding they require.”
Sarah Abrahams is SME finance manager at Grant Thornton. She says around 20% of her clients still rely on the bank but also points to a growing appetite for equity finance and angel investment. “Two years ago it was pretty much 50:50 in terms of companies choosing debt and equity,” she says. “We’re now more like 65:35, so 65% are choosing equity.”
Television programmes such as Dragons’ Den have helped to raise the profile of wealthy business angels, she says, but there remains a lack of interest among venture capitalists in start-ups that have proof of concept but have yet to start trading or turn a profit. “They’re not even looking at businesses with turnover of less than £500,000 to £1m, and even angel investors want to go in when there is real traction and perhaps a few very early customers, rather than funding pre-revenue.”
Yet other methods are also having an impact. Alternative finance, such as peer-to-peer lending, crowdfunding and peer-to-peer invoice discounting, are generating considerable attention, entering the thinking of entrepreneurs. The BDRC survey found 37% of small firms, excluding permanent non-borrowers, are now aware of crowdfunding – up from 22% in early 2014 – although just 1% have actively raised money through this route.
Research by UK Bond Network, meanwhile, suggests 68% of small firms in the UK would consider using some form of alternative finance to raise capital, increasing to 94% for those with turnovers of more than £1.1m. “Crowdfunding and peer-to-peer lending have given the market a jolt in that once they have a fully completed application it takes them a very short time to decide whether to loan or list them, and that’s forcing the banks to sharpen up their practices,” points out Lewis.
The government initiative due to come into force in 2016, under which banks will be able to suggest alternative finance providers as another potential avenue for businesses they are unwilling to lend to, will also give this sector a boost, he adds, although he warns this will increase the need for business owners to seek professional advice around what is the best source of finance for their needs.
Asset-based finance – borrowing against a debtor book or other assets – is also an option for small firms, and one which can avoid business owners having to commit to long-term finance. It has also been given a boost by online and peer-to-peer-based products. “Online invoice factoring and discounting is becoming more popular because they will be much more flexible than traditional factors and discounters, who normally ask for your whole debtor book,” says Lewis.
Many entrepreneurs also rely on their own finances, or those of their family or friends. BDRC’s research suggests 26% of small businesses put their own money into their businesses, with half of these choosing to do so rather than doing so out of necessity. But this is dwindling; in 2012 some 42% of entrepreneurs put their own capital into their business. Bibby Financial Services’s SME Tracker, meanwhile, suggests 14% of small firms use either their own savings or money they have borrowed from friends or family.
Government schemes are another option that can provide entrepreneurs with grants or access to loans, helping to fill the gap for businesses yet to fully establish themselves. One option is the British Business Bank (BBB), which helps put small firms struggling to get finance in touch with more than 80 different partners including the Start Up Loans Company.
Keith Morgan, the BBB’s chief executive, says: “It could be an angel syndicate, a venture capital firm, an asset finance provider, an alternative marketplace lender or a bank, but in all of these cases it allows us to bring in private sector funding,” he says. To date, some 40,000 businesses have benefited from more than £2.3bn of funding, he adds (see box, page 43).
Even angel investors want to go in where there is real traction and perhaps a very few early customers, rather than funding pre-revenue
Other British schemes include grants from Innovate UK, as well as those such as the European Regional Development Fund or the Regional Growth Fund, although Abrahams warns that there can be an over-reliance on these in certain parts of the country, particularly the north.
Many businesses, though, have simply chosen to self-finance, using profits retained in the business to fund purchases or even business acquisitions. “Many traditional small firms that existed pre-2007 have generated cash surpluses for which they have no immediate home or need,” says Les Leavitt, managing partner at Manchester-based accountancy firm Leavitt Walmsley Associates (LWA). “This has led to a number of acquisitions that are funded significantly from existing resources.” LWA itself made use of this, he adds, funding the recent purchase of Moore Hill out of its own resources.
This is also the preferred route for capital investments, according to the GE Capital SME Capex Barometer, which found 70% would look to finance these through existing capital, followed by 60% who would seek to lease equipment and 44% who would consider a bank loan.
In the longer term, the proliferation of new financing options are likely to become established parts of the overall borrowing mix for small businesses, sitting alongside a banking sector with a renewed appetite to lend. “There will be some restoration of the acceptability of bank borrowing, particularly as businesses decide to be more adventurous,” suggests Montgomery. “We’re aware of people who have tendered for projects where frankly without bank borrowing they cannot finance it. As they get more appetite for that they will have to revert to a more traditional model. But for people who aren’t looking at too big an expansion we may end up looking at a paradigm shift in the way things are done.”
Adam Tavener, chairman of Clifton Asset Management and catalyst for the creation of the Alternative Business Funding (ABF) collaboration and non-bank funding portal, believes ultimately there will be a gradual blending of bank finance with newer options, as seen in the bank referral legislation. “Basel and other restrictions mean that banks are unlikely to ever regain their former risk appetite, but they do want to keep the customer, the goodwill, and those bits of the funding package that they want to write,” he says. “Bank relationship managers will morph more into the advisory or at least outcome-focused space, and a bank versus non-bank marketplace will be transformed into an environment designed to ensure that the customer gets the best outcome, even though that may be sourced from a number of different providers.”
Case study: A steak at the heart of it
Despite having owned a Brazilian steak house, Andy Aldrich was unable to find any bank willing to finance his vision to start a Brazilian restaurant in Liverpool. “I went out to three different banks and got knocked back from all of them,” he recalls. It was 2010; bank finance was thin on the ground, and sources of alternative finance had yet to become properly established.
Aldrich had some of his own capital from his previous business to invest, and also raised £200,000 from local investors, but still needed more to launch the venture. It was then that he came across what was then the Small Firms Loan Guarantee – a government initiative to guarantee loans to small firms that were struggling to get finance, which has since morphed into the Enterprise Finance Guarantee, operated by the British Business Bank.
With the guarantee in place, Aldrich was able to borrow £200,000 from Santander, and later a further £250,000 to open a Glasgow outlet and £375,000 for a Cardiff branch; all of which has now been paid off.
Since then, Viva Brazil has opened outlets in Newcastle and Birmingham, which have been financed through conventional bank loans, and currently turns over just under £10m, employing 190 people.
“We’re now at a point where we’re self-sufficient and we’re above and beyond the criteria to meet the British Business Bank lending criteria, in terms of turnover,” says Aldrich. “But without it we wouldn’t have got open at all.”
Case study: Equitable thinking
Having already taken a business – Actinic Software – from start-up to stock market, Chris Barling was hopeful he would be able to attract finance for his invoicing app business Powered Now. “It was still really difficult,” he says.
The business was too young to attract venture capitalists, while a bank loan did not fit the business model. “If you’re funding a high-tech start-up business that might underperform the business plan by 20% or 30% but will then ultimately be very successful, a loan is probably inappropriate,” he says. “If you can’t make a repayment you might go out of business.”
With high initial costs and operating in a high-risk but high-return environment, Barling opted for equity investment. After initially attracting angel finance, he raised £585,000 in 2014 on crowdfunding site Crowdcube, and then a further £575,000 in September 2015.
“Crowdfunding was the easiest way of raising money for our business at that stage,” he says. “We’re building a product which typically requires quite a lot of upfront investment and our revenues are mainly through monthly subscriptions, where the value is in the long-term. In that case, equity funding is both appropriate and necessary.”
Trends in sme funding
1. New debt market instruments have emerged that will increase funding flows and allow firms to access more flexible, and in some cases less expensive, financing alternatives to bank loans.
2. SME-specific bond markets have developed in countries including Germany and Italy and in the UK and France the private placement of debt has flourished.
3. The UK’s peer- to-peer lending market, the largest in Europe with a cumulative lending volume of £3.15bn by Q2 2015, predominantly funds SMEs. Securitisation is another option that holds promise.
Capital Markets Union
1. The Capital Markets Union aims to tackle investment shortages head-on by increasing and diversifying funding sources for Europe’s businesses.
2. Capital markets, venture capital, crowdfunding and the asset management industry should play a bigger role to help companies that struggle to get funding.
3. Before the end of the year the EC Prospectus Directive will be amended with a view to making it easier and less expensive for SMEs to raise capital.