SMEs in the UK contributed 54 per cent of total output (GVA) in 2013 and accounted for more than 99% per cent of all private sector companies. Yet despite their volume and impact on the economy, they have consistently struggled to obtain credit.
For every £100 lent by banks to UK businesses, only a quarter of that, just £26, goes to SMEs.
Despite government initiatives such as the Funding for Lending Scheme, lending to UK businesses contracted as the banks persevered to rebuild their balance sheets and respond to new regulatory requirements in the wake of the recession.
Many blamed the banks for this lending shortfall, but the issue also shed light on the knowledge gap facing owners of small companies.
Developing a working knowledge of which funding options are available, their advantages and when to use them could make the difference between growth and bankruptcy for small business owners.
Know your options
SMEs should absolutely be aware of the full range of financial options available to them.
Currently, traditional bank overdrafts provide a key source of funding to one in ten UK SMEs, even though these carry with them inherent risks such as the short term nature of the loan, large fees, potential damage to credit scores and unpredictable interest charges.
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Rather than relying on familiar options like overdrafts, businesses must look for more sustainable alternatives. Government, banks and businesses alike all need to explore and promote, a wider range of financial options that are more appropriate for modern SMEs.
Though traditional loans are harder to come by, funding is out there. This includes several new mezzanine and private equity funds, asset based lending, cashflow finance/ invoice factoring, friends and family, trade credit, hire purchase/ leasing and Enterprise Finance Guarantee loans amongst others. Private and angel investors are also increasingly active.
Weigh the risks
For many business owners, the idea of approaching their existing financier and asking for additional finance can be daunting. What if the lender sees the request as a red flag and reduces, rather than increases the existing facilities? In our experience, most SMEs would prefer to keep a low profile than risk upsetting the apple cart.
Personal guarantees are pretty standard features of many types of mainstream commercial lending, including bank loans and the Enterprise Finance Guarantee scheme. But many business people are justifiably concerned about potentially losing their personal assets, even their homes, if something goes wrong. For some, this risk is not worth taking.
There is, however, a fine line between circumspection and restrictive risk aversion. To overcome the fear of accessing finance, it is important for business owners to get to grips with the specific circumstances of their own business: its markets, its products and its customers.
Get it right
To take the example of asset based lending (ABL) there’s a common misconception that companies without premises, vehicles or heavy equipment cannot benefit. In fact, assets can be as simple as a bulging sales ledger.
ABL also provides a good example of why it’s important to match financing to the individual businesses’ circumstances. Businesses experiencing strong growth can struggle to reinvest surplus cash back into the firm, as there’s often very little flexibility in the short term around the level of working capital required.
Using ABL, the collateral against which borrowing takes place is linked to the growth of the working capital requirement. In a nutshell, this means that borrowing stays in line with the business, whether through seasonal highs and lows or sustained growth.
With ongoing regulatory changes in banking, the lending landscape is clearly set to evolve. While overdrafts are likely to become less attractive over time, a single form of finance will never emerge as ‘the ultimate solution’ for SMEs. Ultimately businesses need to take a more active approach to seek out a funding mix that works for them.
By looking carefully at all the options available, SMEs can seize the control they need to focus on growth.
Peter Ewen is Managing Director at ABN AMRO Commercial Finance
Further reading: Four in ten see EU as a hindrance to business