Over the last year, much has been said in the press about the decline in traditional bank lending to SME’s. Also the Government’s failed attempts to rectify this.
To fill the void left by the big four banks a raft of new, alternative financiers have entered the market.
In fact barely a week goes by without another company launching in this already crowded space.
The alternative lending market has brought with it benefits of:
- Innovative new products.
- Easily accessible finance driven by new technology.
- Quick credit decisions.
The market has also generated huge amounts of positive publicity.
Little has, however, been said about any risks associated with these sectors.
Alternative finance offerings & their rewards
Here, we look at the various alternative funding options and discuss the risks to both investor and borrower:
Peer to Peer Lenders/Crowd Funding
Numerous online crowd funding and auction sites enable corporates and private individuals to participate in equity, loans and invoice finance.
High returns available to investors have resulted in the sector seeing rapid growth.
Without doubt peer to peer and crowd funding lenders have been very successful in supporting smaller SME’s.
Asset Based Lending
Whilst Asset Based Lending can be seen as one of the more mature alternative finance options, the competitive nature of the sector has seen lenders differentiating one another by expanding their product offerings to include specialist products such as:
- Construction Finance.
- Single Invoice Finance.
Asset Based Lenders can also provide additional value by financing non-receivable assets; also add in trade finance and short-term cash flow loans.
With approximately 100 companies operating in this sector we are now starting to see a greater degree of flexibility and transparency around contract terms and fee structures.
Competition from the Peer-to-Peer lenders has also pushed Asset Based Lenders into investing in new technology.
The asset finance sector provides an ideal medium term solution for all types of businesses. As a result it has seen very strong growth over the last couple of years.
Although the market is dominated by some of the banks, independent financiers are servicing smaller SME’s.
Over the past few years a number of new ‘challenger’ banks have entered the market. Whilst only one has developed a retail footprint; they have all been successful in offering products in the property and asset based lending sectors.
Trade Finance/Purchase Order Finance
A number of new trade finance houses have entered the market. These companies can either purchase goods (raw materials or finished products) on behalf of a company, or pay their suppliers direct on terms of up to 120 days.
Whilst the majority of providers insist on purchases being supported by confirmed customer orders, some financiers will finance an element of stock.
Supply Chain Finance
For corporates and their finance partners, supply chain finance or reverse factoring provides a range of payment options to suppliers to support their working capital needs.
Bridging and Development Finance
The boom in property prices in London and the South East has seen the emergence of specialist bridging and development finance companies.
Rates are high, reflecting the risks associated with this type of lending and the short-term nature of the loan.
A number of companies now provide short-term loans, which are supported by directors’ personal guarantees.
Alternative finance risks to consider
Whilst it is commendable that small financiers and private investors have stepped into the corporate finance market, risks to both the investor and the borrower include:
- Alternative Financiers are, in the main, providing funding to businesses that have a higher credit risk. Whilst this is admirable, failure rates and losses are bound to rise when the current benign economic conditions pass. Indeed we have already witnessed a couple of providers ceasing to trade. Unfortunately other casualties are bound to follow.
- Investors may not fully understand the risks associated with the transaction, as decisions are sometimes made on the financial performance of the company and/or its customers, rather than the quality of the underlying security.
- A number of the financiers have back-to-back finance arrangements with the big four banks. This may affect their ability to grow. It may also place constraints on their ability to underwrite some corporate finance packages.
- Alternative Financiers sometimes only provide some of a company’s finance. Their security requirements do not always reflect the increased risk.
- As competition continues to increase in the sector, new entrants may be forced to further relax their credit criteria and take unnecessary risks to try and win business.
- The costs of some facilities can be high. This means there is a danger that companies will use high cost short-term solutions to fund medium term growth.
Where to seek advice about alternative finance
In summary it is fair to say that SMEs have a huge range of options available to them. Furthermore alternative finance sector has been very successful in launching easy to use and innovative products.
Without support from alternative financiers, SMEs would have struggled to gain access to finance.
Because of the nature of the risks associated with this sector, it is important to consult an independent business finance specialist, whose job it is to have a deep level of understanding of financial risk management.
Not only will you be assured impartial advice on all aspects of business finance, but you will also receive advice and assistance in sourcing the right financial products suited to your specific needs.
About the Author: Director of Business Finance Broking Simon Belton has over 25 years experience in the Asset Based Lending sector. Simon brings with him a wealth of experience within the broking industry. He has also worked for a number of the leading financiers, both in the UK and internationally.
Get in touch to find the best Alternative Finance package for your/your client’s business.