The world of business finance has changed dramatically over the last decade. As well as traditional banks and private banks we now have an array of challenger banks, peer-to-peer funding platforms and more. It is now possible to arrange business finance in just a matter of hours with finance companies embracing technology but also good old fashioned common sense. Even though some traditional banks have reduced their risk profile and exposure to business finance, many are now directly funding alternative platforms such as private banks and becoming more involved in peer-to-peer companies.
We will now take an in-depth look at the world of business finance, how the markets have changed, reasons for raising finance and the myriad of opportunities available today.
Why do businesses raise finance?
There are many different reasons why a business might look to raise finance. Some of the more common reasons include:-
- Providing additional working capital
- Asset purchases
- Business start-up
- Funding growth
- Debt restructuring
The beauty of the business finance market today is the fact it is flexible and able to adapt to changing trends. The injection of competition from different elements of the funding community has led to reduced interest rates, falling costs and ever greater transparency. The world of peer-to-peer lending, often referred to as crowdfunding, has for many businesses removed a layer of cost and created a very liquid funding tool.
While traditional banks are still fairly risk averse on the whole (in light of the 2008 US sub-prime mortgage market collapse) some of the new funding platforms have more of an entrepreneurial spirit. For many businesses and individuals there is now the opportunity to use non-standard collateral such as antiques, paintings, properties and vintage cars, as well as traditional assets, to secure the best interest rates and repayment terms. This flexibility encourages the use of business and personal assets to secure funding – although there are also many new unsecured funding options.
How has traditional bank led business finance changed in the last 5 years?
There is no doubt that traditional banking has been impacted by the likes of peer-to-peer lending, private banks and niche market players. While the traditional high street banks still have a huge presence in the business finance market, they tend to offer fairly rigid deals. For entrepreneurs and businesses looking to grow, this does not always allow them to utilise their assets and their potential going forward.
In a surprising about turn, this risk aversion to direct involvement in niche areas of business finance has led to a different approach. Many of the high street banks are now directly funding private banks and other niche players, thereby eliminating hands-on management while securing long-term returns. When looking at business finance costs, comparing high street instruments to those of niche players is often a kin to comparing apples and pears. Niche market players tend to be more flexible, more accommodating and likely to find a solution for the vast majority of business finance applications.
Many people would argue that traditional banks now have their hands tied due to the ever increasing regulatory burden. Recent concerns regarding Brexit and the potential impact on UK financial markets and businesses have led to a tightening of the regulatory straitjacket for high street banks. Unsurprisingly, this void has been filled by niche market players, peer-to-peer operators and private banks that are willing to look at the overall picture as opposed to rigid income ratios and security. These operations are still covered by UK financial regulations but are structured and funded differently from traditional high street banks.
What are the main security types for traditional banks?
Business loans from traditional banks tend to be secured in order to comply with their often rigid risk profiles. Some of the main security types considered include charges over:
- Business property
- Personal property
- Specialised machinery
- Business vehicles
- Personal vehicles
- Insurance policies
- Investment accounts
- Savings accounts
- Valuable items such as jewellery and collectables
There are also situations where shareholder or director personal guarantees will be enough to secure a business loan.
Traditional banks tend to consider traditional types of security where some of the alternative finance companies may be little more creative in the security they will consider. There is also the matter of unsecured loans which are available from traditional banks in some circumstances but often more the realm of peer-to-peer finance platforms, private banks, etc.
How has the space evolved – peer to peer and alternative finance lenders
It is just over a decade since the worldwide financial crisis but we have seen some significant changes in the business finance market. Using statistics collated by the Bank of England we know there have been major swings in gross new funding for UK SMEs between 2008 and 2017.
- Bank loans
Gross new funding from bank loans was £44.5 billion in 2008 and bottomed out at £38 billion in 2012. There was a significant jump to £59 billion in 2016 although 2017 saw a reduction to £57 billion. It would appear that a mixture of revised risk profiles for UK banks and a tightening of regulations have impacted growth.
- Private equity
Between 2008 and 2013 private equity finance swung between £500 million a year up to £1.5 billion. Since 2014 we have seen a significant increase with private equity lending to SMEs hitting £2.5 billion in 2014, £3.7 billion in 2015, £3.11 billion in 2016 and £5.89 billion in 2017. Figures for 2018 will likely show further growth as the alternative finance companies continue to chip away at the market share of traditional banks.
- Asset finance
After reaching £14.3 billion in 2008, the amount of asset finance provided to UK SMEs fell to £9.95 billion in 2009 at the height of the financial crisis. Since 2010 there has been a gradual increase from £10.2 billion to £18.6 billion in 2017. This perfectly illustrates the power of security and lending against secured assets.
- Peer-to-peer business lending
Often referred to as crowdfunding, peer-to-peer business lending is the fastest growing source of gross new funding for UK SMEs. Lending was minimal up to 2012, jumping to £250 million in 2013 and a staggering £1.8 billion in 2017. Figures for 2018 will show more growth as platforms which connect small businesses looking for finance with investors, continue to grab market share. It is fair to say that peer-to-peer business lending caught many regulators by surprise. It is only now that the European Union is looking to create a more focused regulatory structure for crowdfunding operations. However, peer-to-peer business lending is still covered by traditional financial regulations.
- Peer-to-peer invoice funding
Invoice financing has been a major market for UK companies for some time now. The traditional invoice financing market is worth around £10 billion a year. While peer-to-peer invoice funding is but a fraction of this. From a standing start in 2008 it grew to £500 million per annum in 2017. There is every chance that more companies will switch from traditional invoice finance to peer-to-peer invoice funding in the short, medium and longer term.
- Invoice finance
Figures released by the Bank of England show that traditional invoice funding has remained remarkably steady during the financial crisis. Advances outstanding as at 31 December 2008 totalled £8.66 billion. While this figure fell to £7.19 billion in 2009 the trend has been upwards and total gross new funding for UK SMEs in 2017 stood at £9.57 billion. For many companies invoice financing is a vital way in which to improve short-term cash flow by effectively selling on invoice income (albeit at a discount to face value or incurring finance charges).
Since 2008, traditional banks have seen their market share of gross new lending to UK SMEs fall from 74% down to 67% in 2017. Peer-to-peer business lending has come from nowhere and in 2017 accounted for 2.1% of the market. Asset finance now has a 22% market share, private equity 7%, invoice finance 11% and peer-to-peer invoice funding is still in its relative infancy with a market share of just 0.6%. These figures are based on gross new funding for UK SMEs taking into account:
- Bank loans
- Private equity
- Asset finance
- Peer-to-peer business lending
- Peer-to-peer invoice funding
- Invoice finance
Since 2008 gross new funding across these instruments has risen from £59.8 billion up to £83.9 billion in 2017. Despite the fact that Brexit has had an impact on business confidence there is no doubt that relatively low interest rates have encouraged growth in the business finance market.
Short term loans and unsecured loans
Even though the traditional bank lenders have a reduced appetite for short-term/unsecured loans, this is not the case with alternative finance companies such as peer-to-peer business lenders. It will depend upon the level of funding required but pre-offer documents required include:
- Bank statements going back three months
- Latest report and accounts filed with companies house
- The current profit and loss spreadsheet/balance sheet were accounts are more than 16 months old
Where there are discrepancies, missing information or perhaps there have been financial challenges for the company in the past, there is still some flexibility and all is not lost. Companies such as Funding Circle will even consider director personal guarantees from those with a chequered personal credit history – as long as they are upfront about historic issues. Some of the key considerations with peer-to-peer business lending companies include:
- Maxim lending between 60% turnover and five times net profit
- The loan will need to benefit the applicant’s business (not personal use)
- Where a personal guarantee is offered no charge will be taken on assets/property
- Where majority ownership has changed within last 12 months, lending may be refused
- Maximum lending for non-homeowners of up to £100,000
- Evidence of appropriate external income in business/bank statements
As short-term loans are very often time critical, a decision can be forthcoming within hours from peer-to-peer business lending platforms, private banks and non-traditional banking groups. Decisions are typically made within 24 hours and the funds available within five days of receipt of signed loan acceptance. There are some extremely attractive rates available in the peer-to-peer business lending sector starting from as little as 1.9%.
Invoice factoring is a very efficient means of improving short-term cash flow and gaining access to funds due from slow paying customers. There are two basic ways in which you can receive funds which are:-
- Sale of invoice income
An outright sale of invoice income, less a discount for risk, etc is a very useful means of receiving outstanding funds immediately. The discount will depend on a number of factors including interest rates, with the finance party taking full control and receiving future invoice payments.
- Stage payments
The other common option is to receive stage payments with around 80% of invoice face value paid in an immediate first instalment. The client will receive the additional 20%, less finance fees, once the invoice has been paid in full.
Prior to any invoice factoring transaction the validity of each invoice will be checked to ensure there are no disputes which may prevent payment. There will be occasions where difficulties emerge further down the line but on the whole invoice factoring is a very useful tool for many SMEs in the UK.
Using real estate – a cheaper approach – bridging finance / remortgage main residence
As we touched on above, there are many different reasons why a business may require additional funding and also many different ways to secure this funding. One of the more common routes is to use business/personal real estate which could be a factory or a home. Some of the more common financial options include:
- Equity release
- Remortgaging a property
- Bridging finance
Using any form of real estate as collateral for a business loan can have a significant impact on the headline interest rate and terms and conditions. While there is obviously a risk of losing a property in the event of defaulting on the business loan, it can prove very useful in obtaining short, medium and long-term finance. As the average UK home is now worth in excess of £200,000 (more than double that in London) this can prove to be a very useful form of collateral.
How does the process differ between traditional and alternative finance providers?
As we highlighted above, bank loans to UK SMEs have seen a marked reduction in their market share over the last decade. There are a number of differences between traditional bank lending and alternative finance providers. These include:-
The vast majority of high street banks still work to a tried and tested system which relies on a variety of financial ratios to calculate creditworthiness. This system is relatively inflexible and does not always allow additional assets and income to be considered. The new breed of alternative finance provider is very nimble, utilise the latest technology and while incorporating financial ratios into their calculations, they are not as rigid as traditional banks. They also allow a variety of personal guarantees and assets to be used.
While it would be foolish to suggest that unsecured loans are standard, there is no doubt that alternative finance providers don’t always require the same degree of security as traditional banks. A simple personal guarantee with a crowdfunding platform will often be enough to secure significant short to medium term funding. There will obviously need to be the traditional credit checks but not all alternative finance companies will require a high level of security.
- Bespoke finance
Even though all business finance is to a certain degree moulded around a client’s specific situation and creditworthiness, traditional banks tend to have a much more rigid structure than their alternative finance counterparts. In many ways a company has to mould their requirements around traditional bank offerings as opposed to the exact opposite for the likes of crowdfunding companies, private banks, etc.
- Impaired creditworthiness
On the whole, traditional high street banks have no interest in providing finance for companies with a degree of impaired creditworthiness. Their risk profile effectively eliminates this area of the market leaving something of a vacuum. Many of the alternative financial arrangements available today will consider those with impaired creditworthiness and even individuals and companies who may have seen serious financial difficulties in the past. Obviously, credit checks will be carried out and in many cases personal guarantees will be sought but impaired creditworthiness does not necessarily cut you off from business finance.
- Headline interest rates
Comparing traditional bank business finance deals with peer-to-peer and private banks for example is often akin to comparing apples and pears. The traditional bank structure tends to be an off-the-shelf product while the others are structured around the client’s needs. Obviously, the pledging of collateral will help to reduce headline interest rates but very often there are ways and means of securing finance even without security.
How long does it take to arrange a business loan?
The time taken to present a theoretical business loan and actually complete the transfer of funds varies enormously. Traditional banks can take up to 6 weeks and beyond to evaluate a proposal. However, private banks, peer-to-peer lending and invoice factoring companies can often provide theoretical terms in just a matter of hours. In an age where time is money, cash flow can mean the difference between success and failure, the decision-making process of traditional banks is now under great scrutiny.
Many suspect that traditional banks have historically overplayed the trust factor and relationships they have built up with individuals and businesses over the years. The more nimble alternative finance companies continue to chip away at traditional bank market share. The time taken to present a theoretical finance deal is, for many, a very important factor.
What are the maximum business loans available?
Business loans can vary from just a few thousand pounds in short-term finance to millions of pounds in long-term funding. The maximum business loan available to a company will depend upon many factors such as:
- Size of the business
- Reason for the loan
- Financial strength
- Credit history
- Viable business plan
- Cash flow
- Exit route
Where funding requirements are complex and non-standard there may be the opportunity to mix and match a variety of funding instruments. For example you could see part traditional bank, part private bank with a mix of invoice factoring to enhance cash flow. The market today is extremely liquid which also offers the opportunity to refinance debt further down the line.