The current pandemic will see the world of business financing increasingly evolve beyond traditional bank-based borrowing, writes corporate lawyer Pauline Rigby.
Before the outbreak in the UK, there was a growing trend of alternative business finance originating from outside the high street lenders. In part, this was being driven by alternative lenders embracing digital technologies, which improved their routes to market and awareness among business borrowers.
However, the trend was also being propelled by a growing difference between the financing requirements of companies, especially SMEs, and a resonance among institutional lenders.
A report by The SME Finance Forum in 2018 estimated that SMEs were facing a funding gap of $5 trillion, with 41 per cent of these businesses having unmet financing needs.
Fast-forward to this year and SME businesses have taken on record levels of debt through the Coronavirus Business Interruption Loan Scheme (CBILS) and Bounce Back Loan Scheme (BBLS) measures introduced by Government.
As part of the UK’s economic recovery, companies with strong fundamentals and plans for future growth will be looking to alternatives to support their ambitions.
SMEs embracing the alternatives
SMEs have been turning to alternative sources of investment such as Private Equity, with a realisation there are options for part-investment, rather than having to complete a full sale.
Whereas once smaller companies may have feared relinquishing control to PE houses, they now view them as partners which can provide both finance, network and expertise to accelerate growth.
There’s also a better understanding of the options around long-term and development capital, which allows business owners to take investment for a minority stake, so management teams ultimately have control of the business, as well as the capital to fund the company’s growth plans.
Asset-Based Lending (ABL) has also proved popular among SMEs. Companies are much more comfortable securing capital against property and equipment they own or debtors they’ve delivered goods and services for, instead of saddling themselves with debt.
Debt has also been avoided through vendor assisted deals, which further benefits some SMEs as they sell-off non-core parts of their businesses to better prioritise the focus of capital and resource.
More than money
These alternative forms of finance are resonating with SMEs for three key reasons. They are more accessible than the banks, offer more than capital and are often more dynamic than rigid lending. It’s for these reasons the impact of Covid-19 will increasingly see SMEs turning away from bank-based borrowing.
Accessing finance via traditional lenders can be restrictive and time-consuming. More often than not, SMEs find banks do not share their assessments of risk and growth potential. The end result is either lending which doesn’t fully finance an SME’s plans or lending that arrives too late to realise the opportunity.
Unfortunately, some banks have only reinforced their perception of inaccessibility among some SMEs during Lockdown. The feedback seems to be that a large number of companies have struggled to quickly access borrowing, despite it being very low risk for the banks.
This has strengthened belief of some SMEs that traditional lending is too skewed towards the interests of making money for the bank’s stakeholders. Businesses targeting growth or those looking for ways out of difficultly often want more than money.
They want advice, experience and contacts that provide them with added value. They want capital which works as hard for them, as it does the lender. This is why PE is striking such a chord with SMEs. They see the value in releasing equity to a partner which has vested interests in the success of their company.
Along with a cash injection, PE can bring with it new connections, ways of thinking and problem solving, management incentives and economies of scale that may have previously been beyond an SME.
The funding can be structured to provide companies with a more dynamic means of finance that’s better suited to realising their goals. The PE partner may also draw on its experience to offer fresh perspectives that show new possibilities for driving growth.
Resilience and reinvention
The financial effects and business disruption of the pandemic have undoubtedly challenged businesses and will continue to scar some for quite some time. While this is likely to lead to increased due diligence, risk aversion and some form of a slowdown in financing, it will also encourage innovation and creativity.
We’ve seen companies rethink the conventional during Lockdown, with some completely reinventing themselves. Businesses have re-utilised products, equipment and resource to meet new demand and create revenue streams where others have dried up.
This creative thinking will extend to financing, as SMEs continuously turn away from banks to look for more accessible, dynamic and value-added ways of financing their businesses. It will drive greater appetite for alternative finance and SMEs must ensure they explore all options to find the most suitable solution for them.
Working with external advisors such as lawyers and accountants will support SMEs in taking an independent view of what they want to achieve. This will prove effective in helping them find ways of structuring mutually beneficial financial arrangements, which serve the interests of all parties and move away from debt-based and lender-biased borrowing.
Pauline Rigby is Head of Corporate at Forbes Solicitors