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Filling the funding gap: finding the right solution can be tricky


The days when bank finance was the only option for small businesses looking to borrow are long gone. But with more potential avenues to choose from, finding the right solution can be tricky. David Adams takes a look at what’s on offer

Businesses of all sizes, but particularly smaller companies, have had grounds for complaint about the level of finance available from the UK’s banks, and the conditions applied to the provision of this finance. The situation deteriorated even further following the 2007/08 financial crisis.

In total, 60 per cent of small firms used some form of external finance in 2015, up from 56 per cent a year earlier, according to the British Business Bank (BBB). But the SME Finance Monitor survey for the fourth quarter of 2015, produced by BDRC Continental, classes almost half of small firms as ‘permanent non-borrowers’, while three-quarters aspired to be debt-free. Yet external finance is often the key factor that lets businesses both manage cashflow issues and invest in growth. 

Tony Baron, FSB Tax and Finance Policy Chair, would like to see more small businesses working with a wider range of financial providers. Although the banks are still by far the biggest provider of finance in all forms to small firms, the growth in alternative finance is important, he says. Almost one in 10 (9 per cent) of small businesses that applied for credit in the first quarter of 2016 sought it from peer-to-peer and/or crowdfunding sources – up from 5.9 per cent in late 2015 – according to FSB research. 

Mr Baron advises firms to consult information sources such as the Business Finance Guide, produced by the BBB in partnership with the Institute of Chartered Accounts of England and Wales (ICAEW) and other organisations. Here’s a rundown of the various potential sources of finance for your business.

Bank finance

In May 2016, the Competition and Markets Authority (CMA) published provisional proposals to improve competition in banking services for small firms, including measures to make it easier for them to compare products and prices and switch banks. 

FSB will work with the CMA as it develops its final recommendations on market reform, to be published in August 2016, says Mr Baron. FSB and the CMA also recommend that firms use the website Business Banking Insight, which collects the survey data of 20,000 small businesses, to compare the quality of services that banks offer.

One factor that will improve the situation is new entrants in the banking sector, such as Metro Bank, Handelsbanken and Aldermore. Often these banks try to attract customers through a combination of technology and personalised services. 

Keith Yeoman is the manager at Handelsbanken’s Croydon branch. “The customer is talking to people who know the local market and can make decisions quickly,” he says. Insurance intermediary Hencilla Canworth became a customer in 2009, after a representative of its previous bank visited the company and announced that its (rarely used) £100,000 overdraft facility would be withdrawn. 

“What impressed us about Handelsbanken was that it was back to the traditional bank manager/customer relationship,” says David Pollard, Chief Executive at Hencilla Canworth. “This was a bank that took an interest in the business.”

Some larger banks are also improving propositions for small firms. RBS has introduced a loan without any extra fees for arrangement or early repayment, and new digital services, says Managing Director for Business Banking Marcelino Castrillo. The bank also intends to enable existing customers to obtain a loan ‘in two clicks’ later this year.

Asset-based finance

Asset-based finance, using leasing and hire purchase arrangements, grew strongly among small firms during 2015, with almost £15 billion of asset-based finance provided to SMEs, according to the BBB.  

Meanwhile, invoice finance and factoring, generally used to fund day-to-day cash requirements rather than investment or growth, are becoming more cost-effective, claims Jeff Longhurst, Chief Executive at the Asset-Based Finance Association (ABFA), “because our members have so much money to put out – supply is outstripping demand”. Many ABFA members are banks.

Ming Foods, founded in 2005, provides Chinese pancakes to restaurants and food manufacturers. It turned to invoice finance provider Bibby Financial Services when a previous financial partner changed the conditions. Unfortunately, it did so just as Ming was moving from a 4,000 square foot factory to a 30,000 sq ft one. 

“We’d just signed a 10-year lease on the new factory,” says Ming’s Chief Executive, Sam Duong. “Bibby said it could see what we were trying to do and it could help.” As well as a £300,000 asset-based finance facility, Bibby is also providing foreign currency services for the firm.

Peer-to-peer lending

Peer-to-peer business lending increased by 75 per cent during 2015, according to AltFi Data. Applicants usually need to provide a trading history, sometimes including audited accounts, and meet minimum turnover requirements. 

‘Peer-to-business’ lending platform Thin Cats matches investors to possible lending opportunities. Investors get much better returns than are offered by most savings products – the platform claims average returns of 9 per cent. That suggests it’s a relatively expensive form of finance for small businesses. But, says Founder and Chairman Kevin Caley, “we can be more responsive and we offer loans that banks wouldn’t like”. 

Borrowers include Koh Thai, a chain of ‘Thai tapas’ restaurants in southern England. The business was self-funded, from its birth in 2009, by a small group of initial investors. In 2013, the company’s existing bank pulled out of a proposed arrangement immediately after the founders had signed a lease for a new restaurant. Although Koh Thai obtained some finance through another alternative finance platform, Funding Circle, it was only with the support of Thin Cats’ sponsor company, Freedman & Partners, that the business could go forward. 

The company has borrowed more than £2.5 million during the past three years, opened 11 restaurants and plans to open another 30 during the next five years.

Crowdfunding for lending

Crowdfunding grew by about 135 per cent – albeit from a low base – during 2015, according to the BBB – but only 1 per cent of small firms actually used these forms of finance last year, according to BDRC’s SME Finance Monitor.

There are three main forms: donation-based, lending, and equity funding. 

Crowd2Fund offers lending propositions including revenue-based lending. One firm using this is Ruroc, which makes winter sports helmets, masks and goggles. Between the company’s first year of operations in 2010 and 2014, turnover rose from £100,000 to £1.1 million, says Managing Director and Co-Founder Daniel Rees. 

The problem, from a bank’s point of view, is that Ruroc is primarily a direct-to-consumer online retailer. “The banks looked at us as a much bigger risk than someone making smaller margins with a lot of invoice business,” says Rees. 

The solution was almost 70 Crowd2Fund investors, who have now lent the business £167,000 at a rate of 10 per cent a year via a revenue-based loan, with the business paying back 4 per cent of revenue generated each month. Revenues fluctuate with the skiing season, so in November or December, for example, Ruroc may be paying back £15,000 or £16,000, but when things go quiet in the off-season the figure drops to around £2,000 or £3,000. 

Equity finance

Only one per cent of small businesses used equity funding in 2015, according to the BBB, via various sources, including the Business Growth Fund (BGF). Established in 2011 to support small, growing businesses, BGF is backed by five big banks – Barclays, HSBC, Lloyds, RBS and Standard Chartered – and works through eight regional offices. It usually focuses on companies with a turnover of between £5 million and £100 million, making initial investments of between about £2 million and £10 million in return for a seat on the board and a minority equity stake. 

“The companies we work with get support from BGF and our network to help them expand, in situations where there is more risk than a bank would be comfortable with,” says Alistair Brew, a member of the investor team at BGF. 

BGF also has a venture capital arm, BGF Ventures, which may invest between £1 million and £6 million in firms at earlier development stages. Recent projects have included investing £2.7 million in toucanBox, a children’s activity box service, which was set up in 2012 and is growing at 20 per cent month-on-month.

British Business Bank

The BBB works with 80 financial partners, including banks, alternative and asset finance providers, venture capital and private debt investors. It supports £2.5 billion of finance provided to more than 44,000 small companies. It also manages the Enterprise Finance Guarantee programme, which encourages lenders to work with firms unable to give the level of security a lender usually requires.

A new ‘Help To Grow’ programme, targeting high-growth smaller businesses, will be delivered with the assistance of private debt funds. “With private debt you have a fund that is not subject to the same capital regime as a bank, and those funds are looking for growth opportunities,” says BBB Chief Executive Keith Morgan.

David Adams is a freelance business journalist