Small businesses are finding it increasingly difficult to raise finance from banks and are turning to alternative sources of finance.
In this article we have reviewed the market for corporate debt and look at what
small businesses should do if they need finance to grow.
Since the recession, and to avoid too much risk taking, regulators have required banks to build huge capital reserves and reduce their exposure to risk. Central Banks, meanwhile, have their sights set on fighting deflation and getting growth going. Their aim has been to make credit cheaper and more available and to bolster risk taking with
very easy monetary policy. So while regulators want to reduce risk in the banking system, Central Banks aim to encourage risk taking.
This ‘easy money’ has helped bolster bank lending for larger businesses. Lending to larger firms is relatively low risk and enables banks to benefit from low interest rates and a recovering economy. A recent survey of CFOs reports that the cost of credit for larger
businesses is near an eight year low while availability is better than at than at any time in eight-years.
Conditions are less favourable for smaller and medium sized enterprises (SMEs). They lack the scale and resources to be able to issue corporate bonds, so have missed out on the super-cheap bond finance available to large businesses. SMEs are dependent on bank lending where, while conditions
have improved, problems remain. The latest Federation of Small Businesses' survey show that a large number of member firms rating bank credit as being 'unaffordable'.
This is where the story becomes interesting. Tougher regulation has constrained the capacity of banks to take risk and made it harder for some borrowers to access bank credit. At the same investors are eager to find ways
of earning a better interest rate than they would get from putting their money in a bank. The obvious solution is to put the borrowers in search of credit with the lenders in search of yield together. Three markets are doing just that.
The corporate bond market
The corporate bond
market allows larger businesses to raise debt finance from investors such as pension funds, insurance companies and institutional fund managers. Quantitative easing has lowered interest rates on corporate debt and made it highly attractive to investors. The result has been a boom in debt issuance. Many corporates have restructured their balance sheets, repaying bank borrowing and financing themselves with cheaper, long term corporate debt.
Private equity and alternative lenders
As banks have retrenched, alternative lenders, including private equity firms and asset managers, have moved in as providers of debt finance to medium and larger businesses. Mid-cap private businesses, which do not have access to public sources of equity funding, are increasingly turning to
alternative lenders to diversify their sources of finance.
Crowdfunding
Finally, rapid growth in peer-to-peer lending or 'crowdfunding' is allowing small businesses to raise funds directly from savers. Near zero interest rates mean savers get next to nothing for their deposits while small and
medium sized businesses often face near double-digit interest rates on debt. This has led to the rapid growth in the number of 'platforms', such as Funding Circle and Thin Cats which match businesses in search of funds to those looking for a better return on their savings. The response has been enthusiastic. In the first half of this year peer to peer lending accounted for almost a fifth of the flow of credit to small and medium sized businesses in the
UK.
The conclusion for small businesses is clear; as the financial crisis ushers in a new era of more regulated banking, new forms of lending are seeing strong growth as businesses seek credit and investors search for better returns.
The fact that ‘traditional’ bank lending to small businesses is,
to all extents, a thing of the past marks a huge shift in the landscape not only in terms of how businesses are financed but also in how they operate in this new era in which lenders require far more, and more frequent, financial information.
If you are raising development capital to fund your growth in 2016 please give me a call. There is finance available – it’s just a bit harder to
find!
Noel Guilford
Noel Guilford is the principal of Guilford Accounting a small business accountancy practice specialising in advising owner-managed businesses on current accounting, finance, and tax matters. You can reach him via email at noel@guilfordaccounting.co.uk or by phone at 01244 660866. He is the author of the best selling book 'Figure it out - an entrepreneurs guide to understanding your business numbers' which you can obtain by visiting http://guilfordaccounting.co.uk/figureit out. His forthcoming book 'Know your business numbers' will be published
December.