Reflections on the changing funding world

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Some onlookers thought that 2015 would be the year when we might be able to move on from the fallout of the financial crisis, with UK banks finally forgiven for their past misdemeanours. There were positive murmurs from the Government and a clear desire to get on with the vital work of restoring trust and confidence in the financial services sector.

Indeed, in his June Mansion House speech, Chancellor George Osborne spoke about the UK financial services industry’s capacity to be the best in the world, with “more competition, more innovation and more players in retail markets.”

The industry expected an end to the loathed bank levy as a result, but surprisingly Mr Osborne levied a new surcharge of 8%, applicable to all banks and building societies, including ‘challenger’ banks, which he previously appeared to embrace.

Defending this seeming U-turn, the Chancellor said “the banking sector has to put something back into the economy, so there will be no changes to the tax surcharge this fiscal year.”

It seemed that all was neither forgiven nor forgotten.

This ongoing stasis in relations with the banks is regrettable mostly because of the unintended consequences of legislation and regulation. The sad truth is that the weight of a tightened regulatory burden falls on the shoulders of UK businesses – the very organisations the Chancellor is hoping will power us on to continued economic growth.

With European and global regulation forcing banks to meet ever-higher capital and liquidity requirements, banks are increasingly unable to lend to businesses. This is even more severe in the case of SMEs and start-ups, who are considered high-risk. As the banks move to shrink their balance sheets, they are also largely exiting many forms of business lending.

It simply doesn’t make financial sense anymore for the banks to lend to businesses.

An even hand

As the head of a large independently owned financier, many may think that this is welcome news to me. But the reality is that – in a business’s funding tool-kit – there is a place for traditional forms of lending, in addition to non-bank forms of funding.

From overdrafts to invoice finance, leasing to bank loans, the market needs a full range of offerings to meet small businesses’ needs.

At present, however, the current media landscape portrays SMEs as having an ‘either or’ option. Either secure funding from a bank or peer-to-peer (P2P) lenders. But there are other avenues for businesses.

You would expect me to highlight invoice finance, but leasing and asset based lending are two other viable forms of business funding.

If SMEs rush to P2P lenders, in place of more established forms of funding, they are putting their faith in – as yet – unproven and untested players that only offer funding pure and simple, without value added services, such as sales ledger management, credit control or payment collection.

A recent Evening Standard article discussed rumours of a looming P2P lending failure and it is my belief that the Chancellor must be even-handed in highlighting risk within the financial system. This includes extending appropriate warnings about newer forms of finance to both SMEs searching for funding and investors looking for returns.

The Chancellor should also remember that the UK has a significant tradition of independent asset based financiers. At any one time such funders provide £19.3 billion in to businesses and this significant contribution to employment, growth and output must not be taken for granted.

Why P2P lending is not a silver bullet

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The myth of the P2P panacea

I am in favour of anything that increases choice and enables the UK’s SMEs to access the funding they need to grow. The peer-to-peer (P2P) lending market has grown substantially since the first provider, Zopa, arrived in the UK in 2005, with the market surpassing the £1 billion funds advanced mark by the end of last year. To be clear, this is the total of all loans and not the funds-out at any one time.

Unlike many traditional funders, however, new players on the financing spectrum have been welcomed by government and policymakers alike, without so much as a hint of caution. Politicians, particularly, have viewed this newly emerging sector as a panacea that will shake-up the market and solve the funding needs of small businesses forever.

Moreover, it has been branded by some as the ‘Uber of finance’, supposedly disrupting an uncompetitive or dysfunctional market that was ripe for innovation. This narrative, though appealing in its simplicity, is far from the truth.

The UK has long boasted a healthy and highly competitive alternative financing sector, which it should be proud of. But, all too often, policy-makers ignore an already mature sector; seeing competition in the market as a two-horse race between major high street banks and shiny-P2P lending platforms. They seem to love the new, just for its novelty.

But, it’s the alternative middle-ground that has proved itself time and time again. In fact, just this month the Asset Based Finance Association announced that £18.9 billion was lent to businesses in the first quarter of 2015 – a £1.2 billion increase year-on-year. Through bull and bear markets, independent funders and asset based lenders have demonstrated their longevity and local presence in the UK market. This strong track record is largely ignored as it is not new. It is, however significant and most importantly, it provides real support for businesses when they need it. It did so right through the last recession and helped prevent the downturn being even worse.

The limitations of youth

Despite the halo effect surrounding new market entrants, these platforms still account for only a tiny fraction of SME lending in the UK. Furthermore, funding amounts advanced to SMEs are limited and cannot yet satisfy the full range of business needs.

Notwithstanding its attractiveness to media and government alike, awareness of this lending option is generally low among business owners. Our quarterly SME Tracker found that just 1% of SMEs used P2P or crowdfunding in Q1 and half of the small businesses we surveyed for our SME Manifesto in May said that they would not use a P2P lender.

It’s evident that many do not share policymakers’ enthusiasm for these lenders and  owners and decision-makers explained that they either distrusted P2P lenders or felt they would not be able to get the financing that would be right for their business through this channel.

Apples and oranges

A fundamental problem with debating comparable merits of different funding types is ensuring comparison on a like-for-like basis. A P2P lender provides funding pure and simple – not credit control, sales ledger management or payment collection. Many can’t offer multi-lingual or multi-currency services, helping businesses to enter new markets or import goods from overseas.

Fundamentally, P2P lending is more about delivering an investor return than the provision of funding and services to small businesses.

Strong funder, strong future

Looking ahead, the UK faces a referendum over its membership of the EU and a tough monetary policy decision on when and how interest rates will change. As recent years have proven – we are never too far away from the possibility of a return to recession. It will be fascinating to see how the market fares through the whole economic cycle. The lack of a capital buffer may expose unwary investors to more risk than they bargained for.

I wish all lenders well and believe there is room in the market for us all. What we do need is more balance when it comes to evaluating options.

Earlier this month, our research found that 14 per cent of SMEs use loans from friends and family to fund their business with a quarter (23 per cent) using a bank overdraft. As this period of political and economic uncertainty continues, SMEs must future proof themselves from financial shocks by ensuring that they have sustainable and flexible sources of funding, tailored to their needs. This could be a combination of financing types, including overdrafts, leasing, loans, invoice finance or even P2P.

However, we must recognise that financing in 2015 should have a wider purpose beyond simply offering a lump-sum. Funders have a larger role to play in society – managing relationships with customers and suppliers and helping small businesses position themselves for growth.

It is here that a finance provider can become an extension of an SME’s own team; a role that many independent funders are proud to play.

The unintended consequences of the ‘Brexit’ spectre

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My last blog looked at the Queen’s Speech and explored some of the uncertainties that arose from this landmark announcement. Since then the Government has announced the exact wording of the EU Referendum Bill. The question will be: ‘Should the United Kingdom remain a member of the European Union?’ For many small businesses up and down the country, the answer will be a resounding ‘yes.’

In May we spoke to a thousand small and medium sized businesses and they called upon the new Conservative government to put in place a commitment to remain in the EU within the next 12 months. With the wording of the referendum question almost designed to solicit a positive response, SMEs may be closer to their wish than they realise.

Psychological and behavioural experts have said that David Cameron has already signalled his commitment to remain within the EU, simply by choosing this particular question, as is evidenced in recent articles in the Guardian and Economist. This belief was further cemented earlier this week after the Prime Minister told journalists on  the final day of the G7 summit that Cabinet ministers would need to back any deal he secures or leave the government.

A separate piece of research we conducted with UK SMEs found that over the last three months, 1 in 5 have seen lapsed customers returning to their business, but only 5% of these businesses have seen increased trade overseas. While UK businesses may be tempted to focus on their domestic market, , they must not become too insular in their outlook. Instead, they must embrace returning customers but at the same time look to build new relationships outside of the UK.

We shouldn’t underestimate the destabilising effect the spectre of a ‘Brexit’ has already had on British businesses and their relationships with suppliers and purchasers in other European countries. We may not be able to quantify the unintended consequences now, but the impact may have already threatened key business relationships, and this makes David Cameron’s negotiation attempts in Brussels increasingly important.

The Prime Minister has said he is confident of securing the changes he wants so he can push for a ‘Yes’ vote to stay in Europe but many believe– in the interest of avoiding a period of stagnant uncertainty – the Government should bring the referendum forward to 2016.

We have to acknowledge and rejoice in the interconnectedness of business and the fact that supply chains reach across the world. From our day-to-day experiences working with small businesses, a good proportion have relationships and supply chains in the European Union, while many of them aspire to export their services and products abroad. We must resist the urge to focus solely on business relationships at home and instead encourage our vital small businesses to expand their networks and linkages with partners beyond UK shores.