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Next-generation finance

Banks' unwillingness to lend to even viable businesses has seen the growth of alternatives sources of finance, like crowdfunding, finds Neil Hodge

COMPANIES WILL ALWAYS need access to finance either to fund expansion or to tide them over until fortunes pick up. But where once this money was the mainstay of banks, such lending is no longer the safe bet it used to be.

While UK interest rates are low – just 0.5% at the time of writing – the rate at which banks will lend is typically about 4%-5%, and the loan sizes they are prepared to offer have dropped from pre-crisis levels. There are those that also argue that banks have taken an unpredictable approach in terms of their lending criteria.

Nigel Barratt, corporate finance partner at Manchester-based accountants Hurst & Co, which typically works with companies with turnovers of up to £50m, says that “banks have little appetite to offer loans these days, and much less to extend them – even to long-time existing customers”.

“The environment is unpredictable. I have seen some of our clients ask for loans with solid business cases and good financial track records, only to come away empty-handed,” Barratt adds.

Undoubtedly, the situation has changed. In a recent report, Ripe for the picking, the CBI argued that the financial crisis had put the UK on an irreversible path to a ‘new normal’ in financing, with regulatory reform, bank balance sheet restructuring and a more realistic pricing of risk changing the nature of lending for the long term.

The financial crisis has forced UK businesses to address their overreliance on traditional bank debt; in the UK, banks are the source of nearly 80% of all credit. While traditional forms of finance will remain a critical source of business lending in the future, businesses are looking to alternative finance options to fund their growth aspirations.

“Britain’s businesses cannot grow, export and innovate without proper access to bank credit. But they also need alternatives when looking for finance, as a traditional bank loan might not always be the answer,” says Vince Cable, secretary of state for business, innovation and skills.

In addition to the emergence of challenger banks, the CBI found the availability of alternative finance options is increasing; not only from the emergence of new, innovative finance options – such as crowdfunding – but also from the increased prevalence of finance options that are well known but under-utilised.
Notably, the UK is seeing a significant increase in the availability of asset-based financing, with the Asset Based Financing Association predicting that the sector will grow by 9% in 2013.

Tim Corbett, managing director at BNP Paribas Commercial Finance, says the preferred financing option is asset-based lending (ABL). This allows companies to have access to about 90% of their sales ledger, rather than wait months for invoices to be processed (businesses can also claim finance against stock, plants and machinery), while presenting less risk to banks. Lenders will carry out due diligence before putting ABL in place, and they will be able to get real-time information on the company’s financial performance through access to the sales ledger.

“ABL is the banks’ choice of lending,” says Corbett. “It provides clients with the cash flow that they need, while providing lenders with greater assurance about a company’s financials. More players are coming into the market, and banks are pushing this kind of arrangement as a way to provide short-term finance.”

Nevertheless, raising investment capital for small and mid-cap companies is tough and there are no signs that the situation is changing. “Companies wanting access to anything below £2m are going to find that they have fewer choices,” Barratt says.
One way that small to mid-sized companies can secure cash is to tout for “business angels” – investors with business management experience that can invest £20,000 and upwards as a short-term loan, with an agreed rate of return.

Another possibility is to take the private equity route – but there are pitfalls. It means selling off a large chunk of the business (private equity firms will often not get involved in a deal unless they are assured of a 30% stake and a return on investment within three years); it can mean changing the management team; and the due diligence process can be onerous.

“Investors are more stringent about the quality and depth of the information they need before they will part with their cash,” says Barratt. “And if there’s anything that does not look right, or if the information is incorrect, they can change the terms of the deal. It can end up being a lengthy process.”

Crowd control

Some companies are resorting to more desperate measures to raise cash. “It’s not unusual for owner-managed businesses to ask friends and family for cash to tide them over,” says Corbett, while Barratt adds that some companies are selling off stock, plant and machinery, and even loss-making or cash-intensive parts of the business to keep afloat. “Around 80% of our work now is selling businesses to release cash, whereas five years ago it was about 50%,” he says.

Crowdfunding graphBut next-generation financing, such as crowdfunding, could provide a lifeline. Websites such as www.banktothefuture.com (which was set up through crowdfunding itself) allow businesses to ask for capital in return for non-monetary rewards (for example, a photographic book publisher can offer investors free photographic prints), a stake in the company, or repayments with interest. People can invest as little as £10, which means such sites may favour those looking for relatively small cash funding.

And it works. The Personal Development Bureau, which provides an online community and training service for former employees of the armed forces, police and fire service to set up in business, achieved its total funding of £12,525 through ten pledges.
Other web-based platforms use online “beauty pageants” to attract investment. For example, Marketinvoice gets its funds from institutional investors, hedge funds and other investment companies looking for opportunities to see a relatively quick return.

Companies apply online for loans against their future sales ledger and list key clients. Investors then compete against one another for the business, based on the amount of cash they will release and the terms of repayment they offer. Once approved, companies can normally expect funds within 48 hours. Anil Stocker, the company’s co-founder, says that “within two years, Marketinvoice has advanced close to £50m to over 200 businesses, with loans ranging from £10,000 to £750,000”.

“There is cash out there – it just isn’t coming from banks,” says Stocker. “Next-generation funding – whether it comes from pooled funding or crowdsourcing – is becoming increasingly popular and viable and more companies should consider it.” ?

What are the alternatives?

Asset-backed finance
Asset based lending is finance that is secured by assets, such as the debtor book, plants and machinery, stock and property.
Invoice financing is the most common form of asset-based lending and in most cases acts to support business to manage their cash flow, bridging the gap between the delivery of goods or services by a business and the payment from its customer.
Businesses typically use this type of finance to fund their working capital. Businesses that are experiencing high growth find invoice finance flexible as the borrowing grows alongside the sales ledger. Businesses that have to pay their suppliers before receiving payment from their customer also benefit.
Asset-based lending is suitable for businesses that have business-to-business sales, where the business is not contractual.

Online invoice trading
Online invoice trading platforms are an expansion of the asset-based financing market and allows businesses, for a fee, to sell outstanding invoices to investors on an online exchange, in real time.

Supply chain finance
Supply chain finance (SCF) is a way that large companies can use the strength of their balance sheet to support their suppliers, which are generally smaller and often SMEs. SCF works by allowing a supplier to sell its invoices to a bank, or another finance provider, at a discount once they have been approved by the buyer.
Instead of relying on the creditworthiness of the supplier, the bank deals with the buyer, which is usually a less risky prospect. This means the supplier gets access to finance at a lower rate than they may have done. That allows the supplier to secure its money earlier and hence improve its working capital position.

Peer-to-peer and crowdfunding platforms enable individuals and businesses to lend to SMEs for a specific project.
On peer-to-peer platforms, investors make a financial return based on the level of interest the borrower pays. Investors in a crowdfunding bid most commonly receive a non-monetary return ie, a finished product.
Peer-to-peer lending is suitable for businesses which have been trading for at least two years. However, this may vary depending on which platform you use.

Mezzanine financing
A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back on time and in full.

Export financing
Whereby government supports companies by financing their export activities. Trade finance is suitable for exporting businesses that require working capital on a flexible basis and broadly fall into two categories:
• Financing some or all receivables
• Financing individual larger contracts.

Retail bonds
Bonds are essentially an IOU debt instrument. The purchaser of the bond – usually an institutional investor – is the lender. It receives a set return each year (coupon) for an agreed number of years, at the end of which the bond can be redeemed.

Business angels
Business angels are often high-net-worth individuals who invest in early-stage or high-growth businesses, either directly or through organised networks and syndicates.
Business angels usually have substantive knowledge and experience of growing businesses and can act as a mentor for the business, providing advice and guidance.
Angel investment is suitable for seed companies looking for their first or second stage of external funding to grow rapidly.

Business Growth Fund
The Business Growth Fund (BGF) was set up in July 2010 by members of the Business Finance Taskforce as an independent company. BGF – with the financial backing of five of the UK’s banking groups: Barclays, HSBC, Lloyds, RBS and Standard Chartered – has capital of up to £2.5bn to invest.
BGF provides growth capital and usually invests £2m-10m for a minority equity stake (10%-40%) and a seat on the board, in established UK companies that can demonstrate a strong growth trajectory, and have a turnover of £5m-£100m.

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