On average micro-businesses need just £2,143 to set up. Doesn’t sound like an unreasonable amount in the grand scheme of things. But with more and more businesses unable to get off the ground, where is the weak link?
In recent years it seems banks have forgotten why they exist – to provide a service to the community. The scandalous truth is that, despite billions of pounds worth of taxpayers’ money being given to them, they’re not lending to these entrepreneurs who are the life blood of our economy. Computerised credit scoring systems have shaken the lending industry, turning away thousands of businesses who will often go on to fail before they have even been given a chance.
For many small business owners, once they’ve been turned down by their bank they need to find the money elsewhere, sometimes resorting to extreme measures like taking out a payday loan. Our latest research showed that just 20 per cent of micro-businesses are funded through a bank loan and one in six have had to resort to a payday loan to fund their business. Just one in ten were able to secure a loan from the bank in their first year of trading with a third having to rely on their business acumen to get them through. It seems absurd that businesses who are starting out with nothing, are being screwed over by 4000 per cent plus APRs, which are undoubtedly to blame for their demise.
Yet what happens to those micro-businesses that don’t manage to secure a bank loan, and who don’t want to resort to a payday loan? Our latest research shows of those people who have had businesses fail in the past, a fifth believe it was because they were unable to get a bank loan.
What often gets overlooked are the impracticalities that micro-businesses, which are more often than not one-man bands, have to go through to be at the stage where they can present a case to the bank. They often need to produce detailed forecasts, show accounts, profit and loss and a lot of the time, they’re just not equipped to do this. Even many peer-to-peer lenders require this type of input, asking borrowers to put a case to the lenders (the investor). It’s clear banks are dishing out cash to bigger, more established businesses who can present realistic forecasts based on previous profits yet failing to give start-ups a chance. It’s clear that the ordinary hard-working people; the window cleaners, the mobile hairdressers, the freelance IT consultants, the driving instructors, (to name just a few) aren’t getting the help they need and deserve.
There have been attempts by the government to inject some cash into small businesses but these initiatives seem to have been short-lived. The Funding for Lending scheme was originally introduced to give the economy a much-needed boost and give banks the push they needed to start lending again but it clearly hasn’t worked so far. The amendment to the scheme announced last month begs the question – will it be any different this time round? The Treasury’s new incentive measures of allowing banks to borrow an extra £5 from the scheme for every £1 they lend to an SME, and then up to £10 in 2014, when the scheme is extended, should make a difference in theory but the proof is yet to be seen.
What strikes a chord is that a staggering four in five micro businesses aren’t aware of the lending options available to them. There certainly needs to be more noise within the industry about the alternative forms of business funding available, whether that’s guarantor loans, peer-to-peer or crowdfunding, so that small business owners don’t feel forced down a route which could jeopardise their whole business.
It’s vital that micro-businesses spread the word that being turned down by a bank is not the end and it certainly doesn’t mean they should run straight to the nearest payday lender. While there is still a lack of awareness about alternative lenders, unfortunately for the time being, businesses need to do their own digging around for an alternative lender who will support their business venture.
Further reading on business finance
Should banks really be the default choice for SMEs in search of finance?
Russell Gould, managing director of Everline, discusses the current state of the small business finance landscape and the options open to companies.
Accessing finance is a struggle familiar to too many SMEs. The Bank of England recently reported that the small business demand for finance grew in the first quarter of this year, with a further increase expected in the second. Yet its Trends in Lending Report showed that lending has fallen across the board. Meanwhile, recent Everline research showed that more than half of SMEs do not believe traditional lenders are interested in lending to them.
In the current market, most SMEs will only approach larger banks when seeking finance, even though the process can be time consuming and the rejection rate is around 50 per cent. This is clearly an issue, especially when considering that more than a quarter of SMEs say a lack of access to cash is restricting business growth. These small businesses have the potential to drive growth and employment in the UK but are hampered by not only a lack of finance but a lack of confidence to try to access the working capital they need; more than half (51 per cent) think traditional lenders aren’t interested in lending to them.
Although there is a growing number of alternative finance providers that may be willing to lend, and might also have more suitable product solutions, business owners often aren’t even aware of their existence. As a result, SMEs need support to increase their knowledge of other finance options and prevent banks being the default choice. This should ultimately improve the supply of cash flow to viable small businesses who need additional working capital to aid growth, fill a cash gap or take advantage of a market opportunity.
What needs to be done to improve SME access to finance?
While there is clearly significant demand for SME credit, to date the market has been dominated by the banks, whose products may not be adequately tailored to the specific requirements of small businesses. Particularly problematic are short-term cash flow needs, which demand a level of control and flexibility around speed of access and repayment timeframes which simply isn’t available from traditional lenders.
One potential game changer is the recently announced Small Business, Enterprise and Employment Bill which builds on a Treasury consultation launched earlier this year. It proposes taking legislative action to help match SMEs rejected for funding from their bank with alternative finance providers.
New proposals under the Bill will also require banks to share small business data with alternative finance providers. These measures will ultimately point businesses to a greater range of funding solutions, making the SME lending market much more competitive and improving opportunities for growth. It will also allow alternative lenders to open up funding to more and more viable businesses by providing valuable data that will aid responsible lending decisions.
Overall, the creation of a mandatory process to help match SMEs seeking finance with a wider range of lenders will be hugely beneficial for small businesses and the UK economy. However, alternative lenders shouldn’t just be viewed as a last resort for SMEs who have already been rejected by the banks. This is far from the case in reality, and a much more effective system would be allowing SMEs to easily access all their funding options up front so they can find the solution best suited to them and their funding need.
The fact the government recognises a need for change in small business lending is a positive step forward.
How can SMEs take advantage of emerging funding platforms?
Due to the diversity of SMEs in the market, data is a key ingredient to any algorithm-based approach to assessing risk when lending and so it is definitely encouraging that moves are being made by the government to improve access to SME credit data for non-traditional providers. The more business data that is available, the better the basis for digital lenders such as Everline to continue to make responsible lending decisions, and the more supportive they can be of small businesses seeking finance.
SME lending is a far broader landscape than simply business bank loans. It could include overdrafts, online working capital options, peer-to-peer funding, invoice factoring, and merchant cash advance among others. Whether or not legislation is introduced to connect SMEs with alternative finance options, we’d recommend that SMEs seriously consider making their credit application data accessible through funding platforms as it will allow them to easily find the best finance option for their business across a wide range of products. Additionally, data on rejected applications for finance could enable alternative credit providers to fill in the gaps and tailor their finance offering to an individual business.
Banks have enjoyed a monopoly on small business lending without keeping on top of what today’s SMEs need and want. The reality is that hard working small businesses need fast and flexible finance, and banks are simply not built to provide this sort of funding. It is therefore important that emerging lenders be given the opportunity to step in.
Funding platforms with a mandatory process for sharing credit provider and SME data could be used to offer financial options that may be more suitable for SMEs’ needs. Most importantly however, it would open up the market and give small business owners better control over their finances and how they access funding.