The real cost of business finance

Transcription

1 Exposed: The real cost of business finance Award-winning finance journalist Emma Lunn lifts the lid on the SME lending landscape, revealing the hidden costs you need to watch out for and guiding you through the maze of options on offer.

2 Contents The business finance landscape an overview 3 Making sense of your options 8 Identifying the hidden costs 21 Introducing Verus All prices and rates stated are correct as of date of publication. Where specific companies are quoted, the information has been taken from publicly available or quoted data from that company. 2

3 1 The business finance landscape an overview At the Federation of Small Businesses recent National Conference in Birmingham, politicians including David Cameron made keynote speeches which placed smallto-medium-sized businesses (SMEs) at the heart of the UK s economic future growth. I didn't get a bank loan Key challenges highlighted by businesses at the conference included late payments by suppliers, red tape, the lack of access to finance and its high cost. Tightening credit policies from banks mean that it s increasingly difficult for SMEs to borrow money or attract investment, and traditional lenders are still not lending to businesses on a scale that meets demand. 31% BANK OF SMES THAT APPLIED FOR A LOAN WERE TURNED DOWN In fact, research last year by the peer-to-peer lender rebuildingsociety found that 31% of SMEs that applied for a bank loan were turned down. 3

4 Meanwhile, the financial services sector as a whole is rife with bureaucratic and lengthy loan application processes. There is also deep-seated mistrust of the banks. It can be difficult for businesses to know which lenders offer the best total value I'm not sure how much I'm paying for finance Business finance is notoriously vague over both interest rates and other, often hard to spot, account-related fees, and it can be difficult for businesses to know which lenders offer the best total value, or to understand what additional fees lie beyond the headline rates. Independent research carried out by Future Thinking in 2014 for Verus360 showed that 40% of UK SMEs are unaware of not just the effective Annual Percentage Rate (APR) they re paying for finance, but also of the actual total cost. 40% RATE OF UK SMES ARE UNAWARE OF THE THEY'RE PAYING FOR FINANCE To help, we take a look at the typical costs of different types of SME finance, and what hidden costs to look out for so you can make the best choice regarding your finance. 4

5 Why is finance pricing so complicated for businesses? The APR of a business loan is rarely advertised, and different lenders will use a variety of methods to calculate their costs. Needless to say, business lending is a very different proposition to personal lending. Personal loan providers are obliged, by law, to advertise the Annual Percentage Rate (APR), which takes into account both the interest rate and any fees. In contrast, business lenders don t have to adhere to quite the same rigorous Financial Conduct Authority (FCA) legislation as consumer lenders do. The APR of a business loan is rarely advertised, and different lenders will use a variety of methods to calculate their costs. For example, if you search for business loans on Moneyfacts, two leading banks both state an interest rate of 0.5%, but don t explain if this is weekly, monthly or annual. They also both state that fees are negotiable. 0.5% =? WEEK OR MONTH OR YEAR But even when the interest rate is advertised, you can still be hit by a raft of charges in addition to that headline cost and that s where you need to be informed and diligent, asking the right questions to understand the true costs. 5

6 Lack of transparency I'm not confident that my current provider explains my costs clearly Our research found that one third of businesses are not confident in the transparency of their current finance provider when it comes to explaining costs. The challenges facing businesses trying to research finance include: Lack of advertised effective APRs No comparison sites or search engines that are able to show typical comparative costs Lack of clarity on how different types of finance stack up in terms of cost Attention-grabbing headline interest rates which don t include extras Rafts of potential ad hoc fees hidden in the small print So it s easy to pay more than you think you will. But it s not just about the rates if you have to wait months to get the finance you need, there s the opportunity cost. ⅓ TRANSPARENCY OF BUSINESSES ARE NOT CONFIDENT IN THE OF THEIR CURRENT PROVIDER 6

7 Lead time for loans According to Smarta Business Builder, a support platform for business owners, the average lead time for a business loan is three to six months. JAN MAR FEB 3 TO 6 M O N T H S average lead time for a business loan This is largely due to the huge amount of paperwork needed to successfully apply for a business loan or other type of business finance. Business finance is still largely stuck in the analogue age. It generally involves face-to-face interviews or lengthy phone calls, application forms, faxes, and reams of other documents which need to be posted, received, checked and signed. For entrepreneurs running a business, time spent on a loan application especially an unsuccessful one could have been better spent generating sales. And, even after going through this time-consuming process, the loan may not be as big as you need or you might be turned down completely. Traditional lenders often take a one size fits all approach, and don t always fully understand your company s commercial and financial profile. So if you re looking for finance to expand and grow or just to manage month-to-month cash flow better how do you avoid paying more than you should? And which types of finance offer the best total value? 7

8 2 Making sense of your options There is a bewildering array of finance options for SMEs, and each type has advantages and disadvantages in terms of pricing and costs. Our guide can help you understand which option s right for your business. Traditional lending Alternative finance Bank loans 9 Business credit cards 10 Bank overdraft 11 Peer-to-peer loans 18 Crowdfunding 19 Invoice trading 20 Invoice finance 12 Equity finance 14 Asset finance 15 Short-term loans 17 8

9 Traditional lending Traditional lenders are still the first port of call for many SMEs. But lengthy application processes and high operating costs can prove a barrier to SMEs looking for simple, low-effort and fairly priced lending. Bank loans Bank loans do at least generally offer fixed rates if you can afford to wait. PROS You normally get all the money upfront and commit to repaying it, with interest, over a set period. Unlike overdrafts, loans are not repayable on demand, so you re guaranteed the money for the time you need it once you re approved, you can forget about it. CONS On the downside, it may be hard to keep up repayments when times are tough, and failure to pay a secured loan can mean you lose assets that secure the loan. You ll also need to know how much finance you re going to need for that period upfront sometimes tricky, unless you re sure of future sales. TYPICAL R A T E S Santander quotes fixed rates from 7.9% to 12.9% per annum with a 100 arrangement fee. HSBC starts from 7.9% annual interest rate with a 100 fee. Other high street banks do not publish typical rates. 9

10 Business credit cards PROS Credit cards are easy to use when you need quick borrowing for purchases, and there's no cost if you repay within the credit period. CONS Unless you pay off the balance every month, you ll be hit with a high interest rate compared to other forms of lending. It can be hard to increase your limit, and you re likely to pay an annual charge just to have the card. TYPICAL R A T E S Lloyds offers 22.4% APR, with an annual fee of 32 per card. Barclaycard comes in at 21.9% APR. HSBC charges 15.9% APR with an annual fee of 32, while RBS offers 23.2% APR. 10

11 Bank overdraft PROS Used correctly, and if you stay within your limit, overdrafts tend to be cheaper than a loan as you only borrow what you need at the time, and you can pay it at any time. They re also simple to use. CONS You ll probably be charged a fee to set up the overdraft. Being permanently overdrawn will be expensive and the bank can call in the overdraft at any time. Plus, you can t pick and choose overdraft deals, as you re tied to your bank account. If you exceed your limit, then expect much higher rates of interest and possible additional penalty charges. TYPICAL R A T E S Rates are typically between 10% and 12% but if you are overdrawn without authorisation, you ll generally be charged upwards of 25%. 11

12 Invoice finance Invoice financing is where a third party agrees to buy your unpaid invoices for a fee. There are two types of invoice finance: factoring and invoice discounting. Invoice finance providers will typically offer 85-90% of the value of any approved invoices, but will impose conditions of acceptability which may mean some of your invoices will not qualify. FACTORING Factoring is where your customers are aware of the involvement of the provider, who will make regular direct contact with them either as part of the approval process, or to undertake credit control and chase for payment. INVOICE DISCOUNTING Invoice discounting is typically confidential, which means you remain responsible for credit control. The provider will typically only contact your customers when problems arise. This service is normally offered to better risk businesses, with a good track record and proven ability to manage their sales ledger. PROS Both types of invoice finance improve company cash flow in a flexible way, and can be ideal for businesses that either have a poor credit rating, or wish to out-source their sales ledger operation. It requires regular provision of data and can be operationally time-consuming so if you re cash-poor but time-rich, it may be the solution for you. 12

13 CONS The paperwork may prove onerous, and running costs are typically high. Invoice finance providers charge service fees for managing your sales ledger, while their agreements typically include a large number of ancillary fees meaning both the actual cost and the compliance time cost can be high. Many will also have notice periods to exit the agreement, or otherwise charge for earlier exit. TYPICAL R A T E S Typically, you will pay an interest charge, facility fee (% of total turnover) plus admin fees, which can significantly increase the total cost. Factoring: An interest margin of between 2.75% and 6% over the base rate, and a service fee of 0.5-3% invoice value irrespective of how much you actually borrow or a monthly fee of 500 to 1,000. A well established low risk business with turnover of 6.61m and average borrowings of 448,000 paid up to 49,600 per annum or 19% APR. Overall APR % can reach up to 45% on this type of product. Discounting: Generally, the rates are lower than for factoring, including charging a flat service fee rather than a percentage of invoice value, ranging from 500 to many thousands, depending on the size of the lend. Typical rates are an interest rate margin of 1.5-4% above base rate, and a service fee of 0.2-2%. A well established low risk business with a turnover of 7.43m and average borrowings of 465,000 paid up to 61,500 per annum or 13.8% APR. Overall APR % can reach up to 25% on this type of product. 13

14 Equity finance Investment or equity finance involves selling part of your business to an investor. Common types of equity finance include business angel investment and venture capital. PROS There s no loan to repay and you may benefit from the skills and experience of your investors to help grow your business. CONS You re selling part of your business and need to be sure that the short-term gain of the cash injection makes the loss of equity, or dilution, worthwhile. TYPICAL R A T E S There s no interest rate for equity finance. Businesses selling a share of the company for cash will negotiate with the investor how big a share they will sell for a sum of money think Dragons Den. Ultimately, you are giving away a share of the business and of future profits. 14

15 Asset finance Asset finance is used to break down the cost of buying equipment into smaller payments. For example, a printing firm may buy machinery in this way. Asset finance is usually done via leasing or hire purchase, and it releases capital against currently encumbered assets. bb Lenders will look at the following criteria when assessing pricing: Asset type Asset age Sector Credit quality Supply route They will also look at any additional security, such as: personal guarantees supplier warranties company s track record 15

16 PROS Some businesses can arrange a lease and/or lease back arrangement on equipment used by the company for business purposes, such as running vehicles, etc. This reduces the pressure of raising up front capital for purchases, and is useful as it allows the business to spread the costs across a pre-determined timescale. CONS You usually won t own the asset itself following the end of the arrangement (unless you pay extra for an option to purchase within the agreement), and asset finance can be more expensive than buying the asset outright over the term of the arrangement. You can t claim capital allowances on a leased asset if the lease period is less than five years. TYPICAL R A T E S Most lenders base their pricing on a risk versus reward model, and/or the size of the transaction. For example, the cost of a 45k, 60-month asset finance agreement for an A1 credit manufacturing company with a net worth of 1m would be charged at an interest rate of 9% plus fees of 275. In contrast, the cost of a 75k, three-year agreement for a start-up leisure facility with no financials, weak assets and personal guarantor driven security, would be charged at an interest rate of 22% and no other fees. 16

17 Short-term loans As well as high street names, there are numerous short-term lenders and finance providers. These tend to show loan costs in different ways. PROS Access to this type of finance may be faster than via the banks, and you may be able to apply partly online. CONS Prices are typically much higher than other forms of business finance although this isn t always apparent in the headline rates. Check the APR, if this is available, to see the true total cost which may be significant. TYPICAL R A T E S These vary hugely, but you re looking at more than most traditional lenders. Many lenders don t quote an interest rate, but APRs well above 500% are not uncommon. Both Ezbob and Everline charge 2,600 interest on a 20,000 loan over 12 months. Iwoca would charge 2,800 interest on a six-month 20,000 loan. 17

18 Alternative finance Alternative finance can be cheaper and more easily accessible than traditional lenders largely due to lower operating costs, given that many of the providers embrace digital technology. It can also mean faster funding and more transparent costs. Peer-to-peer loans PROS Peer-to-peer loans are a cheaper and faster alternative to bank loans. There s no bank instead, borrowers are matched with lenders via internet platforms. CONS Businesses will need to meet certain criteria such as having a proven track record so it s not necessarily appropriate for start-ups. You may also be charged a completion fee by the platform based on the amount you re borrowing, in addition to the interest you ll pay. TYPICAL R A T E S Funding Circle rates its borrowers by risk band. Over the past 100 loans, A+ band customers paid 6% to 10.6%, while D band paid 12.2% to 15%. Completion fees are included in the rate for example, 1,800 on a 60,000 three-year loan. 18

19 Crowdfunding Crowdfunding describes a large number of people investing, lending or contributing smaller amounts of money to your business or idea. PROS Crowdfunding can be a faster alternative to traditional lenders, and you might find more support here than via the banks if your business is a start-up. CONS You may need to return the money to investors if you don t reach your stated target. You ll need a compelling business idea, and plan, to attract investment. TYPICAL R A T E S There are no interest rates as such as you are either selling a share of your business or offering rewards. If you sell equity you ll have to share your business s success with investors. 19

20 Invoice trading Invoice exchange platforms allow investors to bid for your invoices. PROS In some cases, you can apply and have funds in your account within a week or two and it s flexible in that you can choose which invoices to sell. CONS You need to apply each time you want extra working capital, so it can be time-consuming if you need finance on a regular basis. It s not particularly cost effective, and you run the risk of nobody bidding for your invoice. TYPICAL R A T E S Market Invoice quotes a typical cost of 3.8% to 4.1% of the face value of the invoice, based on an invoice of 12,500 and an annual turnover of 100,000 although this varies by invoice value and quantity. Platform Black charges interest (discount), plus a fee of 1% of invoice value. 20

21 3 Identifying the hidden costs So what are the hidden costs you need to look out for, and how do you spot them? Here's our handy guide to some of the most common pricing pitfalls. tt Arrangement or set-up fees Arrangement fees (also known as set-up or commitment fees) are commonly charged for different types of business finance. There are two types: non-refundable and refundable (once you are a customer). HOW MUCH WILL IT COST? These can range between 500 and 10,000, but some lenders charge a percentage of the amount borrowed. One leading bank, for example, charges up to 1.5% of the loan amount, while Everline charges 2%-7%. 21

22 tt Fees for everyday services Many business lenders charge you for everyday administrative services and lenders tend to add a (sometimes significant) margin on to fees from third parties such as banks. These invisible costs can include making a transfer, creating a report, extra documentation, personal visits, extending your funding limit and much more. They can be calculated in different ways (a percentage on the excess or facility limit, or fixed). The risk profile of your business may also affect what you're charged. One major high street bank, for example, charges an account maintenance fee of 5.50 a month, 19p per credit, 23p per bill payment made online or by phone, 5 per bill made in branch, and 80p plus 0.6% of the amount per branch credit. HOW MUCH WILL IT COST? The factoring and invoice discounting industry has a wide and varied tariff mechanism which allows those lenders to charge additional fees for any and all potential eventualities thus making the overall facility more costly than would have been originally negotiated. Fees could include the following: Payment transfer fee ( per transmission), payment extensions (0.5% to 4% charged against the additional value required above agreed fundable limit), annual review fees, charged either on a fix value basis (eg. upwards of 500) or a percentage against the additional uplift (ranging from 0.5% to 2%), plus various charges for generation of paperwork, visits, surveys and audits. Breach fees can range from 50 to several thousand pounds, dependent on the severity they judge that breach to be. 22

23 tt Penalty fees (missed payments etc) If you stray outside of your agreed overdraft limit, even for a very short time, the total amount you pay for your finance could balloon past the costs you see upfront (your core borrowing). Penalties are commonly charged for unauthorised borrowing. HOW MUCH WILL IT COST? These can be significant and are often hidden sometimes lenders will just include a generic clause which doesn t explain rates or charges. tt Non-utilisation fees (or monthly or annual minimum fee ) Some lenders often those offering factoring or invoice discounting will charge you for access to finance, even if you don t use it, to keep the account open. HOW MUCH WILL IT COST? The amount charged depends often on your turnover. For typical SMEs, fees generally start at between 6,000 and 10,000 a year, although they can run to tens of thousands, equivalent to APRs of 10-20% of the facility limit. 23

24 tt Contract/facility review fees Annual facility reviews are often chargeable, generally within the invoice finance industry. If you re a growing business, or one with seasonal peaks and troughs, check if the lender charges for these reviews and work out how much this will cost you over the first year to see if the cost is justified. HOW MUCH WILL IT COST? This is usually an annual event to check your risk profile, and you ll be charged around 500 to pay for the audit (and a visit if necessary) but the amount will vary according to the complexity of your company accounts. tt Exit fees It might seem unfair, but some lenders will charge you for closing your account, even if you re fully paid up especially if you leave before your contract end date. HOW MUCH WILL IT COST? It depends on how far into your contract you are, if this is fixed term, but as a guide it could be up to 15% of your facility limit. 24

25 Covering off the basics Research carried out in 2014 for Verus360 found that more than 50% of SMEs don t complete consistent due diligence when it comes to researching finance and finance providers. I didn't read the small print This may sound obvious, but be sure to read the small print carefully. You d be surprised at just how many people don t. Always ask the lender for a full list of both their standard and ad-hoc tariffs. 50% CONSISTENT OF UK SMES DON'T COMPLETE DUE DILIGENCE Make sure you know your rights, which you can find out from the appropriate regulatory or industry body (which could be the FCA or The Asset Based Finance Association, depending on the lender). Finally, if you are charged, and you don't think it s fair, challenge the fee. Most lenders have a complaints process, and many can waive or reduce charges if they are deemed to be unjustified. It s a confusing landscape, so weigh up your options carefully and make sure you know what you re committing to! 25

26 4 Introducing Verus360 Versus360 is a new type of business finance, available online, offering SMEs a unique combination of benefits. `` One simple, transparent fee `` No hidden charges `` Online account management `` Zero notice period `` Pay as you use ` ` 24/7 account access We work in a different way to traditional lenders. We use our tried and tested technology to securely analyse your financial data, and combine this with independent commercial data to make fair and commercially objective decisions. You decide how much finance you want to use (up to the agreed amount) and when you want it. You only pay for the money you use and only for the time you use it. You ll pay one simple rate, there s no minimum fee and no zero notice period. By looking into your business finances, we can also help you make more informed decisions and potentially save money. We think that s fair. 26

27 Verus360 is a UK-based business dedicated to delivering innovative online business finance products and services to small-to-medium-sized businesses (SMEs). Get in touch info@verus360.com (0) linkedin.com/company/verus360 Verus360 Limited, 1 Eversholt Street, London NW1 2DN Registered in England and Wales (co. no ). Registered office: 105 Duke Street, Liverpool, L1 5JQ, United Kingdom.