The rise of the debt-shy SME: Why business borrowing is broken and how to fix it

Transcription

1 The rise of the debt-shy SME: Why business borrowing is broken and how to fix it Verus360 s TIM EVANS explores the phenomenon of the permanently non-borrowing business, and looks to a fairer future for SME finance. The funding gap for UK businesses is well documented. However, there is evidence that risk-averse lending strategies by the big banks have created a new breed of debt-shy SMEs who are permanent

2 Contents 1. The problem for SMEs 3 2. The challenge for traditional lenders 5 3. The tech-enabled customer 8 4. The business solution What s next for business finance? Introducing Verus

3 1. The problem for SMEs Commercially responsible lending is essential for the UK economy to continue to grow post Yet, seven years on from the UK s deepest recession since World War II, and many small-to-medium-sized businesses (SMEs) are still feeling the pinch. SMEs clearly need access to funding to expand or improve their businesses but the fact is that they re still finding it difficult to borrow. Despite occasional signs of an upturn, banks are still not lending on a scale that meets demand. The British Business Bank s recent report, The Business Finance Guide a journey from start-up to growth, estimates the finance gap for small firms to be a modest 1bn a year. The Breedon Report, published by a government committee led by former Legal & General boss Tim Breedon, actually suggested a gap of up to 190bn by The Treasury Select Committee s recent report on Conduct and Competition in SME Lending revealed that bank loans to business plummeted by 800m in the final quarter of 2014, as well as highlighting a lack of choice and poor treatment of customers. The findings also pointed to providers' inability to justify excessive and often vague fees. This was reiterated in a recent Market Invoice report, which revealed that British businesses were stung to the tune of 425m in hidden costs last year. 3

4 The lack of comparable data around the true cost of business finance can be confusing for customers. Independent research conducted by Future Thinking for Verus360 in 2014 shows that 40% of UK SMEs don t even know how much they re paying for finance, while 60% say they're not easily able to compare finance costs between lenders. Access to finance is often further hindered by bureaucratic, lengthy and prohibitive loan application processes, as well as outmoded thinking, lo-tech systems and a lack of truly customer-focused solutions. Combine this with an industry-wide lack of transparency around pricing and confusion over alternative financing options, and it s understandable why businesses can t easily access funding essential for survival and growth. It also starts to explain why some businesses are turning their back on using finance altogether with an impact on their business growth potential and, arguably, the broader UK economy. I don t know how much I m paying for finance I can't easily compare lenders and costs 40% 60% All of this has helped to create a debt-shy culture among high-growth SMEs, along with a reluctance to borrow for their business. Last year a British Banking Association report highlighted that 48% of SMEs were permanent non-borrowers, who did not want or plan to use external finance in the future. And earlier this year, Phil Orford, Chief Executive of the Forum of Private Business, pointed out that there was still a subdued appetite for lending among SMEs. 4

5 2. The challenge for traditional lenders The main institutional lenders seem unable to respond to the funding gap, and therefore play their part in closing it. There needs to be a greater alignment of products and services with client needs, while also acknowledging the changing nature of SMEs and re-establishing customer confidence. Confidence has been badly shaken, and that needs to be re-built. That s a big job, and it s not going to be done in a year or two. It s a job that will need to take place over many years. While finance provision remains low, many SMEs are reluctant to apply for funding in the first place. This is The Chairman of the Treasury Committee, Andrew Tyrie, recently confirmed that SMEs remain wary of asking banks for loans, or even for advice, admitting that: "Confidence has been badly shaken, and that needs to be re-built. That s a big job, and it s not going to be done in a year or two. It s a job that will need to take place over many years." 5

6 So how do major lenders go about rebuilding customer confidence, re-gaining trust and changing behaviours to encourage borrowing and further economic growth? There are multiple issues they need to address: 1. RESTRICTIONS ON LENDING Post-2008, there has been an increased focus on capital adequacy, with banks needing to manage risks more closely to ensure they re able to withstand future crises. This has created more restrictive lending policies, and tighter underwriting to which lenders have to adhere which in turn means fewer SMEs getting the funding they need, whether it be first-time loans or corporate overdrafts. According to the Treasury Select Committee, SMEs have also underestimated their chances of securing bank finance by between 7 and 16%. 2. RISK-CENTRIC CULTURE The industry has to accept that customers are good, honest business people, looking to make a success of their lives. This will mean moving away from a risk above everything culture, where lenders response to the prospect of customers defaulting is to increase the cost of credit. 3. THE VALUE OFFERED Financial institutions have to think about why they re in business, and what it means for them to offer best total value. Of course, lenders need to make money, manage risks and generate shareholder dividends, but that s only part of the picture. What about solving the problems that customers may have in making a success of their businesses? There is arguably a greater social part here for lenders to play. 6

7 4. ENGRAINED INFLEXIBILITY It s no longer acceptable to attempt a one size fits all approach to products and services. Lenders need to be more flexible and re-think what they offer to customers. This means considering how their propositions fit in with clients businesses as a whole including other products, services and processes they may be using. 5. OUTDATED BUSINESS MODELS The industry has to shake off outmoded mindsets and embrace a customer-led culture. This may be a big ask for the established and traditional financial services institutions. They have massive legacy infrastructures to contend with the technology and systems, plus ingrained policies, processes and internal reward systems where targets are linked to employee pay. culture that s anything but customer-led. That s not to say there aren t great people working in these institutions who want to make a difference, but it s about enabling them to do so. 6. LACK OF CUSTOMER FOCUS Since the financial crisis, we re still seeing the aftereffects of inappropriate lending decisions, and a lack of funding options that are truly customer-focused. If lenders start with concern for their customers at the very heart of their thinking, they can create customer first finance products that are set at a commercially responsible price. That way, they can provide real value, and treat the customer fairly while acknowledging that their customer base is also changing. The legacy operating models of these Goliaths are not designed to be changed quickly, and can perpetuate a 7

8 3. The tech-enabled customer An explosion of tech-enabled finance is removing barriers... The ways in which SMEs are undertaking transactions and connecting their businesses together are evolving, thanks to a seismic shift in how technology is used to enable business....product development is no longer the sole domain of the banks. 8

9 Customer Relationship Management (CRM) by businesses is increasingly shifting towards social media to engage with customers, with businesses building accessible LinkedIn-style networks that foster a more open market and encourage real-time collaboration. Greater numbers of transactions are processed using cloud-based technologies, as businesses become comfortable with connecting and extending their processes online via innovative, customer-friendly apps. SMEs now have greater choice and control over products and services, in terms of both business finance and the financial technologies ( FinTech ) that support business operations. This explosion of tech-enabled finance has come about because it s easier, cheaper and quicker for lenders to build applications using today s technology removing barriers that once made financial product development the sole domain of the banks. The number and sophistication of services online is growing daily, giving customers greater access to niche products that may better suit their specific needs. In turn, as it becomes easier to find new products, services and recommendations, further market opportunities are created for lenders, meaning more product choice. It s the classic long tail effect, as described by Chris Anderson in his best-selling book The Longer Long Tail: How Endless Choice is Creating Unlimited Demand. All of this is great news for SMEs in terms of accessing finance. It means they can sidestep the continued challenges of borrowing from traditional lenders and no longer have to rely on one size fits all offers. It s also providing opportunities for a new, alternative breed of business funders. 9

10 4. The business solution THE RISE OF ALTERNATIVE FINANCE As the banks struggle to serve SMEs, we re seeing a boom in alternative finance a broad term taking in a potentially bewildering range of non-traditional funding options... corporate venturing asset-based lending venture capital private equity crowd funding peer-to-peer lending supply chain finance self-issue retail bonds business growth funds pension-led funding business angels invoice trading public equity retail bond markets 10

11 The Independent innovation charity NESTA released its own survey of the alternative finance market in Its Alternative Finance Industry Report highlights that the value of the UK market more than doubled year on year from 2012 onwards, while estimating that, in 2014, SMEs accessed 1.74bn in funding through various alternative finance models. Customer concerns around the robustness of non-traditional lenders are disappearing. Alternative finance routes are fast becoming the new normal for SMEs to access funding, with a recent survey by the UK Bond Network finding that more than two-thirds (68%) of UK SMEs would now consider alternative finance as a way to raise capital. I might use alternative financing 68% 11

12 There are four key factors contributing to this surge: 1. ACCESSIBILITY Ease of access is fundamental to the success of alternative finance, as discouraging barriers around onerous paper-based application processes are removed. Thanks to technology, getting funding online is becoming simpler and speedier than traditional forms of funding meaning fewer SMEs missing out on time-sensitive business opportunities. 2. FLEXIBILITY The sheer variety of options available means borrowers can mix and match providers, products and services, customising the products to their particular needs and to meet different events in their business lifecycle. 3. INCREASED CUSTOMER FOCUS The culture of alternative finance, including the more disruptive FinTech industry, is less risk-obsessed, and open to greater collaboration with its customer base, creating products and services that are more customerled than those offered by the traditional lenders. 4. IMPROVING PRICING Pricing is becoming more competitive as increased use of technology reduces operating costs so the cost to businesses can be lower than the overall cost from more traditional forms of funding. That said, SMEs must establish the full cost of the finance, not just the headline rate. Pricing is still not transparent enough. All of this results in better products, a greater fit to need, and improved access to finance, supporting the growth of UK business and helping to optimise working capital needs. Alternative finance is by no means a mature business environment, however, and this emergent form of funding still comes with caveats. 12

13 The lure of the headline rate As with traditional forms of finance, the temptation to be drawn in by initially attractive headline rates remains an issue for businesses. While the true innovators in this space try to make pricing simple and transparent (compared to the maze of hidden fees, unexpected charges and ambiguous extra costs levied by many of the institutional lenders), customers have to look beyond the headline rate and make sure they re aware of exactly what they re paying for. For example, one UK business loan company offered a headline rate of 2.1% for a 10-week business loan. Closer examination of the offer revealed that even a low-risk five-star rated company which repaid the loan in 10 weeks would pay an APR of 11.4%. A higher-risk one-star rated company would pay 14.4% over the same period, translating into an APR of 101.3%. HEADLINE RATE 14.4% ENDING APR 101.3% 13

14 Finding the right product I didn't know about all of these options Alternative finance is a noisy sector. While the choice of finance products is increasing, the breadth of options can be confusing. NESTA s report found that 42% of businesses with an annual turnover of less than 1.1.m weren t fully aware of the options available. Knowing where to find the right providers is important. Some forms of alternative finance come with restrictions, while others are sector-specific, so businesses can find it hard to understand which products and services are right for them. The key consideration for SMEs is to do their homework before committing. 42% 14

15 5. What s next for business finance? We re currently at a tipping point in the UK regarding the way that businesses access finance, and although this has brought about much in the way of positive progress, further change is needed. Things are improving as customer awareness rises, but more effective signposting is still required. Conrad Ford, Chief Executive of Funding Options, an online 'one stop shop' for alternative business finance, points out: "Not all firms fit traditional bank lending, and for most of the hundreds of thousands rejected each year there are other finance options if they only know where to look." There are other finance options, if only businesses know where to look. MORE INFORMATION ON ALTERNATIVE FINANCE As the lending landscape evolves, the new kids on the block must provide SMEs with clearer directions on how and where they can access alternative forms of finance, as well as what the different options are. Sadly, most of these businesses will give up after the first hurdle leading to lost growth and employment opportunities across the UK. It's incredibly encouraging to see a growing focus on helping firms to navigate the often complex and confusing world of alternative business finance, most notably through the government's new mandatory bank referral scheme." 15

16 REFERRALS FROM BANKS While banks continue to turn down potential customers for funding, they should be more willing to refer those businesses on to alternative finance lenders. Such partnering is already happening to an extent (between Santander and Funding Circle, for example). That said, it will be interesting to see the shape of the industry and which business sectors are channelled en masse to alternative finance providers by the 'big four' UK banks in the following months, now that this has been made mandatory as part of the Small Business, Enterprise & Employment Bill. A different mindset is required from both banks and SMEs. A DATA-SHARING CULTURE A different mindset will also be required of SMEs themselves, to embrace an open data-exchange culture between themselves and lenders. The majority of the new, technology-driven funding services are enabled by information, and require good data from the customer. To get the best out of alternative finance, plus other FinTech-style products and services, SMEs should not underestimate the importance of having high quality data (including indepth accounts, transaction data and customer details), as well as its ongoing management. So, in the same way as in the consumer world we are all heading towards the idea of the quantified self using the personal data gathered by wearable and mobile apps to improve our lifestyle the same will happen with financial data. Businesses will quickly aggregate all the different information about their performance, their customers and their competitors, giving rise to the quantified business. 16

17 The insights this data produces will enable SMEs to become more agile in their performance, and more competitive. In essence, the future of business finance is a positive one. A shift away from the restrictions of the institutional lenders, combined with an explosion of new opportunity offered by technological advance, has enabled a more diverse market that s easier and faster to access, as well as being more competitive. What s needed now are solutions that address the problems with traditional lenders and embrace the positives of alternative finance (such as its flexibility and availability). At the same time, they need to address the continuing issues around transparency of pricing as well as providing information, choice, and best value for the customer. Only then will we see the next great leap forward in what can be achieved within the lending landscape. Whether this changes the permanent non-borrower attitudes and behaviours remains to be seen. But what's certain is that, in order to succeed, this cultural shift needs to be put in place by people who are passionate about doing the right thing and in the right way. And that's where we come in... 17

18 6. Introducing Verus360 Our vision is quite simple to reinvent business finance Verus360 is a brand new business, dedicated to providing fair finance for SMEs. Many businesses sometimes feel that their finance arrangements are in control of their business, rather than the other way round. We re here to change that, with an innovative online business finance facility that s easy to use, fairly priced and puts you in control. 18

19 How does it work? We re offering a flexible business loan (similar to a secured overdraft), based on a full understanding of your business profile. Delivered totally online, at your convenience. Instead of borrowing a set amount of money over a fixed period, we provide a facility up to an agreed limit. You choose how much you want to use each month, and we charge on that usage alone. There are no minimum fees, no service charges, and no hidden costs. If you don t use the facility, you don t pay a penny. What s more, we don t ask for personal guarantees, and there is no assignment of personal property. Our vision is quite simple: to reinvent business finance. We ve created something we believe can revolutionise the market. Join us as we change the face of the business finance landscape. Tim Evans STRATEGY, INNOVATION & BRAND DIRECTOR FOR Tim leads Verus360 s thinking on how we bring value to our customers in a digital world. With nearly 20 years experience in SME finance, he ensures the customer voice is heard and that we continue to break new ground in search of the perfect customer experience. 19

20 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 Verus360 Limited