SME finance . . . the invisible tidal wave

The difficulty is not a lack of available funding, or willing funders, it is, if anything, that there are too many of them, making the whole marketplace incredibly crowded, complicated and, possibly, a bit intimidating if you’re not used to it. There is also the problem that most smaller alternative funders remain all but invisible to your average small business owner.

These are well documented issues which have, in part, been addressed by the bank referrals legislation contained within the Small Business, Enterprise and Employment Act. This has also led to the emergence of a few very good alternative business funding resource sites which quickly clarify to a business owner, or their adviser, which lenders would be most appropriate out of the burgeoning population of new style offerings.

So some order is coming to the marketplace but the success of this sector is not a done deal. Significant dangers remain, the biggest of which is that there are simply too many funders chasing too few deals. This will inevitably lead to the failure of some new lenders, and therein lies real reputational risk for the whole sector.

My friend and former collaborator in chief, Louise Beaumont, wrote a good article a couple of years ago headed “Lions, not Turtles” highlighting the dangers of too many (often quite shaky) new entrants in the alternative funding marketplace. Drawing a parallel with nature she suggested a better outcome for all would be achieved by emulating the strategy that Lions employ for rearing their young, nurturing a small number closely to ensure optimum numbers survive, as opposed to the turtle strategy which relies on a tiny survival rate, but thousands of hatchlings in the first instance.

Of course, in the real world, you can’t realistically stop new entrants into the SME lending space, and thus, so far, the turtles hold sway. The parallel ends there, however, since, sad though it may be, the demise of large numbers of baby turtles at the hands of predators is a natural thing. However, the demise of significant numbers of alternative lenders holds the real risk of cross contamination to even the stronger businesses in the space.

It is my belief that much of this overpopulation is due to a lemming-like mindset amongst many VC and Private Equity investors. Alternative finance was seen as the next ‘big thing’ and you had to be “in it” or you would miss out on the resultant fortunes that were to be made. “The banks aren’t lending” became the new truth, and thus the magical gap in the market was evident to all. Let’s set up a lender with a USP, put a few million in and lend off our own balance sheet. As long as we can net eight or nine percent (which, allowing for defaults and costs means lending at 11, 12 or even 13 percent) we’ll make good money. Marketing won’t be a problem, SMEs are crying out for this stuff, and as they can’t get it elsewhere, they won’t have any choice but to pay our very reasonable 113/4 over base. We’ll get a business development guy to sell it into accountants and brokers. Bobs your uncle, we’re all rich. Bish bash bosh, lunch anyone?”

Oh, if only it were that easy. The more expensive propositions are finding it incredibly hard to get their deals away. By their very nature SMEs are very careful with their own money and would often prefer not to borrow at all than to borrow at a rate which they regard as unreasonable. The El Dorado of SME lending simply will not appear in the way that these businesses envisaged, and the costs involved in acquiring customers are far higher than many anticipated. So we are seeing a stratification of the space, with the longer established and very large players moving ahead and into profit, and in the process hoovering up most of the desirable deals, thus effectively cutting off the oxygen of new business enquiries to the newer and smaller funders. Very Darwinian.

Evidence for the problems to come can be seen in the number of recent redundancies made in the sector, especially in the business development roles, as investors begin to lose patience with investee companies that are nowhere near profit and demand cost cutting rather than throwing more money in. Understandable but actually tantamount to saying “this business has failed”.

I don’t think we will see a wave of closures just yet. For one reason there are too many egos at stake but they will start to happen and a drip will become a stream. Not much we can do about that, but it will be crucially important for the sector as a whole to work together to ensure that not one single customer is disadvantaged in the event of their funder going under. An orderly wind down of the book is essential, since alternative funding’s love affair with the press can easily turn sour, and a damaged reputation in an emerging marketplace will make all of our lives much harder.