Seven years on from the 2008-09 financial crisis and alternative finance is no longer new, nor is it very alternative. In the UK alone, to date close to £6bn has been advanced through online alternative finance platforms. The market is expanding at such a rate that by the end of the year we can reasonably expect origination totals to have grown by an estimated 50%, and very likely more.
Research by Cambridge University’s Centre for Alternative Finance found that of the 536 UK businesses surveyed, 53% reported an increase in employment after accessing a peer-to-peer (P2P) loan, 63% reported an increase in net profit and net income, and nearly three in four saw their turnover increase. Similarly, of those that had used online single-invoice discounting services, 60% reported an increase in employment, 90% increased their net profit/net income, and 80% said that turnover increased.
On the other side of the industry, the traditional banking market has experienced its own changes over recent years. Statistics from the British Bankers Association (BBA) show that in the first half of 2012 banks approved 114,707 overdraft applications from smaller businesses (defined as those with annual turnover of up to £2m), but by the first half of 2015 that total had dropped to 60,133 – a decline of 47%.
An analysis by Funding Options, a investee platform of the small to medium enterprise (SME) alternative finance group GLI Finance, estimates that since 2011 UK banks have withdrawn £5.7m a day in small business overdrafts alone – cutting available credit by £8.4bn (from £20.9bn to £12.5bn) at an estimated cost to the British economy of £2.9bn.
When considered alongside research by UK government department the Competition and Markets Authority (CMA), which revealed that the main four British high street banks collectively represent over 80% of all SME business lending, this paints a worrying picture for the prospects of the UK’s smaller enterprises.
Although it might seem clear that alternative finance has a vital contribution to make in helping businesses achieve their growth ambitions in a difficult market and provide the key investment that the UK economy needs, there is still a widespread lack of awareness among potential business borrowers about the range of financing options that exist today. According to a 2014 joint study by innovation charity Nesta and the University of Cambridge some 56% of UK smaller businesses had not even heard of any of the major forms of alternative finance.
In the attempt to increase awareness of their services, alternative providers also have to contend with various negative misconceptions about the industry. One of the most common misconceptions is that platforms such as P2P lenders and online single-invoice discounting providers are targeted solely at small, marginally profitable companies that are unable to obtain funding from mainstream sources. In reality this is far from the case, as may be evidenced by the existence of several funds specialising in funding mid-market businesses that are large enough to have a range of options for raising finance, but prefer to work with alternative lenders.
A further misconception – and one endorsed recently by Lord Turner, former chairman of the Financial Services Authority (FSA), predecessor to the Financial Conduct Authority (FCA) predecessor – is that these finance providers have no quality control and rely solely on algorithms to decide which borrowers to accept. Again, incorrect. The leading alternative finance providers have very robust credit underwriting processes and consistently illustrate low levels of losses on bad debts as proof.
These lenders do not simply hand out money to anyone and everyone, but rather use technology to speed up the process of evaluating credit applications; thus enabling businesses to move forward with their investment plans. The best way to think of online alternative finance providers is as “technology-enhanced lending businesses”.
A particular area of alternative finance – offering a solution to one of the biggest challenges facing mid-market companies today – is supplier financing. Banks are major providers of supply chain finance for large companies but tend to be uncompetitive in the sub-£50m revenue market, leaving a natural opening for alternative providers.
Building resilience into their supply chain is one of the biggest challenges that mid-market companies face today. Supplier finance is vital among companies of this size as their suppliers are under increasing pressure, creating a clear source of business risk that demands fresh solutions.
This is happening, In part, because average payment terms have shown no sign of shortening in recent years. According to research published last year by the Asset Based Finance Association (ABFA), average payment waiting times for SMEs in the UK have grown to 72 days, from 61 days in 2009 when the financial crisis was at its height, For some industries, including construction and real estate, the wait is even longer.
Supplier financing platforms enable mid-market companies to ensure their suppliers can access liquidity quickly. This gives them greater financial security but, equally, allows funders to advance capital to these companies against invoices that have been approved for payment by a much larger end-customer. It allows the funder to take on the credit risk of the larger end-customer, rather than the smaller supplier, and so enables that supplier to access liquidity at cheaper rates. In effect, the mid-market business lends its credit rating to its supply chain at no financial cost to itself.
Payment terms in the UK are generally among the shortest in the world; elsewhere standard terms of 90 or 120 days are common. As bigger companies start to adopt global supply chain finance programmes, many will seek to standardise their global payment terms. For businesses in the UK, this is most likely to mean a longer wait to get paid by their largest multinational clients. Additionally of course, changes like this at the top of the supply chain will inevitably trickle down to the suppliers of those suppliers.
The market for supplier finance is in its infancy, but developments so far point to alternative providers increasingly having a critical role to play in funding companies that fall below the natural banking market.
Overall, it is clear that the alternative finance industry has a huge amount to offer businesses with ambitions to invest and grow. With all signs pointing to the fact that alternative finance providers will prove vital in the funding of businesses in coming years, the challenge is not access to finance in itself, but rather the lack of awareness of where to find it.
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