The Need for Industry Innovation to Improve SME Financing
Originally published in Entrepreneur Country, 23 November 2011.
Credit/lending to SMEs continues to catch the headlines. The banks’ promises under Project Merlin are still not being met, though the situation has improved. Interestingly, the proportion of lending through various means of asset based finance has apparently risen, with ABFA’s recent press release specifically highlighting the growth of invoice finance over the past year.
ABFA (http://www.abfa.org.uk) do a stellar job of promoting the industry with the limited budget they have, but I believe more can be done.
Looking at ABFA’s own statistics: 48,172 companies used factoring or invoice discounting at the end of 2008 – a figure which has fallen to 41,486 by 30th June 2011. They also claim that,
“the latest figures show invoice finance clients are (again) choosing not to access all of the funds available to them. Total available funds this quarter were £22.2bn, with £6.5bn of finance available but not drawn.”
Can it be that the majority of clients are “choosing not to access all of the funds available to them?” I believe the truth is more likely to be that the figures are rendered somewhat meaningless by the 496 companies with annual turnovers in excess of £50m who represent 1.2% of clients by number but one third of the turnover in ABFA’s statistics.
The reality is that as far as the SME sector is concerned, the invoice finance industry, dominated by our well known and creaking high street banks, is running fast in the same spot, and has been for the past few years.
With the state of the traditional lending to SMEs being what it is, the window of opportunity for independent, non-bank firms within the asset based finance industry is tremendous. An opportunity to be the good guys, an opportunity to help the economy, resuscitate business, play a key role in getting the Economy growing again. They can work to change the perceptions of asset based finance and specifically invoice finance – make access easier for business and demystify the perceived complexity. Bolster marketing, re-position, innovate.
Sadly this is not happening, well, not to the extent it should be. Some claim (the banks) that the British Banker Association statistics for company borrowing continue to show that demand for debt from companies, specifically SMEs, is not there, and that the continued fall in net borrowing is a result of companies paying back loans to wipe debt off their books in these gloomy times.
Certainly, reduced confidence in growth and the economy as a whole does make SMEs cautious in their ability to continue to service debt. But in this lies the solution and enlightenment; traditional debt finance requires continued interest payments, impacting a firm’s cash flow and further straining working capital – the cash available to a business to service its monthly operations. Injecting capital through Invoice Finance does not. To simplify: Cash in from debtor, repayment out to financer, debt closed. Eureka!
The incentives for selling invoice finance to SMEs are just not strong enough. If an invoice finance salesperson is trying to grow their loan portfolio by 10 percent, they are more likely to get there by making fewer larger sales than a whole lot of smaller ones, particularly as the time taken to sell the facility to a larger firm relative to a smaller one is still marginal compared to the potential return.
Many small businesses have lost faith in the banking sector and are looking at other means of finance. Research firm BDRC recently published a survey that found that bank refusals on borrowing applications/renegotiations have increased since the 2008. The mere fact that SMEs are turning to other forms of finance – Peer to Peer lending networks, retail bonds even pawnbrokers, suggest there is still a demand for capital. Asset based lenders should seize the opportunity.
Having spoken to many in recent months, I also believe that other non-banking financial firms, those that do not currently compete in the asset based finance arena, can add considerable value. There is a demand to access the market from a variety of firms: hedge funds, family offices, alternative investment advisors, private banks. These firms, more streamline in their operations with lower overheads, can deliver more competitive funding rates for business while still turning a decent profit on the risk they are taking. They are very interested in investing in new and alternative asset classes to diversify their portfolios and exposures.
It was interesting to read the following in the interim report by the Independent Commission on Banking Reform, published in April 2011,
“…..reforms that stabilise the UK banking system may also raise its costs. This may cause some activities to move to non-banks, foreign banks, or capital markets………. Non-banks may well be better-placed than banks to conduct some financial activities, and limiting the implicit government guarantee for banks may also encourage some activities to move out of the banking system. To the extent that shadow banks can safely remove risk from the banking system, an increased role for them will be positive for financial stability.”
The issue for non-banks is one of sourcing – they have no capability in this area nor in the area of due diligence. Sourcing and relationship management is a heavy cost even to existing participants in the industry and, coupled with consumer perceptions, makes client acquisition far from easy.
What is the solution? We all have an opinion, here is mine. Fragment the industry value chain. Narrow the focus of firms within the industry to a small set of core capabilities that they can excel at, let others take over the management of marketing, sales and distribution; going beyond the “lifestyle” brokers that proliferate the industry. Put more emphasis on consumer needs in the delivery of financing, make them more comfortable with the solutions provided. Leverage a new breed of innovative services that use technology to deliver massive scalability in terms of clients, services that demonstrate competency in marketing and sales and are driven by volume rather than deal size.
All participants, old and new, supporting service providers and potentially most importantly, businesses, will win– innovation at the industry level, not just at the product and process level, delivers the greatest rewards.