"Alternative finance can offer highly cash-generative firms a way of accessing the funding they need."
If Britain is to climb out of the economic black hole it finds itself in due to the coronavirus pandemic, it will need its army of SMEs (small and medium-sized enterprises) to come to the rescue. This important sector of the business community is agile, adaptable and innovative enough to kick-start an economic recovery by creating wealth and employment.
Recent research from Barclaycard revealed that almost two-thirds of SMEs are planning to invest in their business over the next 12 months, especially in areas such as marketing, new equipment and technology. Moreover, despite the impact of COVID-19 many SMEs are still seen as an investable option. A recent government report showed that investors are continuing to back some of the UK’s high growth tech companies, despite the challenges posed by the coronavirus pandemic. More than £4.2bn has been invested into young UK-based tech firms since January 2020, according to the Digital Economy Council, with fintech and enterprise software firms accounting for around 60% of the fundraising. The findings also reported that the UK raised more than the rest of Europe combined, with London-based tech start-ups raising more than Paris, Berlin and Tel Aviv put together.
Made up of hundreds of fast-expanding SMEs, the UK tech sector will be a driving force as Britain recovers from the pandemic. It employs more than 2.93 million people with salaries that are, on average, £10k higher than other sectors. Importantly, it is still creating jobs; more than 90,000 roles were being advertised at the end of April - a month in which the country suffered the worst effects of the pandemic.
SMEs across all sectors account for 99.9% of the business population and produce one half of UK private sector turnover, according to the Federation of Small Businesses. There are around 5.8 million of them, employing 16.6 million people (60% of total UK employment) and generating an eye-watering £2.2 trillion (52%) of UK GDP. It’s clear that the wealth of SMEs directly affects the state of the UK economy, but their success depends heavily on the availability of growth funding.
Therein lies the problem. SME funding has become increasingly difficult to secure since the 2008 financial crisis, when banks were forced to hold more cash reserves to strengthen their balance sheets and consequently reined in lending to individuals and businesses.
This caution has not entirely dissipated; even SMEs with strong credentials and growth prospects have been turned down by mainstream banks in recent times. Brexit, too, may have exacerbated banks’ caution. The latest annual SME Finance Monitor found that the success rate for bank loans in the UK has continued to decline and is now at just 63%. The UK funding gap between the number of SME applications and the number of loans agreed is now estimated to be £59 billion.
This gap would undoubtedly have been wider had it not been for the rapid emergence of the alternative finance market. This market has grown at a fast pace in recent years and is estimated to be worth more than £8.32bn in the UK as of 2018, the third largest alternative finance market in the world after China and the US. It has certainly been of use to many small firms during the current pandemic; several alternative finance lenders have been accredited to provide loans under the government-backed Coronavirus Business Interruption Loan Scheme (CBILS), which helps SMEs access loans and other kinds of finance up to £5 million. The government guarantees 80% of the finance to the lender and pays interest and any fees for the first 12 months.
There are many types of alternative finance: peer-to-peer lending, microloans, equity finance and angel investments, plus various strands of asset-based lending and refinancing.
Why are these forms of funding growing in popularity? The answer is two-fold. Businesses need an injection of funds (often quickly and on better terms than those offered by mainstream banks), while investors are seeking ways of generating more attractive returns. The advent of technology and changes in regulation have led to the emergence of peer-to-peer (P2P) funding, equity crowdfunding and other alternative finance options - fast-tracking the growth of this vital sector.
The lending model offered by mainstream banks no longer meets the needs of many agile, ambitious SMEs. Traditionally, high-street bank lending focuses on asset-backed financing that requires businesses to provide a physical asset (such as equipment or property) as security for the loan. However, for those businesses with few tangible assets, the traditional lending model is not a good fit with how their business actually works: whilst they may generate healthy sums of cash, their lack of physical assets often deters banks from lending to them. This model tends to penalise service-focused businesses such as IT, telecoms and marketing firms.
Alternative finance can offer highly cash-generative firms a way of accessing the funding they need. A key benefit of alternative finance is its agility, its ability to offer flexible funding arrangements that can be tailored to the needs of individual businesses.
UK equity crowdfunding offers capital investment in exchange for equity. Peer-to-peer (P2P) lending allows institutional investors co-investing alongside individual investors to lend money directly to borrowers, usually via an online P2P lending platform – often at more attractive rates and terms offered by mainstream banks.
The above are just some examples; there are many other types of alternative finance. The value of this form of funding doesn’t just extend to individual companies, either; it can fire the growth of key sectors that will be vital in driving the UK’s post-COVID economic recovery.
Take housebuilding, for example. The UK's unmet housing demand presents an opportunity to utilise mechanisms that provide investors with potentially attractive returns and highly experienced SME housebuilders with the alternative finance needed to tackle the crisis. These mechanisms include an innovative mix of P2P lending, debt-based securities, and equity investment alongside private co-investment.
One housing scheme in the North of England, for example, is being developed by raising £1 million of equity investment to co-invest alongside private investors and the senior debt provider.
This investment opportunity has created that capital needed to forge ahead with development, and has allowed each participating investor to share in the profit generated by the scheme.
The UK’s housing shortage – where up to an estimated 345,000 new homes are required per year to meet demand – means that throughout the current pandemic and beyond, house-building will remain a key priority. Property development will also be vital in driving growth as the UK navigates a path to a post-COVID economic recovery.
Clean energy projects, too, will shape the economy in future years, as many governments around the world seek to reduce their reliance on fossil fuels and cut carbon emissions. Innovative Finance ISAs and other ethical investments that support an industry or cause are another attractive feature of the alternative finance market, which has the potential to deliver social or environmental benefits alongside economic growth and appropriate financial returns for investors.
In the UK alone, the alternative investment market was worth an eye-watering £8.32 billion in 2018, according to the Cambridge Centre for Alternative Finance (CCAF) - the third largest in the world behind China and the US. The size of the market, and its potential for growth, ensures that it will be an increasingly useful weapon in SMEs’ armoury as they go about tackling the current economic crisis.
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