Banks are not the only fruit: firms seek new funding tools

For the UK’s small and medium sized companies, things are — don’t jinx it — beginning to look up. After one of the longest slumps in living memory — though by no means the worst, on some important measures — Britain’s economy is growing.

Company liquidation rates are heading back towards record low territory and unemployment is falling. However, there is little cause for celebration yet. Growth of 0.7% across the economy means some companies and industries may be expanding decently, but others are still flatlining or contracting. Hope is returning, but has not yet been fulfilled.

“Investment intentions have really rebounded in the past few quarters,” says Lee Hopley, chief economist at EEF, the manufacturers’ trade body. “They’ve been very depressed since 2008 but are now at their highest level for six years. We expect actual purchases of new capital equipment to start to rise.”

As the mood lightens, the UK’s obsession with whether banks are starving the economy of credit is beginning to ease and become more nuanced.

“The interface between banks and customers was damaged in the crisis and hasn’t really recovered yet,” says Hopley. “Companies may not be willing to have discussions with their finance providers, perhaps because they think costs will be prohibitive, or collateral requirements too much.”

There is some evidence for this in the quarterly SME Finance Monitor survey of 5,000 SMEs — though it also says 76% of SMEs were happy not to seek finance in the past 12 months.

Stephen Pegge, group external relations director, Lloyds Bank, says SMEs’ deposits are still growing as they hoard cash, while they are only using about 50% or 55% of the overdrafts available to them. “We have to hope businesses do start to invest, because unless they invest in developing new markets, in R&D, they are not going to have the most competitive positions,” Pegge says. 

Lloyds Bank has managed to grow its SME loan book 5% to about £25bn in the year to June, in a market that shrank 3% overall — an uptick from Lloyds Bank’ 3% or 4% growth rate throughout the contraction. 

The government’s Funding for Lending scheme has helped somewhat, most agree, if only as an interest subsidy for some new borrowers.

“The real hard battle in going out and finding customers has been to fight the discouragement factor — the sense that ‘finance isn’t available, so I won’t borrow’,” Pegge says. “The great thing about SMEs is that they are very diverse. Where we’ve made headway has been where we have industry specialists targeting particular sectors.” 

Others who work with SMEs say it is not so much that banks won’t lend, but that they are stuck in an unhelpful mindset. “There is a bureaucratic/regulatory/capital cost/fear of losing money logjam in banks,” says Bill Blain, head of the special situations group at Mint Partners, a division of BGC Brokers. “Do you really want one financial sector to be doing 100% of the lending to the growth drivers of the economy? We want to create a more interesting variety by encouraging the growth of a private placement market.”

While companies at or near investment grade — and unrated equivalents — have long enjoyed many financing options (see box on US private placements), many players are now striving to broaden choice for the next tier down.

“Companies that are deemed too small to come to the private placement market are incredibly well served by the banks at the moment,” says David Cleary, co-head of US private placements at Lloyds Bank. “Banks are short of assets, they want new clients and loan pricing is very competitive. The hardest question for a CFO is when to go from all bank funding to put another piece in the capital structure — do you bring in another bank or diversify?”

The UK’s steadily growing retail bond market, where deals of £25m to £60m are common, suits companies of this scale, especially if they have transparent business models that can readily be explained to retail investors (see roundtable, page 48).

But a few UK institutional investors and specialist credit funds are trying to build a domestic PP market for midmarket companies.

“Most corporate finance in the US happens through alternative networks, PPs or direct lending,” says Blain. “But too many investors are wedded to the idea of only buying bonds that they think are liquid. The costs of ratings and legal fees are also way too high — we think you can get it down from six figures to five by using common sense and standard documents.”

At the bottom of the SME food chain, PPs may sound very remote. But even here, innovation and diversity are changing the landscape.

Alex Jackman, senior policy adviser at the Forum of Private Business — most of whose members have fewer than 10 employees — highlights the strain on small business of late payment by customers.

“There’s £36bn tied up that doesn’t need to be,” he says. An EU directive, now UK law, imposes a statutory interest charge on invoices more than 60 days late.

“But there are ways your customer will get round it,” says Jackman. “Marks & Spencer have extended their payment terms from 60 to 75 days, Sainsbury’s from 30 to 75.” Big companies are effectively using small ones as a free source of working capital. 

To ease it, Lloyds Bank has introduced supplier finance, where big companies can borrow from the bank on the strength of their own credit and pay suppliers on the nail, at a small discount reflecting the borrowing cost.

Jackman also welcomes the government’s new Business Bank, a one-stop shop for entrepreneurs to access help, and its Start Up Loans, as well as trends like crowdfunding. “I don’t think there is that much of a shortage of finance,” he says. “It’s just that businesses need to be more expansive in where they look for it.”