13 Nov Alternative Business Finance: Maintaining Momentum
The alternative business finance market continues to grow at pace. In a climate of political and economic uncertainty, more and more businesses are looking to alternative business finance to provide the funding they need to prosper and grow. The incredible growth seen over the past few years has settled. The market is beginning to show signs of maturity. With governmental support improving and regulatory shifts encouraging innovation and collaboration, the next year will prove to be transformatory. For both the alternative business finance industry and its customers.
Continued uncertainty around Brexit
Brexit negotiations continue and arrangements remain uncertain. Concerns remain within the financial services sector, and the wider SME economy.
According to the ninth annual Hiscox ‘DNA of an Entrepreneur Report’, the number of UK firms saying political instability is having an impact on their business has jumped sharply. From 22 per cent this time last year to 31 per cent in 2017.
Yet it seems that the uncertainty is also encouraging business owners to embrace other means of funding growth. Faced with the concern that traditional finance may become even harder to secure after Brexit, younger business owners in particular are seeking new forms of funding. According to research by Worldpay, alternative finance options are now almost on a par with traditional finance in terms of popularity.
The need for alternatives remains
According to Liberis 68% of SMEs plan on taking out business finance in 2017. Yet research conducted by RateSetter business finance midway through the year revealed that 32 per cent of SMEs that had considered raising finance said that it was harder than at the end of 2016. While more recent statistics show that over 60% of SMEs are still concerned with their ability to finance long-term growth.
This highlights a continuing funding gap, estimated by the British Business Bank to be around £4bn. Coupled with what Mike Cherry, National chairman of the Federation of Small Businesses calls “a chronic issue with permanent non-borrowers in the small business community”, it’s clear that the need for flexible, cost-effective finance is greater than ever.
39% of businesses also value financial advice in person. The continued closing of physical bank branches through 2017 has further pushed SME owners to seek alternative sources of funding.
According to Close Brothers’ research, just 19% of SMEs say bank advice always meets their needs. The meteoric rise of the challenger high-street lender Metro Bank (77% increase in profits on the last quarter) highlights this desire for a new way of banking. Fast, accessible, and customer-centric.
According to the British Business Bank, in the US, where SMEs are less reliant on bank lending, the economy recovered quicker than the UK and many European countries. The greater diversity of finance providers in the US meant SMEs could access finance easier. This encouraged economic growth and stability.
Ratesetter research also found that 63% of businesses looking for finance value speed and simplicity when obtaining a loan. As alternative business finance providers’ offerings mature and become more focused, efficient and informed, these benefits will define the continued success of the industry.
Government support improving
2017 has seen the government step up its commitment to support the development and access to alternative business finance. Back in March 2016, economic secretary to the Treasury Harriet Baldwin stated, “small businesses are the backbone of Britain’s economy and it is right we make every possible source of finance available to them”. However, of the 324,000 SMEs that sought a loan or overdraft in 2016, 26% were rejected, and just 3% were referred to an alternative provider.
Now, a new government initiative for small company owners struggling to access funding from large banks will match them to alternative business finance options. The government developed the matchmaking scheme to make it easier for small firms to access finance. Particularly when they’ve been turned down by traditional lenders. It currently involves nine of the UK’s biggest high street banks and four alternative finance platforms – Business Finance Compared, Funding Xchange, Alternative Business Funding Ltd and Funding Options.
National chairman at the Federation of Small Businesses (FSB), Mike Cherry, said:
“This change will boost alternative lenders, bringing more competition and choice in the market beyond the big banks”.
With government research suggesting that nearly three-quarters of businesses seeking finance only ask a single bank, this is a crucial step towards increasing the awareness of and access to flexible, tailored alternative business finance.
Open Banking – The Power of Data
“Open Banking means that for the first time, we can have the best of both worlds . Historic bank account data in the hands of innovative technology firms.” - Conrad Ford, Chief Executive of Funding Options.
The two-part Open Banking initiative, commenced in March 2017, has a clear mandate:
“Enabling personal customers and small businesses to share their data securely with other banks and with third parties. Allowing them to compare products on the basis of their own requirements and to manage their accounts without having to use their bank.”
The Second Payment Services Directive (PSD2), is due to come into effect in January 2018. It will further speed up the move towards more transparent Open Banking. In this regulation, “authorised third parties can be given consent by the account holder to access their bank accounts to extract statement information and to initiate payments, without having to use the Bank’s Online services”.
Letting alternative business finance providers, through the use of APIs, effectively become Account Information Service Providers (AISP), offering better front-end functionality while plugging into existing accounts, as well as Payment Initiation Service Providers (PISD) is likely to transform the finance industry over the coming years. PSD2 will have wide-ranging implications for established business finance firms – across technological, customer journey, legal/compliance and information security perspectives.
For SMEs, the range of competitive business finance options and interfaces will no doubt increase. This will also provide greater transparency of costs and protection from charges, including reduced liability from fraud.
“The rapid development of any new financial services market segment presents policy makers and regulators with a challenge. Protect the interests of investors and consumers while stimulating innovation and economic growth in their respective communities.” Robert Wardrop, Executive Director, Cambridge Centre for Alternative Finance.
Basel III, the regulation from the Basel Committee on Banking Supervision, aims to retain the banks’ solvency and tighten risk requirements. Its need for banks to hold capital in relation to their asset risk has also been blamed for a decrease in SME lending and an increase in borrowing costs.
“The double whammy of stringent regulations and weak economic growth is forcing banks to review every aspect of their businesses.” - ‘Cognizant White Paper - Gearing up for Basel III’
Alternative business finance providers currently enjoy a relatively light touch. They can take on a higher level of risk with less capital to back the exposure. This is to encourage lending. SMEs are traditionally seen as ‘higher risk’ customers, and so normally need higher levels of capital backing.
It’s unlikely that the Basel III regulations will be applied to alternative business finance providers in the same way that they are to banks. Regulators would likely face criticism for starving SMEs of much-needed cost-effective finance opportunities. The recent matchmaking initiative, as well as the increase in collaboration between banks and altfi providers can be seen as evidence that policymakers are keen to maintain a positive position with regards to availability of finance to SMEs.
According to PwC, whilst many bank CEOs believe the threat of challengers and Fintechs is “a lot of froth and hype”, other CEOs believe they present an opportunity to enhance their offering through partnerships.
There are already many examples of business banks working in partnership with alternative providers. Pay4’s partnership with Santander is but one example. This level of collaboration will continue, with the ability of alternative business finance providers to remain agile and innovate seen as an attractive proposition to more legacy-driven banks and their investors.
PSD2 will level the playing field. Established finance providers will move to “dynamically integrate offerings and data from other players”. This will help them to increase their presence and command parts of the value chain. As well as avoid the potential for becoming what has been termed ‘dumb pipes’ for banking data.
Engaging Established Businesses
The BDRC Quarterly SME Finance Monitor released its Q2 2017 data recently, highlighting the potential demand for alternative finance. According to Shiona Davies, Director at research consultancy BDRC, “there are signs in the first half of 2017 that larger SMEs, whilst concerned about the economic climate and political uncertainty, are looking to grow and to use finance more than before.”
However, according to a new study by Worldpay that surveyed 1,000 small business owners, older, more established businesses are far less likely to consider alternative financing over a traditional bank loan.
For these mid-market, ‘going concern’ businesses, securing growth funding can still be a real challenge. They’re not exciting enough for venture capitalists, and not secure enough for banks. Instead of relying solely on traditional sources of funding, these companies need to broaden their options. They must look to alternative finance.
The challenge for alternative business finance providers is to engage these larger, more established SMEs. This will take them and the altfi industry into the next phase of growth. Again, collaboration with traditional, known-brand finance providers is one way to unlocking this potential market.
The attitude that prevents businesses from trying alternative finance, even after mainstream lenders have turned them down, is, however, rapidly changing. The growing need and awareness of the flexible, customer-centric finance solutions now available is powering the altfi sector into its next phase of growth.
As it moves away from its cottage industry reputation and into the mainstream, business customers will enjoy unparalleled access to tailored, growth-focused finance solutions. The upcoming regulatory changes will likely enhance this development.
With the right government backing and regulatory environment, the UK has a bright future as a global hub of alternative business finance. A strong, talented alternative finance ecosystem and forward-thinking mainstream lenders are key drivers. The past year has seen a lot of changes. Yet they point to an environment that is becoming increasingly nurturing of the disruptive energy that innovative finance providers are bringing to the industry.