Businesses can rarely be categorised as black or white. What might look on paper like a high-risk borrower can appear quite different when one talks to a business owner. Only then is it possible to appreciate how their company operates on a day-to-day basis, what new business is in the pipeline, and the revenue an enterprise is generating in the here and now.
It’s an approach we believe in at Boost Capital. We don’t seek the cast iron guarantees that many conventional lenders insist upon when dealing with SMEs. In my view, few such certainties exist in the real world of business. There’s always nuance, plus a need for intuition, as I’ve debated before. However, what do exist are hordes of healthy small companies desperate for funding, currently being ignored by the mainstream banks regardless of their potential for growth.
Determining the financial health of an enterprise can be tricky. Let’s consider how the big banks size up their small business customers. Audited accounts are a favourite reference tool albeit historical information. However, as we all know, many small firms are exempted from filing such records, and others aren’t big enough to provide any meaningful detail. Little or no publicly available data makes assessing SMEs’ creditworthiness more difficult, but it’s far from impossible. It requires building a relationship with a borrower. Sadly, these days the banks regard this only as an expense.
Conventional lenders want evidence of profitability and sensibly calculated projected income. All well and good – up to a point. At Boost Capital we expect to see that an enterprise has a positive daily bank balance, and want to be confident that a firm is in good overall shape. But demanding a business plan that projects activity and expected outcome for up to three years ahead and detailed financial statements going back over a similar period seems excessive, especially for loans at the smaller end of the scale. We’re more interested in the present – plus a little trading history.
Next come the credit reference agencies. A high street bank typically regards a high credit score as a basic prerequisite before it’ll consider releasing capital to an SME. And a low score is the kiss of death for a business loan applicant. However, there’s more to a story than numbers on a page, so we seek to understand how a company is faring today. Of course, we want to see a business that’s viable and set for growth, but we look to monthly gross sales and ability to generate revenue as an indicator of how robust a firm is.
Another common complaint is that banks require security from SMEs before they’ll hand over funds. Be it business premises, equipment, or personal assets, many firms struggle to provide the material guarantee that these mainstream lenders seek. Small businesses, particularly those that haven’t been trading for long, may have yet to build up such tangible assets. The financial crisis hasn’t helped – many businesses’ and individuals’ collateral has reduced in value in recent years. This is why we use business performance as a measure. We’re prepared to offer unsecured loans if we judge that a company can generate decent revenue and fuel future growth.
There’s another problem – banks don’t like some industries. The oft-quoted statistic that nine out of ten restaurants fail in the first year is one excuse given for many lenders’ reluctance to fund those in hospitality, for example. But that ‘fact’ is a myth, and one that we’ve busted on this blog in the past . As my colleague Willem van Lynden points out, one probable reason that businesses in these so-called high risk sectors fail is not because of what they do, but because they’re under-funded. It doesn’t matter if they operate in hotels, retail, or the beauty industry – an enterprise’s fate is effectively sealed as soon as a bank categorises them as ‘risky’.
We all know the reasons why the banking sector adopts this clumsy approach to small business lending. It’s easier for a computer to do the work rather than a human being who gets to know a business owner, and reads between the lines of their loan application. And it’s not so inconvenient if an automated system says no when you see little profit in lending to such a small operation. Transaction costs on the smaller loans SMEs typically need can be just as costly for banks to process as those on larger tranches of borrowing.
Perhaps the mainstream banks are doing the alternative finance industry a favour by neglecting this fertile part of the UK economy. There are 4.9 million SMEs in Britain today, which account for 99.9 per cent of all private businesses. It’s an enormous market, and one with huge potential. Some of these firms will be the big success stories of tomorrow, and we at Boost want to be able to say that we played a part in helping them on their way.
My intention is not to indulge in some indiscriminate bank bashing. But I do think that our larger peers have become too divorced from the business community they serve, and too trenchant in their lending behaviour. They could learn a great deal from the innovative ways that alternative lenders – and the brokers who work with them – deal with small firms. In reality, it’s part innovation, part a revival of old-fashioned skills of observation, patience and developing human relationships.
Some regulatory moves would help the alternative finance industry in its work. I’ve talked before about the need for a credit register in Britain. Such systems are commonplace elsewhere, forcing banks to share information about how credit-worthy companies are. The lack of such a resource in the UK means those of us on the outside of the closed circle of the big four banking providers have a handicap when making lending decisions.
But while our larger peers may have the edge in terms of volume of data, we have the advantage of really listening to and knowing our customers. We’re learning from them every day. I genuinely believe this will be the thing that will set the alternative finance industry apart from its bigger rivals in the longer term. We are being shaped by the businesses that borrow from us. We grow as they grow. Perhaps the big beasts of banking could benefit from such learning.
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