Yesterday in part 1 of this two part article, I set the context of the SME funding market, once dominated by banks but now challenged by alternative lenders. The alternative lenders have ‘earned’ their market share by solving many of SMEs’ problems and taking advantage of the restrictions placed on banks following the financial crisis of 2008. So successful have these ‘alternatives’ been, it might be time we think of another name to better reflect the increasing mainstream adoption.

"The Risk appetite of banks is not what it was pre-2008."

Alternative lenders have seen a gap in the market left by the banks as they fight to bolster their balance sheets and comply increased regulation. Risk appetite of banks is not what it was pre-2008, for very good reason.

Traditionally, a bank works by taking deposits from one group of customers and lending those deposits to another group of customers making a margin in the middle. Pretty simple? However, in order to protect the savings and deposits of customers the bank must retain a certain amount of liquidity to meet the reasonable demands of depositors wishing to withdraw funds usually on demand. Post 2008, the definition of reasonable has changed drastically forcing banks to take a different view on the risk they can take on the lending side. The description is hugely simplified, but it paints the picture.

"Alternative lenders are much better placed to match assets and liabilities."

By remaining outside of banking regulations, alternative lenders are much better placed to match ‘assets and liabilities’. They have no duty of care to the man on the street. Most cash lent by alternative lenders is sourced from pension funds, insurance companies and family offices – not depositors. Because of this, alternative lenders can offer secured or unsecured cashflow loans to fund growth or acquisitions with repayment schedules as long as 8 or even 10 years, and risk profiles significantly higher than a bank could ever entertain.  A bank on the other hand will be hard pushed to offer a similar term loan over a period of more than 4 years.

A new hero in town?

Because of the alternative lender market, SME growth plans are no longer held back by banks’ ability to lend a company only 1.5 – 2.0 x its proven historical earnings against a rapid capital repayment profile. The alternative market habitually offers loans of 2.5 – 4.0x earnings to smaller firms and as much as 6.0 -7.0x to the larger SMEs over longer repayment periods. This is an important part of the market as this sort of finance better suits a huge percentage of the SME market when compared to bank loans or at the other extreme, equity investment.

So the ‘Hero’ badge can be attributed to the alternative funding market as a whole for empowering SMEs with radically more choice and flexibility. However, to a typical SME CEO or Finance Director, such diversity offers additional problems – we frequently hear:

• Who are these new players?
• Are they reputable?
• Are they regulated?
• Which products does each of them offer?
• Who funds them and how does this drive their lending?
• How to understand all their jargon; what is the difference between ‘unitranche’, term loans or mezzanine debt?
• What do they look for and how to best represent an SME to them?
• How does an SME protect itself from ‘off-market’ terms when these lenders are under less scrutiny from regulators?

These are just some of the questions my team and I frequently address from clients considering the alternative market. These concerns are understandable.

Has the lending market improved?

So are the alternative lenders really improving the market for SME funding or just complicating it?  In my experience of running numerous funding processes – they are certainly improving it!

Another key factor alternative lenders bring is constant innovation due to their more flexible internal structures and challenger attitudes. This improves products, services and flexibility to the benefit of the SME funding market. So, for a CEO or a finance director of today, the alternative funding market holds an enormous promise of fulfilling the constantly evolving funding requirements of a modern business. And with the guidance from the right corporate finance advisor, the perceived opaqueness and complexity of the alternative funding market can be used to gain advantage over your less-brave competitors put off by all the jargon or simply preferring the comfort of only dealing with well-known banks.

We work with growing UK SMEs and small-cap PLCs that have funding needs in excess of £2m and regularly approaching £100m. Our clients’ needs will typically be for sophisticated finance products such as cash flow based lending or private equity investments. Our value lies in helping clients access funding that relies on confidence in future trading and cash flows. For a confidential, independent, no obligation discussion on the funding options available click the 'Let's chat' button.