Financing forms a critical part of starting or maintaining a business. It has become all the more important for small and medium-sized enterprises to look for alternatives means of funding in the current challenging economic times. The absolute reliance on particular financing means, like bank debt, may not turn out to be feasible, and financing needs to be diversified.
Alternative Finance for SMEs
SMEs play a significant role in the economy of the UK. They contribute about 47% of the country’s revenue and 60% to the private sector jobs. SMEs play a pivotal role in the growth and recovery of the economy and boosting the country’s productivity. However, they are small and medium-sized companies that lack financial backing and require alternative financing means to survive and stay profitable.
With a decline in traditional bank lending to SMEs in the UK and a recession looming on the horizon, alternative methods of financing have become increasingly essential. These alternative means include:
Private Individual Finance: Private individual finance through retail bonds and peer-to-peer lending platforms is an excellent means of alternative finance for SMEs. Companies directly issue retail bonds to retail investors through regulated platforms. In this case, the retail investors are usually private individuals who invest in the SMEs in exchange for high yields on the retail bonds. The retail bonds are operated by the London Stock Exchange in the UK and run as The London Stock Exchange Order Book for Retail Bonds (ORB). ORB is a regulated market for the issuance and management of retail bonds and has recently started tending to SMEs as their flexible funding source.
Moreover, small and medium-sized enterprises can also obtain funding from private individuals through peer-to-peer lending platforms. These online platforms connect the borrowers with the lenders directly, creating relative liquidity and it provides additional services like price discovery and credit information. P2P lending is regulated by the UK FCA and is becoming a fast-growing source of alternative lending for SMEs.
Equity Financing: The owners of SMEs also have the option to exchange a part of the company ownership for funds. This is termed equity financing and is available through various means, including venture capital, angel investing, equity offering, IPO, equity crowdfunding, personal savings, friends, and family. Venture capitalists and angel investors invest in startups and SMEs with high growth potential and provide their managerial and technical expertise and financing in return for a stake in the company. On the other hand, equity crowdfunding allows SMEs to raise funds from individual investors through online equity investment platforms.
SMEs owners can also generate funds by drawing from their savings or equity. The personal resources range from early retirement funds such as state pension or self-invested personal pension, equity market assets such as ETF Investments and property investments such as house equity loan.
Leasing and Invoice Discounting: Leasing and invoice discounting are usually unnoticed but critical modes of obtaining alternative finance for SMEs. These forms of financing are collateralized and are, therefore, less risky for the lenders compared to the other unsecured means of lending.
Invoice discounting involves the lender paying a fixed percentage of the company’s approved invoices to it as a loan collateralized by the underlying invoices. It is quite common in the UK and is usually offered by the commercial banks as sales finance. In the same context, leasing is a form of asset-backed finance where the loan is secured against an asset. This form of alternative finance is used to fund the purchase of equipment and functions either through hire purchase, operating leases, or finance leases.
SMEs also have access to supplier finance as an alternative method of financing. It involves large corporations extending the duration in which the invoices need to be paid, thus offering a short-term loan to the SMEs.
Government Initiatives: The government in the UK also provides alternative sources of funding to the SMEs as there is no established insurance-led private placement market in the UK. The government offers these initiatives through the Department for Business, Energy & Industrial Strategy (BEIS) responsible for promoting the businesses and the HM Treasury that controls public spending.
Additionally, the UK government supports the SMEs through initiatives including the Business Finance Partnership (BFP). BFP aims to increase lending to the SMEs through sources other than the banks. It is either done by investing in fund managers or non-traditional lenders who lend to SMEs. The government also offers startup loans ranging between £500 and £2,500 for SMEs to start and grow. Such loans are unsecured and charged at a fixed interest rate of 6% per annum.
Thus, the SMEs in the UK have access to several alternative modes of financing, even in the constrained lending environment. SMEs and the economy can recover and boost by making use of the available alternatives.
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