New opportunities, new risks: Now is the time to invest in alternative lending
A radical shift is underway as small and medium-sized enterprises (SMEs) – often referred to as the backbone of the economy – are increasingly moving beyond traditional bank financing to innovative services, such as crowd and peer-to-peer marketplace lending.
While bank financing will continue to be crucial for the SME sector, there are broad concerns that credit constraints could become the “new normal”. Combine this with recent geopolitical and economic upheavals the alternative lending space has become a more attractive investment opportunity than ever before.
What’s more, alternative lenders have more flexibility than traditional loan providers to take advantage of value-creating opportunities. This is because they can quickly move to prime, recession-proof sectors to protect and allow for future loan growth.
As well flexibility in sector type, alternative lenders have a wide variety of innovative loan instruments to deploy which financing by bank seldom use. These include hire purchase loans, wholesale funding arrangements and financial leases. This lending space has unparalleled benefits for SMEs thanks to its wide industry coverage and diverse loan tool kit. Total transaction value in this space worldwide is projected to reach $361.30bn (£310.48bn) in 2022, according to Statista.
UK data shows that total transaction value in the alternative lending segment is projected to reach $4.11bn in 2022, while the market’s largest segment, crowdlending (business), has a projected total transaction value of $2.47bn in the same year.
Additionally, Covid-19 has accelerated digital transformation in the finance industry in favour of fintechs as technology leaders, with loyalty to banks further declining. There was criticism, however, that alternative lenders were not accredited to dole out government backed loans as quickly as incumbent banks. Even still, SMEs struggled to access funding through traditional ways.
Our research recently revealed that 22% of UK SMEs that needed external finance and/or capital over the last couple of years, were unable to access it. Indeed, more than a quarter have had to stop or pause an area of their business because of a lack of finance. SMEs continue to struggle with accessing finance and that worryingly, this lack of availability is costing them and the UK economy in terms of growth at a time when it is needed the most.
The amount of growth that is being sacrificed is significant and will require new solutions which are designed to address this funding gap. There are three primary reasons why now is the time to invest in alternative lending. Firstly, the current economic environment of stagflation has eroded SME margins while depreciating their dry powder, resulting in record high demand for alternative leveraging.
Secondly, in an environment in which only the most nimble and resilient SMEs will thrive, cash is king and being able to access liquidity is crucial to survival. Finally, despite SMEs and start-ups being the future of the UK economy, traditional lenders will not leverage these high-risk companies, leaving them vulnerable and in dire need of financial support.
Inflation continues to be the top challenge facing small businesses this year as many face forced closures due to a loss of equilibrium on their balance sheets. Once the rising cost of electricity and gas are factored in, many SMEs’ margins will all but disappear. We know that the winter ahead is going to be tough for businesses, so it is best for them to start preparing now for how they will finance these major increases in costs.
What’s more, as the cost of borrowing from traditional lenders also increases, small businesses will require alternative means of financing. This includes cheaper forms like leasing, asset finance and commercial loans.
Access to liquidity
As the demand for liquidity rises, traditional financing providers are increasingly rejecting applications for cash. Despite fears of a looming recession, reducing SME financing hurts the very backbone of the UK economy. Indeed, it is because of the importance of SMEs to a functioning economy that access to liquidity should be expanded during recessions, not reduced.
This is not to say every single SME is entitled to support. Instead, only those that are both nimble and resilient should expect access to liquidity. When loans are granted, they need to be issued on the basis that the company has a realistic chance of survival in a post-pandemic, post-energy crisis and inflationary Britain and it is only now, with harsh market conditions, that they are in need of assistance. We should be careful not to produce any more zombie-like businesses, surviving only to eventually fall of a debt default cliff. SMEs will need to be well-advised to take stock of their current capital structure and, if appropriate, access fixed term, fixed rate loans to prevent additional exposure to an increasingly volatile lending market.
Providing the right SMEs with the pathway to secure lending will play an integral part in the economy’s resurgence – something which is in all of our interests, consumers and businesses alike. The way SMEs change the ways they are financed could act as the fundamental difference between make or break for many small companies and in turn, our economy.
Douglas Grant, Group CEO of Manx Financial Group