Raising Finance

SME Funding Guide: Know your debt finance options

9 min read

14 November 2018

Editorial Director

Real Business unpacks the state of SME debt funding today, helping you know which options are right for your business at any stage of growth.

It’s been a decade since the global financial crisis hit in 2008 which shook and reshaped the UK economy. Back then, new loans to SME customers dropped to a low of just over £38bn a year. Fast forward to 2017, banks provided £57bn of lending to SMEs, approving eight in ten applications for funding today.

As of Q2 2018, there were 69,300 new loans approved to SMEs across the UK for a value of £7.1bn, according to UK Finance.

The shake-up also introduced a whole new stream of funding options for SMEs in the form of fintech. The clarion call for more transparency and wider access to finance has been ringing loudly for the past few years, but what’s the funding landscape like now? Read on for the current funding backdrop, or skip ahead to get to the good stuff.

SME debt funding: Is there a perception problem?

A new report from the Treasury Committee on SME Finance, in 2017, 38% of SMEs used external finance, showing little change from the 37% that used external finance in 2014, 2015 and 2016, but well below the 44% seen in 2012.

Stephen Welton, CEO of the Business Growth Fund (BGF), the UK’s most active investor in SMEs believes the stagnation in demand for debt funding is mostly because of a perception problem.

“What we need to do a better job of is increasing the understanding in the SME population as to where to go,” he says. “One of the frustrations is if you think that the solution to your problem is an overdraft, and you go and ask for an overdraft and you do not get it, that does not mean that you cannot raise funding. It means that you have gone to the wrong place to get funding. There is a big educational piece that we need to do.”

“For somebody who is nonfinancial, it is often quite intimidating to try to find funding. You do not know the language. It feels like a very opaque system, and you think that you are not necessarily going to be right for the person you are applying to.” – Stephen Walton, BGF

Katrin Herrling, CEO of SME funding marketplace, Funding Xchange noted that this perception problem is particularly evident among very early-stage companies. “Often (these businesses) do not have a very good understanding of the different sources of finance, outside of the bank loan or the overdraft,” she says.

The solution is to give business owners the confidence to look beyond traditional debt finance. The British Business Bank (BBB) echoes this, saying that ‘information failures’ is the main contributor to this weak demand for funding.

SMEs with high growth potential sometimes struggle to obtain the right finance that they need to grow to scale. Some UK entrepreneurs cannot fully consider the different options available to them to support long-term growth. This reduces how efficiently capital is allocated to growing firms.

This is backed up by survey data from the BBB which reveals that most UK SMEs are not aware of financial products beyond standard term bank loans, overdrafts and credit cards. When they do know about other options, they often don’t know where to turn to, or how to get started.

This guide aims to clear this up for SME entrepreneurs.

What is debt funding and what are the advantages?

At face value, debt funding is used interchangeably with loans and just means that SMEs make a promise to repay short or long-term financing in a specific period of time.

Pullquote: Scratching the surface, debt funding includes fast business cash, invoice financing, merchant financing, flexible line of credit, unsecured term loans, secured loans and start-up loans from the government.

Pro: If you take on debt, you have access to finance without sacrificing ownership of your company.

Con: Taking on debt means agreeing to a repayment schedule. If you fail to pay back the loan, you risk incurring crippling fines, and may even lose your business.

Debt funding is a risk for finance providers, especially considering the rate of business survival for young startups. Many early-stage companies struggle to access debt funding because they don’t have the track record and steady cash flow to make their case for finance providers.

Debt funding usually carries interest on the amount borrowed, which depends on the amount of the loan, whether it is secured against assets like equipment or machinery, and the length of time you need financing.

Traditional debt funding from high street banks is not as readily available as it were five years ago. Even in 2010, high street banks provided 95% of all business loans. Today, almost 50% of loan applications to high street banks are rejected, but there are over 100 alternative debt finance providers in the SME finance world today to fill the gap.

Pro: Alternative debt funders are generally more flexible and have a famously quicker turnaround process for approvals.

Con: Alternative debt funding can come with significantly higher interest rates and will require SME business owners to have a tighter hold on their cash flow to repay loans.

Real Business is dedicating the month of November to SME debt funding, dissecting what makes this form of financing good for business growth.

Types of debt finance: Are you eligible?

Fast Business Cash: Fast business cash loans give you a lump sum quickly and on short notice. In fact, the money is typically approved and sent your way within 24 hours, subject to turnover level and affordability.

Secured Business Loan: A secured business loan requires the provision of an asset to secure financing.

Unsecured Business Loan: An unsecured loan is a type of loan where you don’t need to offer up a personal or business-related asset. This means you don’t have to put up your house or business equipment as collateral.

Flexible Line of Credit: A flexible line of credit is an open line of credit that allows you to borrow between £1,000 and £200,000 depending on the size of your business and other criteria. You only pay interest for the amount of time you keep the money you borrow and can draw on your line of credit at any time. As long as you repay the principal owed your available credit is renewed by the same amount.

Invoice Financing: Invoice financing is a general term used for asset-based lending products that allow companies to finance slow-paying accounts receivable.

Merchant FinancingMerchant financing provides a cash advance on predicated debit or credit card sales. It’s a form of unsecured business financing targeted at retailers and other consumer-facing sectors, such as restaurants and online businesses.

Start-Up Loans: In 2012, the UK government set up The Start-Up Loans Company, a subsidiary of the British Business Bank, for the purpose of delivering the Start-Up Loans programme. The initiative is designed to provide finance and support to individuals that may otherwise struggle to get an enterprise off the ground.