With many small businesses facing problems securing commercial bank lending, alternative ways of gaining access to finance are being explored.

At a time when the UK's largest banks are being pressured to lend to small businesses under the terms of Project Merlin, entrepreneurs are increasingly looking at alternative financing options.

Enterprise Finance Guarantee

The government's Enterprise Finance Guarantee (EFG) scheme was launched to encourage loans from banks that had been reluctant to lend to small businesses.

As part of the scheme, the government guarantees part of the loan and takes a small fee from the SME.

However since its launch in January 2009, lending through the EFG scheme has plummeted – most recently down a further 11% in the last three months from £103m in Q4 2010 to just £92m in Q1 2011.

The scheme is clearly not working as well as intended and there are continuing calls for the government to invest more and bring some life back into it.

As of yet there is no news about its replacement, but according to the Department for Business, Innovation and Skill website, it will continue up until 2014-15 delivering an additional £2bn to small businesses.

Under EFG the following facilities can be guaranteed:

- new term loans - unsecured and partially secured for working capital or investment purposes
- refinancing of existing term loans
- conversion of part of all of an existing utilised overdraft onto a term loan
- invoice finance guarantee
- overdraft guarantee

According to one AccountingWEB member that has used the EFG many times: “the scheme has been open to abuse in the past so it is important that the business case is strong and that you have a well prepared business plan/projections”.

Invoice Finance

Invoice finance is now more widely understood among SMEs and can immediately provide the working capital that many businesses need to grow.

As an alternative to bank loans and overdrafts, invoice finance is fast becoming a first port of call for funding small businesses.

Through invoice finance, such as factoring and invoice discounting, businesses can use a number of services.

Factoring, or debt factoring, is a financial transaction whereby a business job sells its accounts receivable or invoices to a third party in exchange for immediate money.

It releases the money tied up in up to 85% of a company’s approved customer invoices, and raises cash for working capital and expansion.

This is done through a professional credit control, debt collection and sales ledger management service.

Invoice discounting is an alternative way of drawing money against your invoices; however, your business retains control over the administration of your sales ledger. It provides regular and predictable cash flow, and leaves the business in control.

Peter Ewen, managing director of Venture Finance, said: “Invoice and asset based lending could be a step in the right direction as raising finance against real orders provides a long-term, sustainable solution against the easy, debt-based lending of pre-2008. Even the high street banks are becoming wise to this and are increasing their offerings in this area.”

Further information on factoring is available on the Asset Based Finance Association(ABFA) website.

Other options to help to ease cash flow problems - for companies paying staff on a weekly basis and for temporary recruitment - include:

- sales ledger administration
- optional payroll management
- debtor protection services

You may also wish to cover the invoices against any potential non-payment with bad debt protection.

Debtor protection insures you against the risk of debtors failing to pay, but also protracted default, whether debtors are based in the UK or overseas.

This safeguards profits, cash flow and the balance sheet.

Emerging Alternatives

At the start of the year the ICAEW published a new SME Access to Finance report, concluding that banks need to improve their relationships with SMEs as they are currently breaking down. An update from the institute is expected next month.

As a result of this breakdown more and more SMEs are turning to alternative finance models rather than traditional high street bank lending, and as such new alternative options are emerging.

Clive Lewis, head of enterprise at the ICAEW, recently said: “I think there is more interest in non-bank finance because it’s been so difficult.

“We’re trying to interest people in equity finance, but there are misalignments with venture capitalists who typically want to invest £2-10m in firms turning over up to £10-100m.”

However, these are not the same kinds of companies that are looking for smaller investment amounts, and this is the so-called “equity gap” that needs filling.

Emerging ideas in this area include online debt finance websites and private equity-backed finance websites, such as ThinCats.com which offers secured business loans without banks. 

One of the most interesting emerging alternatives is crowd financing. Several websites have been launched which allow the public to invest in businesses for as little as £10. One entrepreneur recently raised £75,000 using one such service.

What other alternatives have you come across?

Conclusion

As is often the case, the only barrier to a small business is trying to think like a bigger one. SMEs need to realise that some of these alternative sources of finance that they might not think are aimed at them, could in fact be suitable.

New funding models can certainly provide businesses with additional means to improve cash flow and growth through ongoing financial uncertainty.

Too much surviving and existing business in the UK is under-capitalised and as such we need to consider where the capital for recovery and growth is going to come from.

Venture Finance’s Peter Ewen added: “Those in power must take a common sense view of the financial landscape and ensure that they are helping businesses understand the full repertoire of funding they can access.

“Only by regaining financial confidence will businesses be able to look towards stronger growth and become the ‘recovery engine’ the UK so desperately needs.”

Rather than government focusing solely on the banks, the corporate finance mix will require new thinking going forward.

Source: Business Zone