The rise of the debt-shy SME: Why business borrowing is broken – and how to fix it

Verus360’s TIM EVANS explores the phenomenon of the permanently non-borrowing business, and looks to a fairer future for SME finance.

© Verus360 May 2015 | www.verus360.com

The ‘funding gap’ for UK businesses is well documented. However, there is evidence that risk-averse lending strategies by the big banks have created a new breed of ‘debt-shy’ SMEs who are permanent non-borrowers.

@Verus_Tim

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Contents

1. The problem for SMEs 3

2. The challenge for traditional lenders 5

3. The tech-enabled customer 8

4. The business solution 10

5. What’s next for business finance? 15

6. Introducing Verus360 18

© Verus360 May 2015 | www.verus360.com3

The British Business Bank’s recent report,

The Business Finance Guide – a journey from

start-up to growth, estimates the finance gap for

small firms to be a modest £1bn a year. The Breedon

Report, published by a government committee

led by former Legal & General boss Tim Breedon,

actually suggested a gap of up to £190bn by 2017.

The Treasury Select Committee’s recent report on

Conduct and Competition in SME Lending revealed

that bank loans to business plummeted by £800m

in the final quarter of 2014, as well as highlighting a

lack of choice and poor treatment of customers.

The findings also pointed to providers' inability to

justify excessive and often vague fees. This was

reiterated in a recent Market Invoice report, which

revealed that British businesses were stung to the

tune of £425m in hidden costs last year.

Commercially responsible lending is essential

for the UK economy to continue to grow

post-2008. Yet, seven years on from the UK’s

deepest recession since World War II, and many

small-to-medium-sized businesses (SMEs) are

still feeling the pinch.

SMEs clearly need access to funding to expand

or improve their businesses – but the fact is that

they’re still finding it difficult to borrow. Despite

occasional signs of an upturn, banks are still not

lending on a scale that meets demand.

1. The problem for SMEs

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The lack of comparable data around the true cost

of business finance can be confusing for customers.

Independent research conducted by Future Thinking

for Verus360 in 2014 shows that 40% of UK SMEs don’t

even know how much they’re paying for finance, while

60% say they're not easily able to compare finance

costs between lenders.

Access to finance is often further hindered by

bureaucratic, lengthy and prohibitive loan application

processes, as well as outmoded thinking, lo-tech

systems and a lack of truly customer-focused solutions.

Combine this with an industry-wide lack of transparency

around pricing and confusion over alternative financing

options, and it’s understandable why businesses can’t

easily access funding – essential for survival and growth.

It also starts to explain why some businesses are turning

their back on using finance altogether – with an impact

on their business growth potential and, arguably, the

broader UK economy.

All of this has helped to create a ‘debt-shy culture’

among high-growth SMEs, along with a reluctance to

borrow for their business.

Last year a British Banking Association report highlighted

that 48% of SMEs were ‘permanent non-borrowers’,

who did not want or plan to use external finance in the

future. And earlier this year, Phil Orford, Chief Executive

of the Forum of Private Business, pointed out that there

was still a subdued appetite for lending among SMEs.

I don’t know how much I’m paying

for finance

I can't easily compare lenders

and costs

40% 60%

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While finance provision remains low, many SMEs are

reluctant to apply for funding in the first place. This is

The Chairman of the Treasury Committee, Andrew Tyrie,

recently confirmed that SMEs remain wary of asking

banks for loans, or even for advice, admitting that:

"Confidence has been badly shaken, and that needs to

be re-built. That’s a big job, and it’s not going to be done

in a year or two. It’s a job that will need to take place

over many years."

2. The challenge for traditional lenders

The main institutional lenders seem unable to

respond to the funding gap, and therefore play

their part in closing it. There needs to be a greater

alignment of products and services with client

needs, while also acknowledging the changing

nature of SMEs and re-establishing customer

confidence.

Confidence has been badly shaken, and that needs to be re-built. That’s a big job, and it’s not going to be done in a year or two. It’s a job that will need to take place over many years.

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So how do major lenders go about rebuilding customer

confidence, re-gaining trust and changing behaviours to

encourage borrowing and further economic growth?

There are multiple issues they need to address:

1 . R E S T R I C T I O N S O N L E N D I N G

Post-2008, there has been an increased focus on capital

adequacy, with banks needing to manage risks more

closely to ensure they’re able to withstand future crises.

This has created more restrictive lending policies, and

tighter underwriting to which lenders have to adhere

– which in turn means fewer SMEs getting the funding

they need, whether it be first-time loans or corporate

overdrafts. According to the Treasury Select Committee,

SMEs have also underestimated their chances of

securing bank finance by between 7 and 16%.

2 . R I S K - C E N T R I C C U LT U R E

The industry has to accept that customers are good,

honest business people, looking to make a success

of their lives. This will mean moving away from a ‘risk

above everything’ culture, where lenders’ response to

the prospect of customers defaulting is to increase the

cost of credit.

3 . T H E V A L U E O F F E R E D

Financial institutions have to think about why they’re

in business, and what it means for them to offer best

total value. Of course, lenders need to make money,

manage risks and generate shareholder dividends, but

that’s only part of the picture. What about solving the

problems that customers may have in making a success

of their businesses? There is arguably a greater social

part here for lenders to play.

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4 . E N G R A I N E D I N F L E X I B I L I T Y

It’s no longer acceptable to attempt a ‘one size fits all’

approach to products and services. Lenders need to be

more flexible and re-think what they offer to customers.

This means considering how their propositions fit in

with clients’ businesses as a whole – including other

products, services and processes they may be using.

5 . O U T D A T E D B U S I N E S S M O D E L S

The industry has to shake off outmoded mindsets and

embrace a customer-led culture. This may be a big ask

for the established and traditional financial services

institutions. They have massive legacy infrastructures

to contend with – the technology and systems, plus

ingrained policies, processes and internal reward

systems where targets are linked to employee pay.

The legacy operating models of these Goliaths are not

designed to be changed quickly, and can perpetuate a

culture that’s anything but customer-led. That’s not to say

there aren’t great people working in these institutions

who want to make a difference, but it’s about enabling

them to do so.

6 . L A C K O F C U S T O M E R F O C U S

Since the financial crisis, we’re still seeing the after-

effects of inappropriate lending decisions, and a lack of

funding options that are truly customer-focused.

If lenders start with concern for their customers at the

very heart of their thinking, they can create ‘customer

first’ finance products that are set at a commercially

responsible price. That way, they can provide real value,

and treat the customer fairly – while acknowledging that

their customer base is also changing.

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The ways in which SMEs are undertaking

transactions and connecting their businesses

together are evolving, thanks to a seismic shift

in how technology is used to enable business.

3. The tech-enabled customer

An explosion of tech-enabled finance is removing barriers...

...product development is no longer the sole domain of the banks.

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Customer Relationship Management (CRM) by businesses

is increasingly shifting towards social media to engage

with customers, with businesses building accessible

LinkedIn-style networks that foster a more open market

and encourage real-time collaboration. Greater numbers

of transactions are processed using cloud-based

technologies, as businesses become comfortable with

connecting and extending their processes online via

innovative, customer-friendly apps.

SMEs now have greater choice and control over

products and services, in terms of both business finance

and the financial technologies (‘FinTech’) that support

business operations. This explosion of tech-enabled

finance has come about because it’s easier, cheaper

and quicker for lenders to build applications using today’s

technology – removing barriers that once made financial

product development the sole domain of the banks.

The number and sophistication of services online is

growing daily, giving customers greater access to niche

products that may better suit their specific needs. In

turn, as it becomes easier to find new products, services

and recommendations, further market opportunities are

created for lenders, meaning more product choice. It’s the

classic ‘long tail’ effect, as described by Chris Anderson

in his best-selling book The Longer Long Tail: How

Endless Choice is Creating Unlimited Demand.

All of this is great news for SMEs in terms of accessing

finance. It means they can sidestep the continued

challenges of borrowing from traditional lenders and no

longer have to rely on ‘one size fits all’ offers. It’s also

providing opportunities for a new, alternative breed of

business funders.

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4. The business solution

T H E R I S E O F A LT E R N A T I V E F I N A N C E

As the banks struggle to serve SMEs, we’re

seeing a boom in alternative finance – a broad

term taking in a potentially bewildering range of

non-traditional funding options...

● corporate venturing

● asset-based lending

● venture capital

● private equity

● crowd funding

● peer-to-peer lending

● supply chain finance

● self-issue retail bonds

● business growth funds

● pension-led funding

● business angels

● invoice trading

● public equity

● retail bond markets

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The Independent innovation charity NESTA

released its own survey of the alternative

finance market in 2014. Its Alternative Finance

Industry Report highlights that the value of the

UK market more than doubled year on year

from 2012 onwards, while estimating that,

in 2014, SMEs accessed £1.74bn in funding

through various alternative finance models.

Customer concerns around the robustness

of non-traditional lenders are disappearing.

Alternative finance routes are fast becoming

the new ‘normal’ for SMEs to access funding,

with a recent survey by the UK Bond Network

finding that more than two-thirds (68%) of

UK SMEs would now consider alternative

finance as a way to raise capital.

68%

I might use alternative financing

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There are four key factors contributing to this surge:

1 . A C C E S S I B I L I T Y

Ease of access is fundamental to the success of

alternative finance, as discouraging barriers around

onerous paper-based application processes are

removed. Thanks to technology, getting funding online

is becoming simpler and speedier than traditional

forms of funding – meaning fewer SMEs missing out on

time-sensitive business opportunities.

2 . F L E X I B I L I T Y

The sheer variety of options available means borrowers

can mix and match providers, products and services,

customising the products to their particular needs and

to meet different events in their business lifecycle.

3 . I N C R E A S E D C U S T O M E R F O C U S

The culture of alternative finance, including the more

disruptive FinTech industry, is less risk-obsessed, and

open to greater collaboration with its customer base,

creating products and services that are more customer-

led than those offered by the traditional lenders.

4 . I M P R O V I N G P R I C I N G

Pricing is becoming more competitive as increased use

of technology reduces operating costs – so the cost

to businesses can be lower than the overall cost from

more traditional forms of funding. That said, SMEs must

establish the full cost of the finance, not just the headline

rate. Pricing is still not transparent enough.

All of this results in better products, a greater fit to need, and improved access to finance, supporting the growth of

UK business and helping to optimise working capital needs. Alternative finance is by no means a mature business

environment, however, and this emergent form of funding still comes with caveats.

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For example, one UK business loan company offered a

headline rate of 2.1% for a 10-week business loan. Closer

examination of the offer revealed that even a low-risk

‘five-star’ rated company which repaid the loan in 10

weeks would pay an APR of 11.4%. A higher-risk ‘one-star’

rated company would pay 14.4% over the same period,

translating into an APR of 101.3%.

The lure of the headline rate

As with traditional forms of finance, the

temptation to be drawn in by initially attractive

headline rates remains an issue for businesses.

While the true innovators in this space try to

make pricing simple and transparent (compared

to the maze of hidden fees, unexpected

charges and ambiguous extra costs levied by

many of the institutional lenders), customers

have to look beyond the headline rate and

make sure they’re aware of exactly what they’re

paying for. HEADLINE RATE

14.4%

ENDING APR

101.3%

© Verus360 May 2015 | www.verus360.com14

42%

I didn't know about all of

these options

Finding the right product

Alternative finance is a noisy sector. While the

choice of finance products is increasing, the

breadth of options can be confusing.

NESTA’s report found that 42% of businesses

with an annual turnover of less than £1.1.m

weren’t fully aware of the options available.

Knowing where to find the right providers is

important. Some forms of alternative finance

come with restrictions, while others are

sector-specific, so businesses can find it hard to

understand which products and services are

right for them. The key consideration for SMEs is

to do their homework before committing.

© Verus360 May 2015 | www.verus360.com15

We’re currently at a tipping point in the UK

regarding the way that businesses access

finance, and although this has brought about

much in the way of positive progress, further

change is needed.

M O R E I N F O R M A T I O N O N A LT E R N A T I V E F I N A N C E

As the lending landscape evolves, the new kids

on the block must provide SMEs with clearer

directions on how and where they can access

alternative forms of finance, as well as what the

different options are.

5. What’s next for business finance?

Things are improving as customer awareness rises, but

more effective signposting is still required.

Conrad Ford, Chief Executive of Funding Options, an

online 'one stop shop' for alternative business finance,

points out: "Not all firms fit traditional bank lending, and

for most of the hundreds  of thousands rejected each

year there are other finance options if they only know

where to look."

“Sadly, most of these businesses will give up after the

first hurdle – leading to lost growth and employment

opportunities across the UK. It's incredibly encouraging

to see a growing focus on helping firms to  navigate

the often complex and confusing world of alternative

business finance, most notably through the government's

new mandatory bank referral scheme."

There are other finance options, if only businesses know where to look.

© Verus360 May 2015 | www.verus360.com16

R E F E R R A L S F R O M B A N K S

While banks continue to turn down potential customers

for funding, they should be more willing to refer those

businesses on to alternative finance lenders. Such

partnering is already happening to an extent (between

Santander and Funding Circle, for example). That said,

it will be interesting to see the shape of the industry –

and which business sectors are channelled en masse to

alternative finance providers by the 'big four' UK banks

in the following months, now that this has been made

mandatory as part of the Small Business, Enterprise &

Employment Bill.

A D A T A - S H A R I N G C U LT U R E

A different mindset will also be required of SMEs

themselves, to embrace an open data-exchange culture

between themselves and lenders. The majority of the

new, technology-driven funding services are enabled by

information, and require good data from the customer.

To get the best out of alternative finance, plus other

FinTech-style products and services, SMEs should not

underestimate the importance of having high quality

data (including indepth accounts, transaction data and

customer details), as well as its ongoing management.

So, in the same way as in the consumer world we are all

heading towards the idea of the quantified self – using

the personal data gathered by wearable and mobile

apps to improve our lifestyle – the same will happen

with financial data. Businesses will quickly aggregate

all the different information about their performance,

their customers and their competitors, giving rise to the

‘quantified business’.

A different mindset is required – from both banks and SMEs.

© Verus360 May 2015 | www.verus360.com17

The insights this data produces will enable SMEs to

become more agile in their performance, and more

competitive.

In essence, the future of business finance is a positive

one. A shift away from the restrictions of the institutional

lenders, combined with an explosion of new opportunity

offered by technological advance, has enabled a more

diverse market that’s easier and faster to access, as well

as being more competitive.

What’s needed now are solutions that address the

problems with traditional lenders and embrace the

positives of alternative finance (such as its flexibility and

availability). At the same time, they need to address the

continuing issues around transparency of pricing – as

well as providing information, choice, and best value for

the customer.

Only then will we see the next great leap forward in what

can be achieved within the lending landscape. Whether

this changes the ‘permanent non-borrower’ attitudes

and behaviours remains to be seen.

But what's certain is that, in order to succeed, this

cultural shift needs to be put in place by people who

are passionate about doing the right thing – and in the

right way.

And that's where we come in...

© Verus360 May 2015 | www.verus360.com18

Verus360 is a brand new business, dedicated to

providing fair finance for SMEs. Many businesses

sometimes feel that their finance arrangements

are in control of their business, rather than the

other way round.

We’re here to change that, with an innovative

online business finance facility that’s easy to

use, fairly priced and puts you in control.

6. Introducing Verus360

Our vision is quite simple – to reinvent business

finance

How does it work? We’re offering a flexible business

loan (similar to a secured overdraft), based on a full

understanding of your business profile. Delivered totally

online, at your convenience.

Instead of borrowing a set amount of money over a fixed

period, we provide a facility up to an agreed limit. You

choose how much you want to use each month, and

we charge on that usage alone. There are no minimum

fees, no service charges, and no hidden costs. If you

don’t use the facility, you don’t pay a penny. What’s

more, we don’t ask for personal guarantees, and there

is no assignment of personal property.

Our vision is quite simple: to reinvent business finance.

We’ve created something we believe can revolutionise

the market. Join us as we change the face of the business

finance landscape.

Tim Evans

S T R A T E G Y, I N N O V A T I O N & B R A N D D I R E C T O R F O R V E R U S 3 6 0

@Verus_Tim

Tim leads Verus360’s thinking on how we bring

value to our customers in a digital world.

With nearly 20 years’ experience in SME finance,

he ensures the customer voice is heard and that

we continue to break new ground in search of the

perfect customer experience.

19

Get in touch

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Registered in England and Wales (co. no. 08812878).

Registered office: 105 Duke Street, Liverpool, L1 5JQ, United Kingdom.

© 2015 Verus360 Limited

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Verus360 is a UK-based business dedicated to delivering

innovative online business finance products and services to

small-to-medium-sized businesses (SMEs).