As the UK looks to new businesses to boost economic growth prospects, access to finance for SMEs remains a thorny issue. 

According to research from alternative lender iwoca, 82% of SME finance brokers believe that high-street banks have reduced their appetite to fund UK enterprises. At the same time, 79% predicted that demand for SME finance will only rise in the coming year – and 84% signalled clients’ concerns about their ability to survive higher energy prices.

As the reality of that funding crunch hits home, business advisers are increasingly extolling the virtues of alternative finance routes, such as challenger banks – including brands such as Cashplus, Monzo, Revolut, Starling Bank and Tide – plus invoice factoring and asset-based lending (ABL).

Leveraging tech

Launched in the majority of cases from 2014 onwards, challenger banks have sought to distinguish themselves by operating in more agile, digitally driven ways than their high-street counterparts and providing more flexible services.

That flexibility extends to their lending criteria. “They can be more willing to assist SMEs with limited track records, shorter operating histories and lower credit scores – as well as unconventional business models,” says ACA-qualified portfolio CFO and fundraising expert Matthew Grimsdale. “If an SME faces difficulty in obtaining a loan from more traditional avenues, challenger banks offer a viable option.”

Applications can be much quicker and more streamlined, Grimsdale points out. “Challenger banks leverage tech within the process, so the majority of them integrate directly with your accounting system and go straight for your bank feeds. As such, there’s no requirement to print out the paperwork, put together a pack and send it off. The caveat is that the data in your accounting system needs to run pretty much in real time.”

Antony Smith, Director at funding advisers Business Expert, also hails the technological conveniences of challenger banks. “For example,” he says, “towards the end of last year, Tide acquired Funding Options – a smart move that enabled Tide to seed its banking app with credit options for SMEs.”

Grimsdale and Smith both stress that owners must conduct a thorough, side-by-side analysis of all the different loan products available across the UK challenger banks spectrum before making a commitment, to assess eligibility criteria, repayment terms and the scope for scalability in line with business growth.

To set the stage for a healthy working relationship, Smith urges, SMEs must also ensure they provide factual, transparent information. “This may seem an obvious point,” he says, “but National Audit Office research on the Bounce Back Loans Scheme found that a number of SMEs had led themselves into difficulty, specifically because information they provided on loan applications failed to reflect the true situation of the owner or business.”

Ahead of the curve

In its autumn 2022 report Don’t Bank on It, alternative funding specialists Growth Lending found that, despite the significant amounts of capital that are tied up in late payments, 49% of SMEs are unaware of the ability to relieve that pressure through invoice financing – or to unlock working capital through ABL.

Growth Lending Director of Debt Finance Vicki Taylor says: “By using invoice factoring or ABL to enhance its cash flow, a business is leveraging assets that it already has. That can provide additional flexibility over a traditional bank loan, as some lenders will enable businesses to either pay as they go, or pick and choose the assets to leverage – meaning that the business pays only for the cash it actually needs to advance.”

“SMEs always face cash-flow challenges from slow-paying customers,” Grimsdale says. “As a contingency, invoice factoring enables an SME to sell the debt held in outstanding invoices to a specialist provider at a discount. Typically, the maximum you can get invoice factoring out for is 120 days. So, the decision-making is about assessing what your capital flows look like.”

Importantly, he stresses: “You can be selective. For example, if you have major supermarkets on your order book, and most of them are good payers, but one happens to be awful, you can obtain factoring facilities for just that one client. It’s not an all-or-nothing deal.”

ABL, Grimsdale says, would suit any SME with a capital-intensive industry base – particularly in manufacturing or construction – as it enables businesses to leverage inventory, and/or hard assets such as machinery, to obtain loans.

“I work with a couple of businesses that make canned alcoholic drinks,” he explains, “and they utilise stock financing – a form of ABL – to maintain growth. To drive sales, they need physical gin and tonics sitting in their warehouses, ready to go out to retail within 15 days. ABL helps them get ahead of the curve by advancing them cash on that inventory.”

Richard Frazer, Director at Frazer Finance, points out: “Factoring companies typically base their decisions on the creditworthiness of the SME’s customers, rather than the SME itself. Similarly, ABL focuses more on the value of the physical collateral than the borrower’s creditworthiness.”

By leveraging their accounts receivable or tangible assets, he says, “SMEs can seize growth opportunities and increase payment security while covering the cost of the financing in the purchase cost of associated products.”

To ensure a positive experience, he adds, “Businesses must thoroughly evaluate the costs, terms and potential impact on customer relationships before committing to either option.”

Growth potential

In addition to the funding options provided by challenger banks, invoice factoring and ABL, growth-focused UK enterprises can also explore two finance routes available via the government-owned British Business Bank (BBB).

Companies have until 30 June to apply for funding through Phase 3 of the Recovery Loans Scheme (RLS), which – unlike its two previous phases – does not require businesses to demonstrate that they have been impacted by COVID-19.

Open to smaller businesses with a turnover of up to £45m – either individually or, where part of a group, on a group basis – RLS 3 supports term loans and overdrafts, as well as invoice financing and ABL facilities. Interestingly, challenger banks such as Atom Bank and Allica Bank are among the scheme’s accredited lenders.

RLS 3’s maximum facilities are £2m per business or group outside the scope of the Northern Ireland Protocol, and £1m for borrowers who fall within the Protocol.

Meanwhile, for high-growth potential enterprises with a laser-like focus on R&D and innovation, BBB subsidiary British Patient Capital is offering Future Fund: Breakthrough – a £375m, UK-wide scheme designed to catalyse co-investment from private backers.

Launched in 2021 and supporting funding rounds of a minimum £30m, the Breakthrough programme is open to businesses that have raised at least £5m in previous funding rounds.

Beneficiaries of the scheme so far include cooling technology developers Iceotope, computing innovators Oxford Quantum Circuits and biotech specialists Nucleome Therapeutics, who raised funding rounds of £30m, £38m and £37.5m respectively.