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The evolution of innovative finance models continues

Changes to the SME lending market are showing no signs of slowing down, so SMEs and accountants need to keep on the ball moving forward.

Insights Karen Mortimore, SRJ Walker Wayland 07 July 2017
— 3 minute read

The ability of SMEs to grow and innovate is being stifled by current tightly-controlled lending practices by the major players in the finance industry.


Do SMEs need to have a total mindset change, accept a higher cost of funds to unlock funding options and to keep the risks confined to their business?

Challenges faced by major banks

The banking sector is facing increasingly restrictions by APRA on their lending practices.

Banks, required to consider risk and governance, have internal checklists and rigorous processes with traditional parameters and restrictions on lending to some industries.

The major banks have generally continued their stance in favour of asset-based secured lending which usually means the family home is on the line.

Non-bank lending

Non-bank lenders are regulated and, although they don’t hold a banking licence, they are still held to the same fair lending policies as banks.

These types of institutions are privately owned, which gives them more leverage and flexibility with terms, rates and products they can offer to their customers.

Non-bank lenders provide financial services such as investment, risk pooling, contractual savings, market brokering and could also include insurance companies that issue bonds.

SMEs have typically had fewer opportunities to diversify their funding sources through equity and international debt markets.

What SMEs want from lenders

Ability to grow – An appropriate covenant structure that will not constrain but facilitate the company’s growth and ensure its position is protected in the event of a downside scenario.

Certainty – Appropriate facilities to meet objectives.

Personal asset protection – Separation of personal and business interests while potentially freeing cash for personal wealth creation. Facilities that exclude residential home as security.

Funding package for future – Multi-option facilities, term debt, working capital funding and offshore growth assistance.

Do SMEs need to change their attitude to the cost of funds?

The question often asked of an accountant by their client — what is the right return for an SME? Cap rates of around 33 per cent are often considered reflective of SME risk.

Having determined their personal risk, the same client will be aghast at paying greater than 6 per cent cost of funds while bemoaning the fact that the family home is on the line.

This expectation divide can negatively impact on the ability of existing businesses to raise finance, affecting the ability of the businesses to grow and having the potential of reducing the growth of the businesses, thus decreasing value.

Should SMEs have a mind shift around the funding model for their business and consider a lender with alternative funding strategies (more of a funding partner) and accept a higher cost of funds if this means not having to provide personal guarantees or personal assets as security?

What could a non-bank lender potentially offer?

Non-bank lenders have a different attitude to risk than the major banks and may focus on lending to the business rather than an individual while factoring the increased risk into their cost of funds.

There are currently limited products available for cash flow funding for SMEs with debtor financing and trade facilities, the main product offering for SMEs.

This is because, from the funder’s perspective, an interest return only is not an appealing proposition, even if the interest rate is appropriately adjusted for risk.

A non-bank lender/private equity may consider a blend of debt and equity return in the form of convertible notes or preference shares with coupons.

The accountant’s role

Typically, an accountant’s role has involved passive introductions to first-tier banks and to build a financial model for the purposes of the finance application.

Often, this financial model sees no further light of day and the benefits to the business of an effective budgeting, management and control tool are lost.

Accountants should consider broadening their horizons and developing networks of non-bank lenders who could potentially offer funding solutions for their clients who currently are struggling to grow due to cash flow challenges.

The role for the accountant would be a proactive one to get their clients “debt and equity ready” and, in the process, gain a deeper understanding of how the business manages its risks. Assistance would be provided to the client to complete a strategic business plan with risk profiling.

Accountants can also assist SMEs to improve business performance, their financial literacy and financial management by creating a three-way financial model well in advance of a finance application in order to –

  • Improve quality and timeliness of financial information available to the business to assist in decision making processes
  • Demonstrate serviceability as the business grows
  • Stress test the business model under different cost of funds scenarios
  • Show how the business manages risk by providing a track record of budget versus actual performance (i.e. the business is under control).
The evolution of innovative finance models continues
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