UK businesses main source of finance is bank lending,however, “bank lending is changing, with both cyclical and structural factorsat play” (“Boosting finance options”, 2012). In the case of SMEs, they mightface certain difficulties and problems when trying to access bank lending,which is why they should focus on raising finance from different available sources,which must appropriately fulfill their capital needs and requirements. Thecrisis of 2008 to 2009 affected the UK economy in many ways, in the case of banks,they became more risk averse.
This means that banks might have become lessinterested in giving loans to SMEs, because it might present a greater risk asopposed to investing in government bonds or treasury bills. Therefore, it canbe expected for SMEs to not be given any loans, in fact, “33% of SMEs applyingfor a loan were rejected” (“Boosting finance options”, 2012). This shows thatSMEs might not have been able to raise finance on time as not only did banksbecome more risk adverse, but they implemented additional requirements forborrowers to meet, such as “higher collateral requirements” (“Boosting financeoptions”, 2012). Hence, this can act as an obstacle for SMEs because they mightnot have enough collateral good, but also it might be risky to undertake. Thisis because if unable to repay the loan on time, the lender will be free to posesall the collateral goods, leaving the SME at a disadvantageous position, withthe possibility of going out of business. Therefore, alternative sources offinance, both internal and external might be of great potential for SMEs to useas well as larger companies, as it will be discussed in the next section. Due to the lack ofbank lending available to SMEs, it can be stated that a debt finance gap mighthave become more present.
In general, a finance gap exists because the totalfunding a company needs is smaller than the actual funding that is needed andavailable for the company to access. In the case of small start-up companies, accessingfunding might be a significant issue. This is because it might take themseveral of years before they are well established, but before this happenstheir business operations, sales and such might fluctuate greatly. This meansthat they might not be fully aware of their total expenses and might be unableto clearly and rightfully determine whether they need financial help.
Therefore, it is fair to establish that the debt finance gap might be mainlymade up of these companies, which might not play a key role in the UK’seconomy, yet. Nevertheless, the finance gap SMEs might experience can bereduced if they use other sources of finance as it was indicated previously. Corporate bonds, one of the main sources of finance SME’scan access, is often used to finance large scale projects, which is why itprovides them with long-term working capital. In 2009, 2% of SME’s usedcorporate bonds to finance their activities, and in 2010 this increased to 4% (Whiting,2010). This statistic shows that therehas been double the increase among SME’s using corporate bonds to finance theirbusinesses. Hence, it can be established that it presents a high potential forfirms to access and use it.
However, one of the reasons why SMEs might have notshown interest in relying on corporate bonds is due to concerns investors havein terms of liquidity and credit rating. This is because they “lack theappetite and resources to analysethe credit risk of small companies” (“Boosting finance options”, 2012), which means that it is more difficult forSMEs to access the bond market. Nevertheless, new policies are to beimplemented to address this issue and it is recommended for the “Associationof Financial Markets in Europe to explore the creation of an aggregationsagency to lend directly to SMEs and/or to pool SME loans to facilitate SMEaccess to the public corporate bond markets” (“Boosting finance options, 2012). Hence, this can help with therecommendation of UK retail investor to increase their interests for corporatebonds.
This is because retail investors might be more willing to purchase SMEsbond as it might be more trustworthy, and they are more likely to feelconfident to do so. Thereby, in the long term more SMEs will be activelyoperating in the corporate bond market, with the right policies in place aswell as receiving the support from the government during the early stages tolaunch it appropriately. Thus, this might make corporate bonds a highly usedsource of finance, helping tackle the debt financing gap among SMEs.
Moreover, many UK firms relying less on externalsources of finance, mainly to reduce the risk it involves and to be lessdepended on other entities. Therefore, firms might focus on raising financeinternally to carry out their business activities and this can be done through asset-basedfinance. SMEs can raise working capital and short-term cash loans by securingtheir assets including “invoices, stock, property, machinery and intellectualproperty” (“Boosting finance options”, 2012) as collateral. For example,”42,000 of the UK’s SMEs use accounts receivable finance” (Boosting financeoptions for business, 2012). This mightbe because some firms might no longer be able to receive bank lending as theymight have reached their limit, or they might be repaying an older loan and itmight not be sensible to take a second one.
Also, because they might only needto finance short-term needs, asset financing might be more adequate to use.Thus, this might not affect nor contribute towards a change in the finance gap.Furthermore, asset-based finance can be particularly beneficial for start-upsand other companies that might lack a credit rating and may be unable toqualify for a loan.
Thus, it will be relatively challenging for them to receivebank lending, and the process might take several months, making it timeconsuming. Hence, asset financing provides these companies with the financethey might need during the early stages, which can be crucial in the developingand growth of these firms. On the other hand, more mature and well-structuredfirms like SMEs can benefit from this finance. For example, firms that haveintellectual property rights in place against their assets might increase thelikelihood of being financed by any type of lender. This is because having IP rightssuch as trade-marks, patents and such add some degree of exclusivity of thefirm.
This indicates that there’s a great potential for this SME to appeal tothe targeted market place and perform well too. Therefore, if asset financingis used appropriately by small firms and SMEs, they should have more financeavailable and might not experience a finance gap. Nevertheless, there are behavioural barriers to the growth of asset financing by UK SMEsas they “appear to have negative perceptions and a general lack of awareness” (“Boostingfinance options”, 2012) because they tend to use it as a last resort. Hence, itis vital for educated and experience entities like financial advisors toprovide the guidance and advice for SMEs to rightfully access asset-basedfinancing. A third source of finance is that of mezzaninefinance, “a form of debt sharing characteristicsof equity” (“Boosting finance options”, 2012). It is a distinct form of debtfinancing mainly because it can be tailored specifically to the needs of acertain business. This means that it tackles explicitly certain businessesactivities, which include product development, penetration of new markets, andstrategic expansions including mergers and acquisitions. Therefore, mezzanine finance might help reduce the finance gap in theUK, as it provides a source of finance for SMEs looking to engage in any of theprevious strategic developments.
This is because, the mezzanine financer mightbe more likely to provide the capital needed if they see that the only purposeof its use is to finance their development. Nevertheless, in the real world a relatively smallnumber of firms use it, “only 1% of firms used mezzanine finance in 2010″(“Boosting finance options, 2012). In part, it is because although UK firmsknow how it works, they were unware of how to use it correctly and thus theymight have refrained from aiming to access it. However, with the help andguidance of financial advisors or programs made accessible for the firms,seeking to access mezzanine finance has a great potential to increase. Ultimately, havinganalyzed the different range of sources of finance UK small and start-up firmsand SMEs can access, it but are not effectively using them, it can beestablished that they are experiencing a finance gap. The “finance gap could be between c£84bn and c£191bn overthe next five years” (“Boosting finance options”, 2012), a relatively large amount that is not available for these firms tofinance their business activities. This is because banks and other lenders mightlack the capital they need to finance SMEs. This can also be due to a lender’spersonal choice on how to use the capital they have and what type of firms tofund.
For example, newer and smaller firms are riskier to invest in which iswhy lenders might not work with these firms. As mentioned before, certainsources of finance like corporate bonds are available but there are certainissues that do not lead SMEs to access it. Hence, influential stakeholders likethe UK government, financial advisors and both institution and individualinvestors should work together to find new ways to solve any issues and unlockgreater resources of finance. Furthermore, SMEs and small start-ups themselvesshould become more engaged in implementing and learning about the most adequatesources of finance they can access.
This means that their accountants orfinancial advisers must be well educated on this matter, to be able torightfully advice a company. They must determine and budget the funds andamounts they may require accordingly, to not find themselves lacking finance. Hence,with the input of both parties, lenders and borrowers the finance gap can bereduced, meaning that finance will be more accessible and available among allfirms in the UK.