One of the biggest issues in alternative finance is how to improve lending to small and medium-sized enterprises (SMEs). By “improve” we mean: get more money to SMEs, and to do it with efficiency. A the risk of endlessly stating and redefining our terms, “efficiency” carries with it the necessary implication that the funds must come from the alternative finance sector, given the consistent failure of banks and a well-meaning government (see below) to get funds across the SME funding gap.
There, we’ve said it: the SME funding gap. It is, broadly speaking, the difference between funds businesses would like to borrow and those they are able to borrow.
The World Economic Forum calls it "a global issue worth addressing".
“[SMEs] account for more than half of the world’s GDP and employ almost two-thirds of the global workforce. However, around the globe, SMEs often have one major pain point – dealing with their finances and ensuring appropriate funding.
Appropriate access to funding remains one of the most critical ingredients for the success of SMEs.” Over the past few years, a number of products and business models have emerged, catering to the needs of small businesses.
Globally, the SME Funding Gap is $2 trillion. In the UK, the SME funding gap is £4.3 billion, according to research by P2P business lender, Money&Co.
There are all kinds of bodies, quangos and theories, many of these last merely pious aspirations in disguise, all dedicated to bridging an SME lending gap that has been with us for decades. In the 1930s it even picked up a special name, being identified as the “Macmillan Gap”, and it had been around long before the report that gave it its name was even commissioned.
So who or what is trying to bridge that gap right now? The Bank of England’s Funding For Lending (FFL), the UK government’s British Business Bank’s various alliances and initiatives (numerous hook-ups and matched lending schemes with P2P lenders, and various innovations, the latest being the Enterprise Finance Guarantee), the Federation of Small Businesses, the Alternative Business Funding hub… the list is long. There’s clearly a diffuse, general ache to get money to SMEs, but a lamentable inability to do so. The latest FFL figures are symptomatic of well-intentioned inefficiency.
But maybe, just maybe, there’s a simple, obvious answer, right under our noses.
There’s a vast source of untapped liquidity in the form of savers’ cash – be it monies simply wasting away in building society and bank deposit accounts, or stored in Cash Individual Savings Accounts (ISAs).
If 1 in14 ISA investors put money into a P2P loan IFISA, the gap would be bridged
This is all the more obvious following the launch of the Innovative Finance Individual Savings Account (IFISA) in April. IFISAs allow individual investors to hold peer-to-peer (P2P) loans within their tax-free wrapper.
The saving public currently settles for very low yields (often less than 1 per cent for cash deposits) on offer “for the £1.4 trillion (yes, a thousand times £1.4 billion) that Building Society Association figures show is lying around on deposit at banks and building societies”, as Money&Co. recently put it.
A small percentage of that money is held in Cash ISAs (earning modestly more – but still very little compared to the average yields offered by leading P2P platforms. A good long-term Cash ISA might bring in three per cent, whereas a conservative portfolio of P2P loans might be expected to yield around 8 per cent).
According to figures supplied by HM Treasury for the last full year (2014-15) there were ten million Cash ISAs taken out in that year, and an additional 2.7 million stocks and shares ISAs The total amount subscribed to Cash ISAs was £60 billion. That means the UK's SME Funding Gap if the equivalent of slightly more than seven percent of the funds UK taxpapers put into Cash ISAs.
In short, the money is there. If one in fourteen investors could be persuaded to put their Cash ISA money into an alternative finance vehicle, a P2P loan-invested IFISA, the SME funding gap would be closed entirely.
Now, how do we go about persuading investors to do this?
The new sector is is hampered by badly articulated demand from SMEs
First, we’d like to see the demand for funds – the cry from the SMEs for cash – get louder, and become more focused. Many SMEs are still not aware of alternative funding (sources too numerous to cite - new articles are published weekly, with variable-quality data but the same findings: the SMEs want money but haven’t looked much beyond stingy banks) SMEs who are aware of the alternative funding providers often do not approach them until they have been turned down by the banks.
On the other side of the gap, retail investors often complain about poor returns on savings and investments (again, citations too numerous to detail) but this does not translate into a change of behaviour. Abundant anecdotal evidence would point to a stream of articles in the mainstream and financial press that promote fear, uncertainty and doubt around alternative investments, but do not alas, promote investor education.
In the middle are the relatively new crowdfunding platforms, be they equity providers (taking a slug of equity in exchange for seed or mezzanine money). Again, there are P2P lenders, who typically deal with later-stage SMEs whose management does not want to give away a stake in the business.
In summary: this new financial sector is geared up to satisfy demand from SMEs, but it is hampered by inchoate, badly articulated demand from the SMEs themselves. This is sometimes compounded by a sense of fear amongst svares and investors. Crowdfunding’s novelty can be presented as dangerous chicanery by sections of the mainstream media.
So what’s our suggested strategy?
It’s simple, but difficult to achieve: let's promote behavioural change in SMEs seeking funds, and amongst retail Investors.
Our aim should be to improve awareness of novel solutions, articulation of one's own needs, and above all communication between entrepreneurs and investors, leading to realistic expectations and mutually beneficial outcomes – which, reduced to the variables of economics, will be manifest as improved allocative efficiency of the SME funding market.
After years of inertia amid loud predictions of change, suddenly it arrived in a flash
Growth could and should come from innovation, diversification and expansion. Typical crowdfunding examples include biotech, FinTech, and digital, but also more down-to-earth SME businesses like catering - the pub that builds a microbrewery in the basement, or the curry house that opens a new branch in a nearby town.
We think change will come in the way that people get rich or go broke – very slowly, then very quickly. The internet was slow to change consumer behaviour back in the 1990s. Remember back in 2000 when latminute.com was IPO’d? Some were predicting the death of print newspapers at the time. A few years later those same commentators were ridiculed. Newspaper circulation had stayed reasonably solid, and advertising revenue was steady. Then… timber! In 2010, Arthur Selzberger Junior, publisher of The New York Times, announced that it would eventually cease its print edition. Just a few weeks ago The Independent and The Independent on Sunday ceased to exist as a newspaper, surviving only online. After years of inertia amid loud predictions of change, suddenly it arrived in a flash – and all those dinosaur of print analogies seemed quite fair.
The behaviour of SMEs and retail investors could and should follow a similar pattern. Through diffuse social lobbying, new methods of media and content consumption, the advent of Millennial Investors (witness a new blogger on this site, who runs a portfolio of P2P debt and equity funds from his mobile phone) and other diverse factors, the change will come. It may come sooner, it may come later. But when it does come, it will come suddenly.