Finally some Spring Sunshine for SME owners

SMEs ahoy! Some good news for you on financing… some enlightenment on just why it’s so scarce… and how you can make a difference to improve financing opportunities for yourself and for others!

There’s not much love from the financing community, who tend to be publicly supportive, but quietly prefer lending to large corporates thanks to regulator-imposed “capital adequacy ratios”. That’s also assuming you’re not auto-screened out by a requirement for ‘three years profitable accounts’ or similar – a high hurdle for a growing business.

OVERLOOKED BY THE BANKS

NEVERENDING BEURAUCRACY

Who would want to be a small or medium-sized enterprise (SME)? It’s a reasonable question.

There’s not much love from the financing community, who tend to be publicly supportive, but quietly prefer lending to large corporates thanks to regulator-imposed “capital adequacy ratios”. That’s also assuming you’re not auto-screened out by a requirement for ‘three years profitable accounts’ or similar – a high hurdle for a growing business.

CRUNCHED BY CREDIT TERMS

You also have the financing needs of your business to balance. The larger corporates, your customers, use their credit muscle to stretch payment terms, often paying late - with seemingly no consequences. This pushes credit requirements onto SMEs who can least afford it – at a macro level a chronic supply chain inefficiency of capital allotment.

And yet… SMEs are always touted as the lifeblood of every economy – upon whose shoulders the success of every nation’s GDP sits. The SME community do the majority of the heavy lifting on employment in most countries.

The above all leads to what’s articulately but euphemistically labelled as ‘the trade finance gap’, a challenge that many parties would like to solve. Efforts to date have proven unsuccessful given the gap continues to grow, with estimates of that number now in the multiple $trillions!

But every business and story is individual. Every company’s struggle behind the big number is real. Despite the high level collective headline of the problem, in whatever country you’re in, entrepreneurialism and SME management can feel like a lonely existence. It’s just as well it’s a calling, not a job!

“Good news the headline said? I’m not feeling it…”

Fair comment. And we’ve not even covered the fact that the export credit agencies, intended to be an ‘SME support function’, are often administered by that same financing community. The standard approach is now lumping products, industries and geographies into crude classification buckets for financial crime compliance convenience. The upshot? … your exciting new (and hard won) potential market is actually their “high risk” headache.

“Throw me bone here – the good news please for SMEs?!”

Simply put, it’s the move from hard copy documents to electronic documents as the acceptable medium for international trade (underpinned by the UK’s Electronic Trade Documents Act 2023). UK law underpins the majority of international trade contracts (so it’s not insignificant – Law itself is one of the UK’s greatest unsung exports in itself - with a global impact).

The trade finance gap, stated to be in the $trillions is, in our opinion, grossly underestimated, with many companies not seeking trade finance due to the time lag for manual documents to traverse the globe in parallel to their goods. These potential trade transactions are not captured within the stated gap. We contest that many companies would seek trade finance if it was worth the effort time-wise. Digital documents are making this a potential a reality, with the speed of execution meaning weeks of additional financing are now being made available. Suddenly trade finance becomes worth the effort.

Invoice financing is not a new concept. But restructuring trades to accommodate digital execution is – and it’s a game changer. With digital payables and receivables finance, SMEs can quickly access funds tied up in their working capital. Unlocking cash held in invoices often requires education though, with less than 25% penetration in the SME market, as small business owners juggle the multitude of challenges they face.

“Revenue is vanity, profit is sanity, but cash is king” is also not a new concept – but for growing companies there is inevitably a small relinquishment needed on profitability to give lungs to the organisation, so that the oxygen (cash) can facilitate longer term growth. Giving up some profit margin on financing for increased revenue is pragmatic business sense to facilitate growth. Freeing up working capital can enable that new factory to run at full capacity, or make possible fulfilment of that game-changing large order which can’t otherwise be funded.

Leveraging sales revenues via digital structuring and execution is an underused lever which can unlock cash quickly and flexibly. Many corporates are not even aware that pre-shipment finance is possible.

“And the enlightenment piece on why funding is so scarce for SMEs?”

So there’s two sides to every story. For SMEs the difficulty in attaining credit isn’t that your business isn’t liked or that your financial institution doesn’t want to support you – it’s related to the capital opportunity cost for that financial institution

CAPITAL RATIO REQUIREMENTS:

Regulations dictate that banks can lend multiple more times of their available capital to products like mortgages than they can to SME funding. This is due to the aforementioned capital adequacy ratios, with banks, not unreasonably, electing to allocate their available capital to mortgages ahead of SME lending, leveraging a significantly higher yield for them on their available funds.

COST OF COMPLIANCE

The cost of compliance has become commercially punitive for banks. The risk profile of lending to an SME vs lending on a locally domiciled house requires the former to have infinitely more active monitoring (and associated operational cost). You can see the banks’ predicament for their own decision making and capital allotment.

LEGACY SYSTEMS

The problem is itself further compounded by legacy bank systems that are ancient and barely capable of accommodating today’s Regulations, which are becoming forever more onerous. Banks’ systems simply were not designed for them.

Looking at the UK as an example – these lending dynamics might help explain why we have continually rising house prices, set against a stagnant economy with productivity decreasing per capita. Inadequate SME lending is fundamentally harming our chances of economic growth…

Not without some irony, given credit creation is overwhelmingly the preserve of those with a banking licence, the availability of private credit has increased exponentially within a generation – that same private credit is now coalescing and flooding the markets as an alternative financing solution/competition to the very institutions that created it. So SMEs keep your eyes out for alternative lenders – that market is growing! A note of caution though – with lighter regulation (and often then with accompanying lighter due diligence for those who want to cut corners) the longevity of Non-Bank Financial institutions (NBFIs) is not comparable to established banks – as recently demonstrated by some notable NBFI failures. SMEs still need a reliable partner for financing to build the preferred longer and trusted relationship – so if going down that route, choose any NBFI wisely!

“Interesting – ok – but as an SME what do I do from here with my business that can actually make a difference to me?” Well, its actions stations everybody….!

For SMEs/corporate personnel

Badger your Bank/NBFI to move to digital execution - it is available in the market right now! It’s one of the rare win wins – there is a long term operational cost saving for both you and them – and crucially time-to-money is reduced by days or even weeks. It is in their interests to be adopters … so your advocacy should be pushing against an open door. Logically this should lead to sharper pricing for your facilities – but baby steps (!).

Digital execution isn’t just coming down the track, it’s here. By courtesy of the Electronic Trade documents Act (2023), electronic documents can be now be possessable and therefore financeable. There’s no API or expensive IT integrations needed – the process can be tested transaction by transaction to see the benefits.

Digital execution reduces operational costs and speeds up time to money - resulting in happy customers! Swifter execution of already approved deals will mean money is at risk for longer, increasing deal profitability too.

For bank personnel

Win wins are a rare commodity (neither tradeable nor financeable in their own right before this audience asks!) – but the digital future is here, today. Electronic trade documents offer benefits to parties across the industry – including both institutional and private credit. If you’ll forgive just one plug (for the benefit helping move the needle on trade digitisation) for anyone still scratching their head – take a look at Mercore – an NBFI providing digitally executed trade finance to SMEs right now.

Additionally, does Mercore provide finance across the more complex markets and transactions, that many other financiers turn away? Absolutely! Through innovative transaction structuring and thorough due diligence processes, Mercore lays the groundwork for long term, sustainable business relationships.

Wishing the best of luck to SMEs globally. And if you think it’s a lonely fight, it doesn’t have to be. For all the economic gloom that may seem to be out there - remember that somewhere its always spring time (and there is help available to find those markets – wherever they may be). Green shoots are always spouting – and there’s a long overdue digital revolution in trade finance coming, with financing partners established and keen to help you on that journey.

In Summary

The intention of this article is simply to spotlight and drive greater adoption of what’s already in existence but to date has, as an unfathomable anomaly, had slower adoption rates than expected presumably due to lack of awareness.

www.mercore.com