Finance Market Update - 26 October 18
Are SMEs accessing the right kind of finance to grow? In this update we discuss differences between banks and fintechs, and the current business loan market.
Slow Spring Season
Before we dive into this update focused on business finance, we wanted to reflect on our update from 28th September when we predicted a slow spring season. While the season is not over yet, the most recent auction clearance rates from Core Logic have hit 6-year lows in Melbourne and almost decade lows in Sydney. We see this “Credit Crunch” being the main driver of weakening property prices and low auction rates, which is set to continue.
The modern business lenders
Over the past few years “Fintech” (financial technology) start-ups have been offering easy to get business loans. This has been both good and bad for businesses.
Good because up until then small businesses main source of finance was a bank, and they had very specific credit policies for lending to businesses and usually needed property as security, so all of these new lenders made finance more accessible. Fintechs have been filling a gap in the finance market.
Bad because the cost of the loan, the effective interest rates and fees, is potentially much more than a bank costs and the default rates on the loans is quite high. The unsecured nature of these loans means effective interest rates could be around 30%.
Many small businesses that took out these loans didn’t grasp that they needed to get significant 'ROI' (return on investment) from the loan in terms of sales and profit to make it a viable option because they cost so much. Running daily operations using these loans is the costliest way to do business, a business should have an efficient source of debt and working capital to grow.
Worse, many small business keep going back to the online lenders when they need cash instead of planning ahead, getting the right debt facilities in place and having a budget. This can trap them in a vicious cycle of taking on easy to get expensive debt and constantly having to pay it back which ultimately drains their cash flow and profit.
Banks are not always easy to deal with, and usually they want property as security for a business loan. The benefit of giving them property as security is the rates are lower.
The Fintechs by comparison usually have slick online application forms and websites that make it really easy to click the apply button, and once you do the funds can be in your bank account within a day or two or even hours.
All of this easy money has flooded into the Australian business loan marketplace and it has been welcomed by small businesses.
Especially at a time when property prices are up, a young entrepreneurs seeking capital to start or grow a business might not be able to get a loan, let alone a property to use as security for a business loan.
Even more established businesses have taken on these kind of loans to supplement cash flow, and when done right, it can make sense.
There are many finance options available to businesses outside of banks and Fintechs, particularly relating to supply trade and working capital finance. Skyward Financial can offer all of these kinds of debt facilities and consulting for your business.
Regulators keeping an eye
One of the most highly profiled Fintechs is called Prospa. In June 2018 they were scheduled to list on the ASX (Australian Stock Exchange) in a much hyped “IPO” (Initial Public Offering) but a mere 15 minutes before the co-founders and co-CEO’s were due to ring the bell they pulled out to address issued raised by ASIC.
The issues ASIC raised asked questions about if the loans were compliant with industry regulations.
Since then, Prospa and other major Fintechs such as Capify, GetCapital, Moula, OnDeck and Spotcap, have joined to together and signed “The Code of Lending Practice” to show the industry can self-regulate.
This is a positive step forward for the Fintechs to becoming more than just unsecured business loan lenders, but true competitors to banks. Whether or not this is enough for the regulator has yet to be seen, but as the Fintechs mature it is likely they will have ASIC and APRA knocking on their door.
Matching the loan to the objective
When we consult businesses on growth we talk about what the goals are and the best funding structure to achieve them.
For example, if the businesses manufactures widgets and their current equipment is nearing the end of its life cycle, and a new version is out and is twice as fast, it makes sense to get the more efficient asset and use a secured asset finance loan type like a lease.
It does not make sense to use an unsecured loan to buy a fixed asset, especially one that produces income.
In another case, if you wanted to take advantage of the upcoming shopping season by marketing new products you want to sell online, an unsecured business loan would give you the cash to run those ads. Note however that you should calculate the total cost of the loan and work out the total sales and profit you could make from those ads, to see if you will get a ROI.
It does not make sense to take out an unsecured loan to use for an objective that will not pay for itself.
So when you are capitalising your business for growth, think about the objective and match the funding type to achieve it. At Skyward Financial we help businesses grow by using the right funding and offer a free initial consultation for new clients.