The bank is the traditional place to take out a start-up loan, but today an increasing number of small and medium businesses are looking elsewhere for financing.
Following the credit crisis of 2008 and the loss of confidence in banking that followed, alternative methods of obtaining capital are gaining popularity. The Office of Fair Trading has suggested that banks’ loan policies may be hampering the growth of SMEs. In particular, many small businesses find that banks make it difficult for them to look elsewhere for finance, for example by being slow to share information about peer-to-peer lending.
Applications to banks for start-up or expansion loans are a crucial indicator of the health of the SME sector, and the rate of successful applications has increased since the previous financial year. However, loans taken out with banks are a smaller proportion of total SME loans than ever before, suggesting that economists will soon need to find new methods of gauging the state of small business enterprise, as banks begin to lose their monopoly on providing funding.
The OFT attributes the shift to poor competition in the banking sector. Recommendations made in the last decade by the Competition Commission are still not being adequately followed, and many SMEs feel that, when it comes to applying to loans, their options are limited to the four or five largest banks. If banks are to continue to provide the largest market for SME business loans, they will need to step up competition and provide more favourable terms and flexible options for business people. In the meantime, a variety of other methods of obtaining funding are on the increase.
It is increasingly common for the founders of SMEs to bypass official sources of funding altogether, turning instead to loans from family and friends. Such loans accounted for about five per cent of SME funding last year, making loans between personal acquaintances one of the front-running methods of obtaining capital. SMEs are also relying more on angel investors, business people who invest their own personal capital in a company in return for shares, equal ownership or other privileges.
The internet age has opened up financial options that were unknown to the businesses of the previous generation. The ‘crowd-sourcing’ of funds is now a viable option, with many aspiring businessmen and women using sites such as Kickstarter and Indiegogo to publicise their ideas and gain pledges from interested parties. Businesses intending to sell concrete products, as opposed to services or expertise, can particularly benefit from this method of fund-sourcing.
It is concerning to think that banks have not yet regained popular confidence, and are unable to prevent SMEs from straying elsewhere. A strong banking system which is able to encourage the growth of small businesses is vital for a strong economy. However, increasing competition and the proliferation of new financing options for businesses may also bode well, suggesting modernisation, development and original thinking among the next generation of companies and those who back them.