To grow a business quickly, growth through acquisition is often the fastest route forward. But this approach requires funding upfront, and increasingly business buyers are turning to shadow banking as the solution.
According to Westminster-based law firm Bircham Dyson Bell, confidence among British businesses is soaring. Its first quarterly Entrepreneurs Optimism Index, released in September 2015, found that 80 per cent of entrepreneurs expect consumer demand to grow over the next three months, while 92 per cent believe their business will be profitable in three years.
While optimism is undoubtedly important – it indicates that market conditions are favourable and that profits are either growing or predicted to grow in the near future – entrepreneurs must capitalise on this confidence and do all they can to accelerate their projected growth. Buying a business is a great means of doing so.
However, many fast-growing firms lack the capital resources to fund expansion plans. Particularly, those wanting to grow through business acquisition often struggle to find the finances to execute this strategy. But this does not have to be the case; alternative finance options are increasingly accessible.
The rise of shadow banking
Despite relatively low interest rates, businesses in the UK are still finding it difficult to secure the funds they need to buy a business through traditional banking channels. Indeed, for every £100 that banks lend to UK businesses, just £26 of this goes to SMEs, despite these smaller firms accounting for 99 per cent of all private sector companies.
As a result, shadow banking, which refers to the lending of money by institutions other than banks, has grown in popularity. The International Monetary Fund reported that as a share of GDP, Britain’s shadow banking sector is more than twice the size that of any other economy, while globally, around $73 trillion of financial assets were tied up in shadow banks as of the start of last year, up from $26 trillion a decade earlier.
The rise of shadow banking has been rapid, and for business buyers it is beginning to provide a much-needed alternative when high street banks cannot or will not lend them the capital they need to proceed with an acquisition.
But what might be welcomed by business buyers is feared by others; the concerns surrounding shadow banking – and there are plenty who are quick to warn against it – focus on the lack of regulation. Specifically, lenders are not subjected to the same level of stringent checks as banks, while borrowers remain cautious that there are not enough safety mechanisms in place to protect their funds.
Nevertheless, exploring alternative finance options is worthwhile for business buyers who are confident they have mapped out a route to greater profits but need the capital to get there.
Invoice financing
Shadow banking has proved popular because a borrower can be judged on different criteria, thereby allowing them to gain access to funding in different ways. For example, entrepreneurs can borrow money against various aspects of their existing business. Invoice finance is a prime example of that.
Invoice finance refers to the borrowing of money against future invoices – this means businesses can get hold of a lump sum based on what their upcoming invoices are going to bring in. It essentially provides business buyers with the opportunity to get an advance on the money they are going to receive further down the line, thereby putting them in a position to pursue an acquisition.
For companies that suffer from late payments or have a healthy order list but need the money sooner, this option frees up cash based on the money that is already coming into a business. In fact, Britain’s small businesses are owed an estimated £26 billion in unpaid invoices – this is a huge hindrance to business owners’ ability to grow, particularly through acquisition, so borrowing against these outstanding invoices can give a business buyer the impetus and resources to act.
This type of lending has been used for decades, but it is only since banks become more selective in who they provide funding to – a problem that has become particularly prevalent since the 2008 financial crash when banking regulation tightened – that British businesses have truly begun to embrace it.
Look at the Parkside Group, one of the UK's largest privately owned distributors of aluminium architectural systems. In August 2015, following the retirement of founder and previous owner Derek Cook, a management team completed an MBO of the company using invoice financing.
Without the capital or backing of a private equity firm, the management team at Parkside – an £18.3 million revenue business – entered into an asset-based lending (ABL) deal, leveraging the funds they needed to complete the buyout against the company's inventory and debtor book.
The management team at Parkside are not alone in using ABL; according to the Asset Based Finance Association (ABFA), more than 44,000 businesses in the UK are already using invoice finance. It allows business owners running solvent companies with strong revenue to get the cash injection they need to accelerate growth or start a new venture by entering the mergers and acquisitions market.
Asset-based borrowing
Another form of alternative finance that business buyers can explore is asset-based borrowing. This is when a company borrows money against their own hard assets, including stock, machinery and property.
The ABFA revealed in September this year that an all-time high of £4.2 billion is currently secured against business assets, which represents a nine per cent rise on the £3.8 billion recorded 12 months ago.
Jeff Longhurst, chief executive of the ABFA, explained: “The benefits of invoice finance are getting increasingly well known, but in addition to that, borrowing against hard assets is one of the innovative forms of alternative finance that has really gone mainstream in the last couple of years.
“More and more businesses are starting to see so-called alternative finance as their primary form of funding, rather than just as an unconventional complement to traditional lending. For businesses with substantial assets tied up in warehouses, for instance, or in plant and machinery, this can be an excellent way to access lending to drive investment.”
Peer-to-peer business lending
Away from the world of asset-based borrowing, there is another option available to business buyers: peer-to-peer (P2P) lending.
P2P business lending, as the name would suggest, allows investors or businesses to lend money directly to those in need of the capital. As with most forms of alternative finance, it poses more risk for both sides than traditional funding options because there are fewer checks and regulations. However, for the lender it typically provides higher rates of return on the money they hand over, while for borrowers it is great way of cutting out the middle man and more easily getting access to an immediate cash injection.
The popularity of this type of alternative finance is evidenced by the fact that P2P business lending is on the brink overtaking P2P consumer lending, which has traditionally been the heartbeat of the peer-to-peer funding world. According to the AltFi Liberum Volume Index, by the end of June 2015, P2P businesses lending had drawn level with consumer lending, with both standing at a little over £1.58 billion.
But this is just the beginning - P2P business lending is poised to experience rapid uptake over the coming years; a study from the Centre for Economics and Business Research projects that P2P financing for businesses will hit £12.3 billion in 2020, up 10-times from the £1.2 billion loaned out in 2014.
For business buyers keen to act but hampered by a lack of finances, P2P business lending is another avenue well worth exploring. With investors and businesses evidently ready to do deals on P2P platforms, this could be the vehicle many buyers require to fund a business acquisition.
Embrace change, reap the rewards
Change always has the ability to spark fear into businesses, but it also presents new opportunities. In this instance, by straying from traditional loans from high street banks and looking towards shadow banking, business buyers can find new ways of securing the funds they need to complete an acquisition.
Importantly, while there are concerns over the safety of these new, unregulated forms of finance, there are clearly many thousands of entrepreneurs reaping the rewards of the new approaches to borrowing. By getting access to money that is either tied up in assets or due to come in through invoices, business buyers can leverage the investments they have made in growing one business to gain the capital required to pursue an aggressive strategy for further growth.
Business finance
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