The U.K. is in the midst of an overhaul of the SME finance sector. While largely brought on by an epidemic of big, corporate buyers paying their small suppliers on longer-than-fair terms, the newly passed legislation is widespread and includes language that requires banks that turn down SME loan applicants away to refer them to alternative lenders.
According to new findings from Alternative Business Funding, a platform of several alternative lenders, the new referral scheme could lead to more than 100,000 SMEs gaining access to funding they might otherwise not see after being rejected from a bank. The rules, experts said, could lead to $3 billion in financing for small businesses.
With the U.K. general election just weeks away, it is by no means guaranteed that the referral scheme will be implemented as intended, and many alternative lenders are skeptical that it will even work.
The rules are built on the presumption that small businesses will turn to mainstream banks first to access funding. But new research reveals that even if approved for a bank loan, small business owners may not see an end to their cash flow management troubles thanks to dozens of hidden fees costing them hundreds of thousands of dollars.
The findings could mean that small businesses may decide to bypass mainstream banks and shift nontraditional lenders from the alternative to the mainstream in the search to secure capital.
The Hidden Cost Of A Bank Loan
For small businesses that qualify for a short-term bank loan, many will access invoice financing to maintain their cash flow. The tool can be critical to a businesses’ survival. Banks purchase unpaid invoices so small suppliers can get the money they need without waiting for their buyers to settle the bill. Invoice financing is especially crucial to suppliers facing longer and longer payment terms by their large corporate clients.
But according to online invoice marketplace MarketInvoice, SMEs face up to 35 hidden fees from the banks from which they obtain this kind of financing. That, reports said, is on top of existing interest and other service fees. These added costs come from a variety of rules in the fine print, including fees for same-day payments or paperwork processing. According to MarketInvoice, banks charge as much as 6.4 pence for every £1 worth of invoice.
Collectively, these fees can amount to £425 million, or nearly $640 million, in extra charges every year for small business borrowers.
According to researchers, the problem persists because there is no regulation controlling how these fees and costs are presented to small businesses when they are approved for a short term financing program like invoice financing. “As a result the market is plagued by bad practice,” said MarketInvoice chief executive Anil Stocker.
The Small Business Act May Not Help
With its passage into law late last month, the Small Business, Employment & Enterprise Act contains a provision that requires banks to refer small businesses that have been rejected for a loan to alternative financers. The rules aim to open the gate to SMEs to access financing even if they do not have a sufficient credit history or cannot afford the high interest rates of a bank.
But according to reports, this referral scheme may not offer small businesses a method of avoiding the dozens of hidden fees uncovered by new research. Some of the mainstream banks, in fact, are partnering with alternative lenders.
Royal Bank of Scotland, for example, has partnered with alternative lender Taulia. Santander UK, meanwhile, is working with peer-to-peer financer Funding Circle. This means that even if a small business is rejected by a bank for short-term financing, the alternative lender to which they are referred may actually ultimately provide financing from the bank from which they were first rejected.
It is too early to tell, however, whether a banks’ hidden fees will be passed on to small businesses that obtain financing from an alternative financer.
“While high street banks find it difficult to provide financing to small and medium sized companies themselves, they’re more open now to using other platforms to originate invoice finance and loans,” small business lender GLI Finance’s head of public affairs Louise Beaumont told the Financial Times, adding that the invoice financing industry is “legendary for its opaque fee structure.”
U.K. lawmakers have charged the small business lending industry with a whirlwind of new regulations aimed at reducing payment terms for small suppliers and increasing the availability of working capital for small business owners. Their intentions aim to prop up the SME community, a smart economic move considering that SMEs account for about half of the U.K.’s growth domestic property and employ more than 80 percent of the workforce, according to figures from Boost Capital.
But the legislation may not adequately address all of the problems, critics say, and the uncovering of these hidden fees that burden small business borrowers reveals the hurdles SME owners face even with supporting efforts from government officials. “Providers of invoice financing advertise the headline cost,” said Beaumont, “but not the full cost to the business in question.”