Why disruptive lenders could spell danger for SMEs

The emergence of “disrupters” to established business models over recent years has had a significant impact on our society and economy. 

Uber and Airbnb have completely changed the taxi and travel industries in a very short time, inspiring other “disrupters” in other fields. 

Peer-to-peer (P2P) lending is one of the most recent trends sweeping the market. It aims to provide direct channels between lenders and borrowers and thus, avoid the need for banks. 

So far it has been quite popular because banks are not. 

Former small business minister Bruce Billson recently threw his support behind P2P lenders as an option for SMEs to finance their business. 

“One of the challenges that small businesses have faced is that the traditional big banks have tended to want coverage by a house or some other personal asset or guarantee to be prepared to make a facility available,” Billson told Fairfax.  

“But we are seeing the emergence through fintech and other models of new avenues for funding whether it be P2P, or crowdsourced equity funding. The new participants coming in offering different kinds of financing is very welcome. It has also shaken the tree of the big banks.  

“We are making sure that nothing government is doing is standing in the way of the fintech revolution and new avenues of finance that may better meet the needs of smaller enterprises.”  

How does it work? 

P2P lenders typically provide cash flow lending as opposed to secured lending, which is offered by the banks, meaning they take on the same risk with their loans without the security of capital (i.e. your house). 

Banks are often extremely reluctant to lend to SMEs unless there is a house title provided for security, meaning most new startups are simply unable to access bank finance. 

In the past, each of the major banks owned a finance company that would usually handle SME lending. The finance companies, such as AGC, Custom Credit and Esanda had a much greater appetite for risk and, of course, their interest rates reflected that. 

New P2P lenders operate in the same way. 

But is it a good idea for your business? 

Fringe lenders can represent danger to borrowers because when loans fall into arrears, their historic response has been to pull the plug. 

As an example, Macquarie Bank in the 80s actively sought real estate agencies by offering attractive loans but, when they saw the sector was heading for trouble, simply exited the market and demanded borrowers refinance their loans. 

Every experiment with cash flow lending on a large scale has failed. 

The underlying problem is that an SME in growth phase is simply unable to generate sufficient free cash to not only service the loan but to also repay it over a relatively short period. And because P2P lenders don’t require capital as security for a loan, they require higher interest rates to cover the risk. If you’re struggling with cash flow, this will simply compound the problem down the track. 

If your business requires capital for short-term purposes, such as funding short-term projects, talk to your bank. Should they knock you back, there is probably a good reason for this. If your proposal is too risky for them, it is also too risky for you. 

Alternatively you could seek an “angel investor” or look for crowdfunding as an alternative to the banks.   

An angel investor will usually be an older, experienced business person who is prepared to become a silent investor in your business. They will have the skills to review your plans and could add enormous value to your business.  Given they’re putting their funds at risk, they are going to ensure that you do the right thing, so that both you and they benefit. Of all the disruptive finance models available, I support one that matches SMEs with angel investors. 

Any loan to a small business, particularly a startup, is extremely high risk and should be handled by equity funding. 

Most importantly, SME operators need to be very cautious about having any debt within their business. The focus of any business, but especially a small business, should be on running tight cash flow and growing from the cash generated through that. 

Be careful about borrowing for your business. SMEs and external debt are like oil and water; they do not mix.  

Roger Mendelson is chief executive of Prushka Fast Debt Recovery and principal of Mendelsons National Debt Collection Lawyers.