Leasing and asset finance have opened up new ways for SMEs to finance and support their businesses. With Brexit looming, this crucial lifeline may be harder to reach. Saad Ahmed spoke to institutions to get a sense of current and future conditions in the UK SME asset finance industry
Small and medium-sized enterprises (SMEs) account for over 99% of all private businesses in the UK, according to the Federation of Small Businesses, and generate £1.8trn in annual turnover – 47% of all turnover from private business.
StartUp Britain, a national enterprise campaign backed by the UK government, has reported that on average 80 new businesses are started every hour.
In the 2015 Business Finance Survey: SMEs, a study of 1,608 UK SMEs conducted by the British Business Bank (BBB), a UK government-owned facilitator for entities to provide asset finance products to SMEs, 28% reported their source of funding to be a bank overdraft. A further 15% stated that a bank loan or mortgage was funding source, and 28% cited credit card finance.
Asset finance and leasing made up relatively small percentages of SME funding sources, but have experienced rises.
In 2013, asset finance constituted 1% of SME funding; by 2015, this had increased to 4%. Leasing and hire purchase, though they experienced a higher share than asset finance, rose to represent 16% of all SME funding in 2015.
Traditional sources of funding have decreased in recent years, and these more alternative routes – leasing and asset finance – are beginning to gain ground, even if it is at a relatively slow pace.
However, since these studies and surveys were conducted, the economic ground seems to have shifted; Brexit is on the cards.
On 23 June, an in-out referendum on the UK’s membership of the European Union was held. A majority voted to leave, and after a political reshuffle, Theresa May’s government is tasked with delivering and working out the details.
The economic environment became uncertain, and with Article 50 of the Lisbon Treaty still lying un-triggered, it seems likely to remain so for at least two years, until such time as the process is completed.
For SMEs and the institutions that fund them, economic uncertainty may have a direct impact on their operations. The inability to determine the nature of future trading relationship, if any, between the UK and the European single market has made many pause to think. Virgin Money has delayed all plans for its SME lending unit reportedly due to Brexit.
In writing this feature, Leasing Life spoke to a number of finance providers and facilitators to determine that if, in the wake of Brexit, the economic environment had indeed “all changed, changed utterly”, and what could be expected for the future of SME asset finance and leasing.
Asset finance products
Asset finance products, which consist of hire purchase and leasing (including operating leases), are used in a variety of industries for many different products to help meet the needs of a business.
An unusual example is cattle finance for certain farming businesses. Largely, however, asset finance lending to SMEs is based around slightly more mechanical assets.
Carl D’Ammassa, MD of business finance at Aldermore Bank, explains how the challenger approaches asset finance: “We tend to be focused on hire purchase. The largest asset classes align to our core roots, things like construction equipment and cars.
“We have, in recent times, been more into softer assets, things like technology and office equipment.”
While speaking to banks and institutions that provided business lending, it soon became clear that hire purchase was the most popular asset finance funding option to SMEs. With hire purchase, typically the assets being used were stationary assets such as office equipment, including printing and reprographic materials, and some forms of machinery.
Ultimate Finance launched its asset finance arm seven years ago, and since then the product offering has grown. According to Martin Bennison, MD, construction finance, Ultimate Finance: “Asset finance is probably one of the fastest-growing parts of what we do.”
Bennison continues: “We probably do more hire purchase than leasing. [We have] customers across all the sectors that you would expect, [including] manufacturing, packaging, and textiles. Waste recycling and processing is one that is coming on more and more.”
The reason for the popularity of hire purchase provoked mixed opinions, with interviewees divided between greater familiarity with the term and concept in comparison to leasing, and specific features of hire purchase being more appealing to SMEs.
D’Ammassa points to the widespread use of hire purchase to explain its popularity.
“The majority of the market these days is hire purchase, and we all understand that, we have used it a lot in our own personal lives, so that can transition into the corporate and business life.”
Sam Dring, senior manager, asset finance product for GTB at Lloyds, and winner of the Leasing Life young professional of the year 2015 award, took the latter view.
“From a client-demand perspective, hire purchase is the most dominant product. There are some fundamental features that work for SMEs around the hire purchase product,” Dring tells Leasing Life.
According to Dring, simplicity and a timeline to eventual ownership of the asset are what make hire purchase a winner among SMEs seeking business funding.
“There is the ownership angle. They like the fact that at the end of the agreement they have control and ownership of the asset, which is certainly the feedback we get from clients. There is also simplicity to [hire purchase] as well, typically a deposit paid up front, followed by fixed monthly payments over an agreed term.
“It does the job that they need it to, [allowing them to] get the asset on board quickly and simply so they can start utilising it within their business,” Dring continues.
Where leasing was concerned, SMEs tended to prefer this option when needing transportation.
Bennison of Ultimate Finance adds: “In the distribution of light commercial vehicles, or people running fleets, trailers tend to be leased, [and] buses and coaches.”
Typically, the asset finance options explored by SMEs seem to align to their needs as a business. For printing and machinery, hire purchase was preferred, whereas when a fleet of vehicles was needed, leasing was the option.
Given that different needs warranted different funding options, the representatives of SME lenders tell Leasing Life that it is not unusual for the same SME to have two different asset finance funding options for different parts of the business.
“We will assess the asset they are purchasing and the needs that are required, and therefore you could have several different products with one client servicing different needs,” Dring adds.
“Depending on the scenario, you could have a client funding some of their purchases on hire purchase, with others on finance lease.”
How to get noticed
The market for SME funding is divided between challenger banks and the older, more established banks.
According to the 2015 Business Finance Survey: SMEs, 43% of SMEs secured funding using a bank loan or overdraft, options which are more commonly associated with the older high street banks.
D’Ammassa says: “The big challenge for the SME is knowing that all these other forces are out there. There is still a significant proportion of small businesses which default into going to speak to their clearing bank, and it is those which are letting the SMEs down.”
Bernard Skivington, director of wholesale solutions at the BBB agrees, saying: “A large percentage of businesses that do just go to their bank get turned away.
“The banks are not so keen to support some of the businesses that are less well established, or a higher credit risk, and many of them still do not know where to go.”
For these challenger banks, which may not be as well known, their issue is twofold. First, they must spread awareness about themselves as an entity. Many of the challenger banks Leasing Life spoke to were convinced that they had emerged, almost organically, due to the financial condition over the past several years.
The global financial crisis of 2007-8 was marked out by many as the key event that allowed their businesses to emerge to fill a niche, and survive – and begin to thrive.
The global financial crisis, they argued, lead to a retreat of the high street banks, and an unwillingness to lend to SMEs.
Challenger banks were able to carve out a niche as smaller financial entities that were still willing to lend. “We were built out of the cinders of the financial crisis,” D’Ammassa says. The space was opened up, and the challenger banks entered.
However, the challenger banks are also competing against each other. While the consensus among those interviewed was that competition drives up standards, very little was offered in the way of preventing rivals from poaching SME customers.
While they extolled the virtue of choice for SMEs, it was not clear how they would ensure that they were that choice. But first and foremost, challenger banks are overshadowed in the public consciousness by the big established banks, and this is their primary battle.
Secondly, challenger banks must increase awareness about asset finance, and convince SMEs that it is a better option. A large percentage of SMEs still turn to bank loans or overdrafts, and the number using credit card finance grew to 28% in 2015, up from 22% in the preceding two years. Though leasing and asset finance have grown in the past few years, it remains the case that these options are used by a minority of SMEs.
Through the interviews, it became clear that the marketing of these challenger banks and products was very much through a slightly more sophisticated form of word-of-mouth marketing.
“The bulk of our business is actually introduced to us via a third party, whether that’s a broker, or an adviser, or an accountant. We have very strong links with accountants and business advisers who recommend us,” says Bennison.
Brokers were very important to the challenger banks, and normally functioned as the primary introducers, linking SMEs in search of funding with the challenger banks and the asset finance options they had available.
Simon Featherstone, MD of business finance at Shawbrook Bank, explains how important brokers were to the bank, to the extent that it has been a long-standing funder of the National Association of Commercial Finance Brokers (NACFB).
The BBB agrees that such organisations had been instrumental in spreading awareness.
Word of mouth and third-party means are not the only ways banks raise the profiles of themselves and their products. Representatives from Shawbrook attend specialist trade shows as an additional form of more active marketing.
“We promote ourselves by being exhibitors, and profiling ourselves at specialist trade shows. We go where we think our specialist customers would look to explore new assets, as well as talk to people in the trade,” Featherstone adds.
The BBB explains that it works closely with bodies like the FLA and ICAEW to spread awareness, and has produced brochures in collaboration with them.
“We recently produced a brochure with both the FLA and ICAEW called Asset Finance: Guide for Advisers and Businesses, which we are actively trying to distribute, both through FLA, ICAEW and their own members, and to businesses where we can,” Skivington says.
In addition to this, the BBB produces an annual brochure with the support of 22 different bodies, with distribution in the hundreds of thousands.
“We produce something called the Business Finance Guide, and, in our third iteration, and it has just gone digital. The second version we distributed around 700,000 copies, both hard and digital; this time we want to get it into a million inboxes of businesses.
“It brings all of this information about finance, not just asset finance, into one place where they can read about it, but also look at the various different sources and where they can get it from.”
The decision for the UK to leave the EU created an immediate shockwave. In the Bank of England’s stimulus package on 5 August, interest rates were halved to 0.25%.
Despite government intervention and other factors leading to a relative level of stability, uncertainty still reigns, and with it an unclear sense of the future.
Unsurprisingly, few of those interviewed were willing to give Leasing Life a sworn-by prediction of the environment over the next few years. However, the banks were adamant that they would continue to provide leasing and asset finance to SMEs, and this was pushed on by a belief that their services would continue to be needed.
“In many respects, it is a continuation of what we have done before. We are very much open for business and we will continue to support SMEs with their funding requirements,” Dring explains.
Though, just like the established banks, they spoke of “business as usual” from an operational standpoint, the challenger banks expected changes in the composition of the market, and with it their future opportunities for business.
Investec’s Andy Hart believes there may be some consolidation of smaller finance houses.
“Will there be some consolidation in the market? Possibly. There has been a lot of activity in terms of equity houses coming in and purchasing brokers and then building books,” Hart says.
The general consensus among the challenger banks, however, was that the established banks would start to retreat from SME funding once the full implications of Brexit became clear, echoing their behaviour after the global financial crisis.
The challenger banks believe that they, and their alternative financing options, would be needed now more than ever, and want to be poised to take advantage of this.
Hart sees an opportunity for challenger banks to profit from the cautious uncertainty of other financial institutions.
“We are feeling very buoyant about the opportunity. We have already seen some in the marketplace that have suffered some substantial losses. We are seeing others that were looking to enter the market but have now decided not to,” Hart explains.
“I think there is going to be a whole plethora of opportunity out there, and we want to make sure we are in the best possible position to take advantage of that opportunity as it presents itself.”
Shawbrook’s Featherstone also takes this view, saying: “We will continue to see the large banks retrench, and leave pockets of marketplaces or specialisms underserved.
“So the structural reasons for Shawbrook existing, the opportunities that caused the formation of challenger banks, will continue to exist.”
The prevailing sense was one of opportunity post-Brexit. Challenger banks hope that uncertainty will work in their favour, allowing them to swoop in with asset finance and further erode the status of established banks as the lender of first resort for SMEs.