Risky business: Navigating the lending landscape for SMEs

Small businesses might be the engine room of the Australian economy, but borrowing money to grow your small business is no mean feat. Even established business owners often find it difficult to convince lenders that they’re a worthwhile risk to take on.

That doesn’t stop small businesses – bank loans to small businesses totalled $261 billion in December 2015^[1]. Borrowing has continued to grow over the last two years, now increasing at an annual rate of almost 4.7%^[2] according to figures from the Australian Bankers’ Association.

However, the way small businesses secure funding has changed in the last decade. It’s no longer just the banks lending money to small businesses. There are now more players prepared to lend to small businesses than ever before, which in turn means a greater selection of lenders for SMEs (small-to-medium enterprises) to choose from, to ensure they are borrowing on the terms that suit them the best.

The banks

The Big 4 banks are increasingly taking notice of the lending opportunities this market segment presents, investing in marketing campaigns to win the hearts, minds and wallets of small businesses.

Big banks are rolling out new financial products that offer small businesses a lot more choice around interest rates, payment terms and security. However, many SMEs don’t have enough credit history to fit the lending criteria of big banks, particularly when their business is just starting out. Banks have also traditionally required property as collateral, which can be a big risk for SME owners who often leverage their family home to get their business off the ground.

The Financial Services Royal Commission has also highlighted the issues facing the traditional banking sector, which may result in tightened lending criteria in the future, potentially creating further barriers for SME owners applying for a loan.

Alternative Lenders

Credit cards have historically been a popular bank alternative for SMEs looking to fund growth. While this can be a more convenient source of funding, credit cards come at a cost, with interest rates as high as 17 per cent.

Use of credit cards is further complicated by the blurred lines between commercial and consumer lending for small business owners, many of whom will put business expenses on a personal card. This behaviour means SMEs may also be affected by the introduction of comprehensive credit reporting (CCR), which was mandated in Australia in July 2018.

Under CCR, lenders have a more complete picture of a person’s credit history. While this doesn’t currently apply to commercial accounts, it could impact a SME owner’s ability to get a consumer loan or a credit card that would be used, in part, for corporate spending.

A number of fintech companies focused on small business lending have given the SME lending sector a firm shake-up over the past several years. While the increase in finance options is a positive move for small businesses, owners need to bear in mind that, while the ease and speed with which these loans can be approved is convenient, the funding may often be far more expensive to pay back than traditional credit.

To navigate the complexities for finding the right loan, SMEs may turn to comparison sites. However, these don’t necessarily allow small businesses to compare apples with apples. Often, comparison sites are comparing different financial products and do not include all available lenders which means small business owners don’t always get the full picture.

Open Banking levels the playing field

Open Banking will be mandated in Australia in July next year, which means financial information will eventually be shared between financial industry players more easily.

If implemented successfully, Open Banking has the ability to make Australia globally competitive across a number of sectors. It may help open the door to greater industry development, innovation and job creation – not only for the financial services space, but also in the fields of digital development, artificial intelligence and predictive analytics. Small businesses will be part of this story.

More immediately, open data will give greater insight into the risks and opportunities that small businesses present for lenders and will, in turn, have a positive impact on loan opportunities available for SMEs.

As the finance industry changes, SMEs have considerably more choice than ever before. However, with more choice comes a number of difficult decisions that SME owners have not been faced with in the past. To navigate this shifting landscape and make the right decisions, SMEs need the right information.

By working with the right partners and arming themselves with knowledge, SMEs will be able to take full advantage of the new opportunities they are being presented with.

Tips when applying for a loan

1. Understand your credit history – The overlap for many SME owners between personal and professional finances means your credit history as a consumer may impact your professional financial applications. It’s vital to understand your credit history and, if you want to dispute a listing on your credit file, have those discussions with a credit reporting agency like Equifax before applying for a loan.
2. Do your research – Don’t apply for funding unless you’re confident the loan on offer is right for you. Most lenders detail everything you need to know on their website or brochures, so take the time to read the fine print before applying. Also, be careful about the type of funding you apply for and how often you apply for it. The simple act of applying for credit leaves a footprint on your credit file and can impact what the next lender sees when they check your credit file.
3. Be on the front foot – Know what lenders may see when they check your credit history and be prepared to answer any questions they might have. Being proactive with any relevant information, such as defaults on your credit file from a difficult financial period and the actions you took to recover, may help ease a lender’s concerns and help with your credit application.
4. Consider the alternatives – Emerging finance options, such as peer-to-peer lenders, offer alternatives that may be better suited to your small business than traditional products.

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The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstance before acting on it, and where appropriate, seek professional advice from a finance professional such as an adviser.