Funding growth for SMEs
Whilst the overall funding landscape in Ireland has improved considerably over the last two years, certain sectors are better served than others, according to John Doddy, corporate finance partner, Deloitte.
“The large corporate debt market is competitive, with banks, direct lenders and the capital markets all demonstrating a strong appetite in this sector. This market was least impacted by the banking crises as it is seen as the lowest risk sector by capital providers. The mid-corporate sector was impacted by the banking crises but has since benefited from the recovery in the banks and the emergence of an alternative lender market. Companies in this space now have real debt funding options available to support their growth objectives,” he said.
The funding challenge remains in the SME sector, Doddy contended. This is a trend not just in Ireland but also in the UK and mainland Europe. The issue in the SME sector is that it is seen by lenders as higher risk and difficult to service.
While the SME lending landscape has improved, new lending in the SME space is largely focussed on asset backed lending such as invoice discounting and leasing. This, he said, restricts the amount of borrowing to the level of eligible assets e.g. the debtor’s book.
“In terms of cash flow based lending, it is harder to secure. This is because it is correctly seen as being higher risk. Where available, the repayment profile can be onerous” Doddy said. “Typically with a five year facility, the bank will look for most or all of the money back over those five years which can put pressure on the cash flow of the business. This can result in the SME taking on a level of cash flow risk thereby increasing the potential for a default on the loan.”
However, there are, Doddy said, new entrants to the market that are looking at making available higher risk debt instruments at the sub €5million level, and the Ireland Strategic Investment Fund and the Strategic Banking Corporation of Ireland are actively promoting capital providers in this sector.
“The availability of new lending products in this sector is obviously welcome, however in many cases the real challenge in the SME sector for funding growth is that some businesses don’t have a sufficient amount of equity. So the question arises whether it is appropriate to borrow more, taking on more risk. Debt is an obligation to repay or refinance within a specified period, this inevitably leads to refinance and repayment risk” Doddy said.
“Overall the SME sector remains over-reliant on debt as a source of funding and needs to be more open to look to combinations of debt and equity to fund growth,” he said.
There are, Doddy said, a number of institutional equity funds supporting SMEs in the marketplace, and equity can play a key role in funding growth whilst ensuring that the risk profile of the business is sustainable.
While access to credit is frequently cited as a major stumbling block for SMEs, Doddy said that his experience is banks want to lend to the sector. “One of their challenges is the quality of information received in applications can be quite limited.”
Doddy finds that business owners and managers can be reluctant to share information with banks. “However, for a debt provider to make a lending decision, it needs to have access to high quality information,” he said.
“When looking to raise new capital, the advice we give to business owners is to fully prepare for the process in which they are about to engage. They need to look at it as a competitive process,” he said. “They should clearly present the strengths of their business and demonstrate to a potential lender the ability of the business to service and repay the required debt from operating cash flow. After all its cash flow and not assets that services and repays debt.”
Through Deloitte’s Debt & Capital Advisory and M&A Advisory teams, Deloitte assists companies in building sustainable business strategies and funding structures to enable them to achieve their growth targets, said Doddy.
Previously published in the Sunday Business Post