Financial shocks seem to be coming thick and fast for the British economy: less than a decade after the country suffered the financial crash of 2008, which led banks to tighten their lending criteria to the detriment of small businesses, the public voted to leave the European Union, and now asset finance is proving its worth.
The uncertainty following the triggering of Article 50 will have an enormous impact on businesses both large and small – and could make asset finance a vital tool when seeking to borrow.
But first: what is asset finance?
All about asset finance
In simple terms, asset finance enables you to take out a loan secured on an asset you own outright: this could be anything from property to plant or office equipment. This provides an alternative to a traditional bank loan or overdraft, and since the lending is secured interest rates tend to be competitive. As a result, 42,000 British businesses already use this innovative form of finance, and the numbers are growing rapidly.
Of course, a word of warning is in order: as with any secured loan, the lender’s reduced risk translates into increased risk for the borrower. Should the company taking out asset finance fail to repay the debt, the lender can simply seize the collateral, whereas with unsecured lending they would require a court order before any assets were in jeopardy.
Why asset finance makes sense
As already stated, banks drastically changed their lending criteria in 2009, and for many small businesses obtaining a bank loan is like trying to get blood from a stone. Furthermore, relationship managers have far less autonomy than they used to, meaning that it’s very often the computer saying no rather than someone with deep knowledge of the customer’s specific circumstances.
In consequence, asset finance lending volumes have increased substantially, and this is now a key tool in any company’s financial armoury – whether they are seeking to borrow for growth or simply to deal with a cash flow hiatus.
Talking of cash flow, it’s not just tangible assets that can be borrowed against. Unpaid invoices can also be utilised if a company adopts invoice factoring or discounting.
Invoice factoring and discounting: the basics
With invoice factoring and discounting, you can borrow between around 70% and 85% of the value of your invoices as soon as you issue them, with repayment being made when your customers pay you.
With factoring, the finance company assigns a team of experienced credit control professionals to secure payment, thus minimising your interest, whilst with invoice discounting you retain control of your own debtor ledger.
There are advantages and disadvantages to both variants. Factoring can save money in the long term, but some businesses are uncomfortable about their customers dealing with a third party over unpaid invoices.
Ultimately it comes down to the strength of one’s customer relationships and of course the calibre of the accounts receivable team. It should also be borne in mind that factoring can free up a considerable amount of time in the accounts department, providing an additional cost saving.
Whichever option proves more appropriate, invoice finance can tame a troublesome cash flow for good and virtually eliminate the negative effects of late-paying large customers.
Asset finance can deliver real stability
Another key factor is stability. With banks becoming increasingly jittery, there is a real risk of overdraft facilities being withdrawn and borrowing and credit card limits being reduced. If a company is already facing a constrained cash flow, this could be enough to push it over the edge.
In contrast, alternative lenders are extremely unlikely to renege on asset finance, provided payments are being made and the asset is still in the borrower’s possession.
But where does Brexit come into all of this?
Brexit: where we are and where we could be going
Until a few weeks ago, the direction of Brexit was relatively clear (even if the outcome was not). Article 50 had been triggered, meaning that the UK would leave the European Union at the end of March 2019.
The Conservative Government, which had an overall majority, had stated its policy that no deal to access the single market was better than a bad deal, meaning there was a realistic possibility that the country was heading for a “hard” Brexit.
Meanwhile, the Labour opposition had stated that it was committed to remaining in the single market if possible, indicating that it favoured a softer approach to leaving. Among the smaller parties, the Liberal Democrats and the SNP opposed leaving altogether and suggested that they favoured a second referendum on the issue.
Everything changed with an uncertain election that reduced the Conservatives to a minority government, requiring the support of the Democratic Unionists. The suggestion now is that the government will favour a softer form of Brexit, whilst messages from Labour – which sees itself as a government-in-waiting despite lacking the numbers to assemble any kind of coalition – have been mixed, with some MPs indicating that it will seek to remain in the single market at all costs and others that it is determined to leave. So where does this leave the UK economy and how will this affect asset finance?
Asset finance really matters post-Brexit
First the good news: the economy has fared far better than predicted following the Brexit vote and the triggering of Article 50, though it is now slowing down significantly. That said, it is still too early to predict what effect actual withdrawal could have, but it certainly seems a safe bet to state that turmoil in financial markets will be exacerbated significantly.
The lack of a clear plan and timescale for exit has worsened matters considerably, resulting in a 10% depreciation in sterling and wild swings in the equity market. Perhaps unsurprisingly, the UK’s credit rating and outlook have been downgraded and consumer confidence is appearing increasingly shaky.
Against this backdrop, it is difficult to make clear predictions. On one hand, following the referendum result the Bank of England reduced British banks’ capital requirements to try to calm uncertainty. This meant that banks had more flexibility to lend and increased injections of capital into businesses, temporarily making loans easier to obtain.
Whether this trend will continue long-term is a different matter. If the economy worsens, this “dash for growth” could continue, with the government continuing to lessen regulations and/or making large injections of cash directly into the economy via quantitative easing. On the other hand, as the economic screw continues to tighten, it is possible that banks will retrench, and that the caution they displayed post-2008 will only be an indication of much more serious problems to come.
If banks refuse to lend to business sectors facing turmoil, then alternative lenders will become vital players in the economy – and in many cases, the only way for smaller and younger companies to obtain the finance they need to stay in business.
How asset finance can work for you post-Brexit
Let’s imagine that the worst-case scenario happens: Britain’s exporters are struggling to sell their goods into the European single market due to tariffs whilst the economy is contracting. At the same time, rather than lend to correct the problem, banks are retrenching and lending criteria are becoming ever more stringent. Where does this leave the typical small business?
Whilst bank loans would clearly continue to be available, borrowers would need to leap through hoops to get them. Many banks already require sight of a company’s articles of incorporation, balance sheet, three years’ profit and loss statements, three years’ tax returns, a detailed and costed business plan and CVs for the directors and principal managers. It is entirely reasonable to assume that they might demand even more paperwork, taking up considerable time and distracting entrepreneurs from the more pressing task of running their businesses.
What’s more, chances are that they would become more demanding in terms of credit scores. Whilst the maximum possible credit score is theoretically 850, in reality there are no financial products available today that require a perfect score, with 700 to 750 being entirely satisfactory for almost all purposes.
In fact, only companies with scores under 600 may face difficulties, and there are clear steps they can take to improve their credit scores, contacting credit bureaux and correcting any errors on their credit report, making up any missed payments, and paying down credit card debt (whilst keeping the accounts open).
However, if minimum acceptable scores continue to rise, then many companies could find themselves struggling to access any kind of business finance from their bank.
This is where alternative lenders and more specifically, asset finance comes into play. Because the borrowing will be secured on premises, plant, equipment or invoices, the company’s credit score assumes far less importance.
With asset finance, the finance company’s interests are safeguarded so long as the business retains the asset in question (and of course, so long as the asset does not depreciate below the value of the loan). Similarly, with invoice financing, the amount the company can borrow depends on its level of business, with repayment of borrowing virtually guaranteed (unless of course a debtor goes into liquidation, which is unlikely to be a regular occurrence).
Suddenly a credit score in the 700s or above barely matters, and the principals will not need to spend many hours drafting business plans or collating complicated financial data. Instead, they can get on with seeking new business and taking the company forward whilst their lender enjoys the security of having collateral to back the loan.
Finally, however, it is important to reiterate a word of warning: with any kind of secured loan, the asset you offer as collateral can be seized if you default on repayments, whereas with unsecured lending your lender would need a court order to enforce the debt before your assets can be touched.
But in a nightmare scenario where Britain’s economy is contracting and banks are becoming even more demanding than they have been post-2009, this minor drawback is hardly likely to be off-putting.
In fact, asset finance could throw many companies a lifeline – and could be a key tool to overcome economic difficulties and help post-Brexit Britain become a stable independent nation.