SME Business loans

Corporate finance

Corporate finance contain different kinds of activities, like mergers and acquisitions, MBO-arrangements, restructurings and ownerships changes, estimates of valuations etc. (PWC. Corporate Finance).

Examples of PWC’s corporate finance department reference customers and what it does in  corporate finance.

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Business loans and debt financing

Many companies need sometimes or regularly debt financing or loans from bank. They borrow money for their different needs in business, like working capital, investing in future, like building new factory or buying new machines, or they want to have good liquidity and cash in hand if different unexpected needs or opportunities arise. Small company can borrow money from bank and big companies can borrow straight from capital markets, when they sell bonds to investors.

In Finland and in Europe banks are still in very important source of debt financing to smaller companies especially. And majority of loans to companies come from banks in Europe. Bank lending in Europe accounts about 80 % or more of business lending. In USA it is much more common to raise capital from markets and bank lending plays smaller role in corporate debt financing. I did not find what is bank loans market share in USA of whole corporate debt financing but probably some 40-50 %. Big companies probably mostly borrow straight from capital markets.

So small to medium sizes companies usually borrow from banks in Europe. Small companies has not access usually to bond markets, they do not have credit rating from some credit rating agency or amounts raised from bond markets should be significantly bigger for example from 1 million or even 10 million at minimum. So for small companies it has been hard to get access to market based debt financing when their borrowing needs are smaller. But that has changed after financial crises since 2007-2008 and also in Europe market based debt financing has become more popular and common, more companies has access to debt markets and smaller sums can be borrowed.

There has also appeared different kinds of  new sources of capital where even very small companies can borrow, like crowdsourcing or private equity companies or other financial companies and intermediaries has come to  capital markets to offer financing and loans to smaller companies. Some of these companies are called “shadow banks”. “The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks” (Wikipedia).

Problems with alternative source of debt financing is that cost of borrowing can be very high, interest rates of 10 %-15 % or even up to 40 % are possible to small-to-medium size companies. Compared to bank financing, interest rates are much higher from these “shadow banks” or other sources. Why do small companies then borrow if it is so expensive? Probably, this is only option they have when bank financing is not available. You maybe just have to take loan that is available if your company’s survival depends on that loan.

So if banks do not lend, options are probably few and expensive. But why do banks then not lend?

Most common reasons for declined loans are:

1. Quality of earnings and / or cash flow, 29 %
2. Insufficient collateral, 23 %
3. Debt load, (too much debt already), 13 %
4. Size of the company, 6 %
5. Customer concentration, 6 %
6. Insufficient credit, 5 %
7. Size or availability of personal guarantees, 4 %
8. Insufficient operating history, 4 %
9. Economic concerns, 4 %
10. Insufficient management team,3 %
11. Weakening industry, 2 %
12.Other, 2 %

(Forbes / 2014 Capital markets report, Pepperdine University)

Bank financing has been tough in Europe. PWC has published report that estimates that challenging bank financing for small-to-medium size business continue to be so next five years. That may be a good thing also, because alternative sources of financing appear, but cost of borrowing should be lower. One reason for reduced bank financing is also regulatory pressure on banks, they need more capital buffers themselves and they can lend less to SME- businesses than before. But “shadow banks” need not to be a threat to banks, there are already some collaboration where banks help small companies to get access to other source of debt financing if bank does not lend to SME borrower.

Maybe in future business loans from alternative sources, “shadow banks” or other non-bank loans, become cheaper to SME businesses. That is important, because small-to-medium size companies are very important employers in Europe and if and when they need to borrow capital to their business and financing needs, they should have access to debt financing.

 

Sources:
PWC kotisivut. http://www.pwc.fi/fi/yritysjarjestelyt/corporate-finance.jhtml?gclid=CP7U5raf8r0CFcoLcwod16wAPA . Luettu 21.4.2014
Forbes, Why Business loans get rejected. http://www.forbes.com/sites/sageworks/2014/03/10/why-business-loans-get-rejected/ . Luettu 21.4.2014

Business Week. Big Banks, Credit Cards, and Small Business Lending.   http://www.businessweek.com/articles/2013-06-04/big-banks-credit-cards-and-small-business-lending . Luettu 21.4.2014

Vänskä, Harri 2014. Rahoituksen monikanavaisuus yleistyy. Kauppalehti 17.4.2014, 7A.

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One Response to SME Business loans

  1. Lily says:

    Well, I like this post. The financing problem always was very crusial and shadow banking system expanded quickly. Therefore, greater access to the debt financing is highly needed nowadays. Thank you, it was quite interesting to read about it.

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