I see that the subject of delayed payments to SMEs by “big business” has come round again as it does every so often. In the recent election campaign in the UK the now ex-Labour leader was vocal in his “outrage” at the damage caused to SMEs by their larger customers, who seemed to take a perverse delight in paying their dues at the very last minute. This outrage was followed in a Hong Kong newspaper article the other day with a similar level of condemnation. And quite right too.
The trouble is this is not a new problem. I remember writing letters, that were actually published for once, to the press in the 1980s on the very same subject. SMEs have lived with a cash flow dilemma for years – but that doesn’t mean to say it’s right.
One suggestion to combat the practice, about which I am less than convinced, is to name and shame the offenders. I personally don’t think it’s an answer because those slow-payers will merely say that they are managing their business effectively to the benefit of their shareholders and, of course, their own cash flow. This is less of a valid excuse in the case of the public services, as seems to be the thrust of the Hong Kong article, where the delays are more of a bureaucratic nature than cash management.
So, if major companies - or indeed the public services - can’t behave like responsible grown ups and pay their small suppliers on time, there may be some help at hand. And it’s not necessarily coming from traditional quarters.
The banks have tried to help – no, honestly(!) – but the statistics on lending to SMEs don’t make pretty reading. I am not sure how many start-ups fail in the first year these days but it used to be a pretty horrifying number. Over 80% I recall, but for the purposes of this note I am not talking start-up SMEs but established small businesses: those with a proven track record, but who still face the ignominy of chasing cash flow so they can operate efficiently themselves and do simple things like paying their wages and utility bills on time.
Now remember, I am a conservative and extremely boring ex-banker not given to wild enthusiastic rushes into new and untried forms of lending, but some of what is on offer out there now is going to make a difference, and in one form at least also reflects a form of financing that seemed to die a death a good many years ago.
I am of course referring to crowd-funding principles, P2P lending, invoice discounting – didn’t we used to call it factoring – and indeed the growth of entities known as Challenger Banks in the UK although I think these latter new banking interests look a little too traditional in nature. They may be more nimble because they are small, and they may use technology effectively, but the mind-set may be too old fashioned, a bit like mine!
You may already have heard of Funding Circle in the UK that has been going for 5 years. Both Prosper and Lending Club in the USA have been going successfully for somewhat longer, over 10 years, and this is not a trend that is likely to abate.
The Middle East now has a number of new-type lenders. For example, I suspect you probably won’t have heard of “Beehive”. Their main focus at present is in the Middle East, but they are a peer-to-peer lender, an invoice discounter, an Islamic finance lender. An online marketplace directly connecting potential investors to creditworthy businesses.
While banks today probably still have upwards of 80% of this type of SME lending on their books, I think there is a definite trend away from banks as these alternatives become more sophisticated and better at marketing. And actually some banks, to be fair to them, and other alternative disruptors in the market such as Amazon, Google and Alipay for example are recognising this new source of funding, and in some cases even joining forces
But does it work? Given a number of caveats, it could.
In the first place, and somewhat unusually, it may provide a lower cost of funding for the SME. Unusual because banks price for risk. SME risk is traditionally higher than large corporate risk (although you wouldn’t think so sometimes), so they have to pay more even though – perversely – they can’t afford more but have so far had no other choice. P2P lending creates an opportunity for the SME to borrow more cheaply because the lenders are likely to demand less and competitively they won’t get into the better deals if they demand high returns.
For the investors they can, if they wish, spread relatively small amounts of money across a broad range of businesses and on average obtain a better rate of return than they might otherwise earn from non-existent interest in bank deposits or investing in high priced and volatile equities.
But … isn’t there always one, this is not an investment vehicle for the faint-hearted and if you are thinking of investing your life savings in these schemes – DON’T!! This will be a market more for a category of people who understand the pitfalls associated with what is largely unregulated lending, and investing through well-established and reliable market participants who you can trust to have done their due diligence properly, and who will on your behalf keep an eye on the borrowing SMEs, paying your returns on time.
Will there be failures? You bet, but there will be successes too. The principle of “caveat emptor” or – “let the buyer beware” is clearly indicated here and sadly there will undoubtedly be some cheats and tricksters.
But if both SME's and their customers are creditworthy, there is a business opportunity in managing the cash-flow problems of slow payment. If old-fashioned banks don't seize it, new players with new business models will do so. Given the rapid rise of new players like Alipay and Beehive, that shift seems to have started!