Last year the website smallbusiness.co.uk, published research findings that seemed to indicate that many SMEs were unaware of the benefits of asset financing.
Its report, citing research by Close Brothers, said that “almost three-quarters (72 per cent) of SMEs in the survey did not know it was possible to secure finance against their turnover” (by which we assume they mean cash flow funding which in practise means book debt), rather than their credit rating.
It also reported that while 44% of SME respondents would consider using asset finance they were not acting on this.
It suggested that many SMEs were sticking with “inflexible and often unobtainable forms of credit” because they weren’t aware of the potential advantages of alternative funding options.
The inference, in other words, was that SMEs were continuing to approach the mainstream banks, despite the widespread perception that the banks were inflexible and unwilling to lend to them.
But how true is this?
Over the 18 months or so since there have been more pronouncements from asset finance providers.
In January this year CityAM quoted the MD of a business finance group, Peter Alderson, who said: “more are exploring financial options outside of traditional bank offerings that can support the level of business development needed to compete in new tech and online spaces.”
In the same month businessmoney.com reported on a survey of brokers operating in the asset finance carried out by United Trust Bank and revealing that 39% of them expected demand for asset finance would grow throughout 2018, identifying the most likely sectors for growth as Construction, Transport, Waste Management and Manufacturing.
Martin Nixon, head of asset finance at United Trust Bank, commented: “There’s no doubt that awareness of asset finance is growing amongst UK SMEs. Lenders, brokers and industry bodies, such as the FLA and the NACFB are working hard to spread the word about the versatility and flexibility of asset finance and how quickly and easily transactions can be completed.”
This may be true, but according to the British Chambers of Commerce (BCC) borrowing among SMEs appears to have stalled.
The BCC yesterday released the results of a study it carried out with the specialist finance provider Wesleyan Bank which found that 56% of British companies did not attempt to apply for finance in the past year. Almost two thirds (63%) of them were small firms.
The study found that those that did seek finance showed a clear preference for the “conventional” which it identified as overdrafts (18%), business loans (16%) and asset finance (9%) and that half of these reported that they did so because of weak cash flow.
The BCC’s head of economics, Suren Thiru suggested that the results revealed a move from the “credit crunch to credit apathy where a lack of demand, rather than supply of finance is now the overriding issue”.
He called for the Government to do more to kick start business investment and to relieve the burden of business costs.
But is it any wonder that two years of uncertainty and opacity about the Government’s proposals for Brexit has led to the perception among businesses that the Government neither understands or takes heed of their concerns and that SMEs are holding back on growth and investment plans?
I would argue that it is not ignorance of asset finance but cost and a fear of a loss of control of assets.
The recent memories of lenders and their insolvency practitioner advisers seizing assets as an early response to default is too recent for business owners to believe that behaviour has changed and that it won’t happen again.
We advise most of our clients to consider building their balance sheet based on slower growth rather than rapid growth based on asset-based finance. It takes one slip for the advisers and lenders with penal default clauses to see profit from misery.
The words: “If it appreciates, buy it, if it depreciates, lease it” are generally attributed to John Paul Getty, the oil billionaire who died in 1975.
While on the face of it the maxim makes eminent sense, the economic world in which 21st Century SMEs live is infinitely more uncertain and complex, thanks to such influences as globalisation, the 2008 financial crash and, more recently, UK’s decision to leave the EU.
Not only that, most service suppliers want to lock in clients for long-term contracts similar to traditional property rental agreements.
Furthermore, long-term agreements, like financial contracts have become increasingly complex.
Modern businesses that provide lease or rental agreements often have terms and conditions that mean the lessee cannot just hand back whatever it has leased, not to mention the payment of financial penalties if they wish to terminate a lease early. These contracts mean that a business is left with a liability rather than an asset to realise.
If an asset is depreciating, it does beg the question as to whether a lessee shouldn’t wait for it to devalue to a point that justifies buying it second-hand. However, whether you are leasing or renting you will always be funding the depreciation, as well as profit for the vendor and lender.
Where a business is considering investing in new plant or equipment to facilitate growth the cashflow argument is that leasing allows it to upgrade or improve without making a substantial, upfront investment. This may not benefit profits when compared with alternative ways of funding the asset.
It can also make sense where a business depends on equipment such as office computers that can become obsolete in a relatively short time.
However, my perspective on this is that there is an assumption that everyone makes that there is, or can be, continuous growth and that therefore it is worth waiting to return an asset. But if circumstances change you end up with the liability of having to continue paying when you no longer need it. An example of this is most cars are now sold under a PCP deal. Personal Purchase Contracts are not purchases but leases with horrendous terms that are applied to make the monthly payment look reasonable, however the cars cannot be returned early without incurring a huge penalty.
We would argue that the better strategy is to own or lease assets on short term agreements. Owned assets can be bought using hire purchase finance providing the asset can be sold with the funds clearing the HP settlement value. Shopping around for HP deals is likely to find a better one than that offered by the vendor. Short term agreements are more tricky and the small print needs checking but essentially you are looking to avoid being locked in to a long-term contract or one that is expensive to terminate.
You should be wary of long-term agreements with break clauses like those used in property lease agreements. They normally include conditional clauses which often mean the break clause cannot be triggered. One example is that all payments must have been paid o time, another is the notice period for triggering the break clause can be unduly long, and there can be many others.
While you might be familiar with agreements for office or factory premises and for company cars, plant and machinery, the above advice also applies to services including telephone hardware, telephone, mobile and broadband services, computer software, website hosting, email and IT services, office plants, hand driers, sanitary and other washroom services, alarm, security camera and guarding contracts, furniture, I have even come across concrete laid in the com car park provided under a long-term finance agreement.
When circumstances change businesses can find that being locked into a long-term agreement can turn an asset into a liability. Many long-term leasing agreements may look cheap but can become a straightjacket.
On the other hand, the asset can simply be returned if rented on a short-term basis or sold if the asset is owned. You will certainly improve your cash flow by saving the ongoing cost of rental or HP obligations and might even realise some cash.