Why start-ups, not incumbents, will be the engines of post-pandemic SME growth

Small and medium-sized enterprises, or SMEs, are the lifeblood of the UK economy.

The UK definition of an SME is a company with fewer than 250 employees. But despite their relatively small individual size, SMEs account for 60% of employment and around 50% of total turnover in the UK private sector.

And while the big names of UK industry get the most attention, SMEs account for 99.9% of UK businesses.

That’s 5.6 million businesses, according to the National Federation of Self Employed & Small Businesses, a UK SME advocacy network.

Which is why their recovery is essential to our wider national economic growth as we begin to look beyond the Covid-19 pandemic.

But many smaller outfits struggle to secure financing in an outmoded and cumbersome lending landscape. Many financial incumbents haven’t been able to keep up with the times and fulfil their duty to provide credit to early-stage growth companies.

But there’s hope. Many fintechs, or ‘lendtechs’, have leveraged the digital revolution and other technologies, stepping up to the plate and helping to drive post-pandemic recovery.

Silver lining

One such firm attempting to provide the much-needed financing for SMEs that fall through the cracks of traditional bank-led financing is London’s Trade Ledger. The company’s stated purpose is to “provide the technology and insight to accelerate and transform business finance, in particular SME and mid-market lending, unlocking economic growth and social mobility”.

Speaking to FinTech Futures, Trade Ledger CEO Martin McCann says: “Some of the banks we deal with have seen spikes in credit volumes at different points during the pandemic, up to 100 times normal volumes.”

“The consequences of 30 years of no investment in lendtech infrastructure is that you basically have processes that are driven by relationship managers, credit experts and lots of paper. And people couldn’t get into the office.”

During the pandemic, many of those legacy processes were completely upended, and it exposed just how antiquated the whole system was. And how much opportunity there was for the taking.

“We’ve grown by six times during the pandemic,” says McCann.

Lending money to businesses used to be (one of) the specialist domains of banks, channeling a personal relationship between the bank and customer. That can not only be preserved, but strengthened, in the digital age. But money makes the world go round, and it’s in this capacity that lendtechs really shine.

At the smaller end of the scale, there’s micro-lending up to around £50,000. Then you have mid-market, which is £50,000 all the way up to £50 million. And then there’s the large corporates.

Banks typically lend 80% of their available funding to the large corporate sector and less than 10% to the SME sector.

Something for everyone

But the industry is becoming more specialist and more digital, and there’s opportunity to come up with propositions for very specific markets.

An alternative lender or a bank can come up with a brand new proposition, with a low cost to serve, and good controls and risk tailored specifically to public sector construction companies, for example.

Because of modern technology and data, banks have the capacity to serve up to a dozen digital propositions, which are all tuned and customised to specific sectors.

“Banks have one inalienable and defendable right in lending, which is they have the lowest cost of funds available because they’re deposit taking institutes. And so, we anticipate that the large scale of lending and most of those new segments will still eventually come from banks,” McCann says.

He also believes we’ll see a lot more fragmentation and a lot more alternative sources of funds that don’t come from banks, as well as banks providing their balance sheets to non-bank lenders.

“I think of it as an inflection point, it’s like the internet age has finally arrived to business and commercial lending like it has been doing for retail lending over the last decade.”

Trade Ledger addresses the sort of challenges SMEs currently face when applying for finance, and the lendtech is also hoping to address the gulf between lenders and businesses.

SMEs tend to be growth companies which tend to face the biggest challenges because typically they do not fit into banks’ credit models.

McCann cites Trade Ledger itself as an example, “because we’re not profitable”, despite growing to be number one in its industry globally, “and you’ve got to consume capital to do that”.

Even though, as a lender, the amount of capital Trade Ledger has is measured in the millions, it could only apply for £50,000 worth of credit — less than 5% of its capital needs.

This is an all too familiar scenario for companies in the early high-growth stage of their journey.

The core problem is that growth companies are just not a good fit with the credit models and securitisation structures of traditional lending products.

Speed is of the essence

Additionally, the application, approval and onboarding process is far from nimble, taking on average about 90 days. Digital, data and technology can drastically shorten this window.

Reducing the friction and time can have a substantial impact on SMEs and their access to capital, “which could be the difference between survival and going under,” McCann says.

“Three months is just not acceptable,” he adds.

Obviously, as the past two years have taught us, a lot can change in three months.

During the pandemic, for example, the hospitality sector such as cafes and restaurants had to change their entire business model.

Despite this, banks have yet to get with the times and step up with the capital SMEs sorely need.

But digital transformation has begun to sweep through the lending sector just as it has with industries across the country.

Winners and losers

McCann says the pandemic has highlighted just how much lendtech has been underinvested within banks when it comes to business and commercial decision-making.

“Providing credit to businesses is one of the three core things that banks do for businesses, and it seems incredible that it’s been so difficult for so long.”

These much-needed innovations are not coming from banking, but rather outside of the industry, from the technology sector.

Any bank which does not have good digital distribution and operational capabilities within the next five years is likely going to lose significant market share, and this inflection point will require substantial investments in digital, data and new technologies.

“I firmly believe that within next five years in business and commercial banking, there will be big swings in market share and there will be winners and losers,” McCann says.

Much of this change will come from the new generation that are starting companies today who are not willing to accept the status quo of laborious and difficult application processes and services.

The desire to see the same slick operational products and services that exist in other consumer spheres is starting to spill over into lending, which is becoming a core differentiation in business and commercial banks.

Just as the creative digitisation of whole industries brought benefits to consumers, the same disruptive but beneficial approaches are now sweeping over business lending. Which, given the parlous state of many UK SMEs after an unprecedented couple of years, couldn’t come at a better time.