At the smaller end of the SME market (below £5 million EBITDA), there is a surge in activity as FinTech platforms come of age. These digital services, including alternative lenders, payment providers and lending platforms, are filling the gap left by traditional capital providers and experiencing tremendous growth in demand. Figures from Business Insider Intelligence show that alternative financial providers accounted for 2 percent, or £11.5 billion, of the UK SME lending market in 2018 but this is expected to grow dramatically to 9.1 percent, some £52.6 billion, by 2021.
With more established SMEs (up to £15 million EBITDA), we are seeing a different pattern emerging. These companies are increasingly looking for highly tailored solutions and teams to partner with to help them grow and institutionalise. This may sound more like the domain of private equity, but companies are often viewing flexible capital solutions – bespoke combinations of credit and equity – as a more attractive option than selling the majority of their business and giving up control. Less equity dilution is an obvious benefit, and more importantly, business owners want to work in partnership with experts who can help them scale, strengthen operations, develop and execute strategy, enhance reporting and business infrastructure, and ideally, provide a single source of capital for future growth.
Back in 2015 we created ESF, an independent business that aims to become the largest secured lending platform focused on smaller UK SMEs. It has already provided over 1,000 loans totalling more than £500 million to fund growing and ambitious UK businesses. This is a huge opportunity that has been largely overlooked by traditional lenders while FinTechs lead the charge.
For larger SMEs seeking enhanced support along with flexible capital, the likes of ESF can bring a combination of experienced private equity skills and proactive asset management. This evolution and increased sophistication of capital provision is increasingly a welcomed alternative in traditional corporate finance or M&A processes, and there are plenty of opportunities below the mid-cap deal size.
The ability to deliver equity-like returns through credit-oriented structures requires an acute focus on downside protection – this will be ever more important in 2020 as we continue to face an uncertain economic environment across both Europe and globally. Working with SMEs is not straight-forward. They do not progress in a straight line and often lack awareness, sophistication and resources when it comes to understanding financing options.
Therefore, in lending to and working with SMEs, the rules of engagement must be communicated early and in as simple terms as possible, particularly around security, covenants, and controls. This, along with a proactive hands-on approach to value creation, enables lenders to partner with ambitious management teams to identify issues early, foresee potential problems and provide practical advice.
Heading off issues before they appear is key and you can only do that if you have scars born of experience. This crucial part of credit investing, effectively balancing risk and return, requires considerable resources and the discipline to take a tough stance on financials, to ensure you identify all the risks that may not express themselves in company numbers. You need an experienced team that is committed to proactively working with portfolio companies when situations and the market environment get tough, not just in the good times. That is why we put so much effort into partnering with companies so that we can anticipate problems and when they (inevitably) happen, we dedicate considerable resources to work through them. For SMEs, it is not enough to just write the cheque and monitor covenants.
With SMEs set to continue to be the engine of growth across Europe and the field of lenders ever evolving, it will be those capital providers with real depth of experience in both adding value and protecting the downside that will succeed in navigating the challenges and uncertainty of the year ahead.
Tingting Peng is head of investor relations & business development at ESO Capital