Funding options available to business owners in a post-RLS lending landscape

In March 2021, the Coronavirus Business Interruption Loan Scheme, the Coronavirus Large Business Interruption Loan Scheme, and the Bounce Back Loans all ended, forcing businesses to transition to the end of an era of government loan schemes and the imminent return to pre-pandemic lending. Between all three schemes, the government paid out a total of £80 billion, according to HM Treasury, not including the Recovery Loan Scheme.

An immense amount of capital flowed freely to struggling businesses, and the shift back to pre-Covid lending will be challenging. However, there are many innovative lending products available to business owners that may be better suited to their specific business needs.

How did government-backed lending distort the market?

Over the course of the pandemic, the government stepped in to guarantee 70-80% of the loan value for lenders. This state-guaranteed mechanism was welcome support for small businesses and allowed lenders to minimise risk as the British Business Bank offered favourable lending criteria. While necessary as an emergency response to the crisis, government-supported loan schemes could have implications for the long-term health of the economy. 

Additionally, before government-backed loans came into play, it was standard practice that lenders included personal guarantees in their lending requirements, this being one of the few ways to mitigate risk. During the pandemic, business owners who received a government loan didn’t have to put up a personal guarantee. Now, with the return to traditional lending, this requirement may come as a surprise to borrowers who’ve been offered favourable terms through government schemes.

What is a personal guarantee?

A personal guarantee refers to an individual's promise to repay finance if their business can't. In other words, if the business can't repay the debt, the business owner/director will be held personally liable. Personal guarantees are usually unsecured, meaning that they aren’t held against a specific personal asset such as a car or your home — you are simply responsible for paying the debt by whatever means possible. Lenders require many small businesses to provide a personal guarantee because of, for example, their unproven trading history.

During the pandemic, many lenders offered personal guarantee free loans, as the government would back up to 80% of the loan debt, with most lenders recently discontinuing this practice. The existence of government-backed funding has shifted expectations in the lending market for the past two years, not only around PGs but also interest rates.

Interest rate changes

Recovery Loan Scheme interest rates have been capped at 15%. So, business owners may now expect lower rates than what would normally exist in market-based lending conditions. For example, with Bounce Back Loans, companies could obtain an APR of 2.5%, which was uncommon in the pre-Covid lending market.

With most government-backed lending falling away, we will begin to see a marked shift in interest rates. Low-risk businesses will likely pay lower interest rates than RLS and higher-risk businesses can expect to incur higher rates. It will take several months before the market recalibrates and interest rates return to pre-Covid levels.

Post RLS lending landscape 

With government support reducing, lenders are quickly reintroducing their pre-Covid lending products, i.e. lending products funded through their own loan books with no government support. Importantly, this includes their own underwriting criteria rather than that stipulated by the British Business Bank. This is an exciting time for businesses as the SME lending market gets back into gear. The terms on offer in post-RLS lending will depend on the type of business finance you apply for. 

RLS versus BAU comparison

It’s essential for businesses looking for finance to know the differences between the soon-to-end government-supported Recovery Loan Scheme and the many alternative finance options on offer, options that, in many cases, offer more choice and increased control, such as unsecured term loans and revolving credit facilities. Each has its own set of advantages and disadvantages, suiting different types of businesses. An unsecured term loan is perfect for a business seeking funding without the need to offer security. While unsecured loans are a great funding option for businesses that don’t own many assets or a company that’s growing fast and needs finance quickly. With a variety of lenders on the market able to offer unsecured loans of up to £20m, there are options available for many situations. 

Another option worth exploring is a revolving credit facility. This type of credit enables you to withdraw money, use it to fund your business, repay it and then withdraw it again when you need it. It’s one of many flexible funding solutions on the alternative finance market today.

Other types of products that are now available 

There are many alternative lending products available to businesses now that the government is reducing its support. While both lending criteria and the underwriting process have changed, many innovative funding options are out there to power your next phase of growth. Some of the more popular products include:

Merchant Cash Advances

Merchant cash advances are one of the most innovative products in alternative business finance. They allow SMEs to use a card terminal to secure funding — perfect for those without assets but with an adequate volume of customer card transactions.

Advantages

• Flexibility: Your business only pays back the loan when it receives customer card payments, meaning that repayments are linked to sales, so you can better manage cash flow.

• Access: Depending on the lender and application process, you could get approved for a merchant cash advance within 24 hours. 

• Unsecured: Merchant cash advances are a type of unsecured business finance. You don’t need to put forward collateral, making it less risky than traditional, secured financing.

• Risk: Repayments are automatically taken from the money you receive from customer card payments, lowering the risk of defaulting on your loan and avoiding late payment fees.

• Transparency: The amount you pay back doesn’t change. The lender will tell you the total repayment cost at the outset.

Asset Finance 

Asset finance is a popular method of borrowing money using a company's balance sheet assets (inventory, accounts receivable) as security to take out a loan. It's recognised as a quick and convenient way to manage working capital for your business. The efficiency of working capital management can be quantified using ratio analysis.

Advantages

• Faster access to capital when compared to traditional bank loans

• Fixed repayments aid cash flow management

• Agreements have fixed interest rates

• Failure to pay results in the loss of the asset, nothing more

Invoice finance

Invoice finance is a way of borrowing money based on what your customers owe to your business. It works by using unpaid invoices to represent any sums that will be paid to you, avoiding the usual wait for the payment terms. These can be anything from 14 days to 90 days (or more). Invoice finance ensures you get finance quickly, so you don't have to wait to get paid.

Advantages

• The clear advantage of invoice finance is that you’re in control of raising cash quickly for your business. It can be made available as soon as an invoice is issued and can be used to grow your business, buy more stock or pay wages.

• Compared to other types of business loans, invoice financing has a very quick turnaround. 

• No risk to assets. As invoice financing is an unsecured business loan in place of your invoices, you won’t have to offer up physical assets as collateral.

Credit history and interest rates

When you apply for a loan, a lender will need to gain comfort over your businesses ability to pay the loan back, and will involve some or all of the following steps:

• When you apply for business finance, most lenders will do a credit check to help establish your financial health. Typically, banks will use one of the main credit score checkers such as Experian, or Equifax and your business will be scored out of 999. Credit rating is one of the most valuable indicators of what interest rate you'll pay for a business loan.

• As well as looking at your business’s credit history, lenders will also run personal credit checks on key personnel i.e. company directors. This is particularly relevant for start-ups, who haven’t had time to establish a credit history, or for sole traders.

• As well to credit scores, there are other factors that lenders might consider when deciding a borrower’s eligibility. For example, limited companies might look for information on Companies House to see if a business has reported its accounts on time.

They may also check if you have paid current tax liabilities, since the late payment of taxes or incorrect filings, could result in credit being rejected.