Should franchises use alternative finance companies for funding?

Given a post-Brexit slowdown in bank lending seems all but inevitable, could alternative finance offer a solution to franchises' borrowing woes?

Should franchises use alternative finance companies for funding?

Shock was the first response of many businesses to the vote for Britain to leave the EU. Even the city’s largest financial institutions were caught unawares on June 23, with no real contingency plan for Brexit in place. With so much uncertainty and the impact on the UK economy yet to be fully felt, franchise owners and smaller businesses will be wondering what it all means for them and their future chances of accessing funding.

However, unlike during the downturn of 2008, today an alternative finance industry exists to keep money flowing to SMEs should bank capital dry up. In fact, the current upheaval may be the prompt many business owners need to finally discover the range of options alternative providers have to offer.

Bank behaviour

It’s still unclear whether the banks will pull credit lines to small businesses in the wake of the Brexit vote – though some anecdotal evidence suggests this may already be occurring – but the UK losing its AAA credit rating is bound to have an impact on high street lenders’ willingness or ability to extend customers credit. And we all know how disastrous the banking institutions’ behaviour during the last recession proved for SMEs.

Smaller firms were starved of credit when the banks shrank their loan books in response to the last economic crisis. According to analysis by RBS, lending to SMEs peaked at £220bn in the first three months of 2009 but fell away sharply after this, with about £50bn less available to firms four years later. In truth, small business funding has never entirely recovered, with bank lending levels still below those of the pre-crisis years.

This brutal stocktaking by the banks was felt strongly in the franchising community. The specific effects of the economic downturn on UK franchise funding have not been recorded but US research suggests franchises in the States only had 10% of the borrowing they needed by 2013 as a direct result of the credit crisis. Nevertheless, the new generation of alternative funders that emerged from that lending shortfall should mean entrepreneurs don’t face the same barriers this time around.

Alternative options

The emergence of alternative finance – or altfi – was a direct consequence of the banks’ reaction to the credit crunch of the late 2000s. A perfect storm occurred where small and medium-sized businesses were deprived of much-needed funding by the banking institutions at the same time that innovative technology was opening up a world of opportunity to fintech pioneers keen to fill the funding gap.

The internet, emerging digital platforms and revolutionary software and algorithms enabled new financial services entrants to offer businesses fast, flexible and radically different ways to borrow money, as well as letting individuals invest their own savings in projects they thought worthwhile.

The numbers speak for themselves: the UK altfi industry did £3.2bn worth of business in 2015. Additionally, it now accounts for 12% of all British small-business lending, according to the latest report from the University of Cambridge and Nesta, the innovation charity. When you consider that altfi was little more than a handful of startups at the beginning of the decade, you appreciate just how impressive a feat this is.

Franchises are among those embracing the possibilities of these new forms of business funding. For example gym franchisor énergie recently raised almost £650,000 for its expansion plans through crowdfunding platform Crowdcube. Like several other industry sectors – such as hospitality, retail, beauty and service firms – franchises have proven less popular with mainstream funders.

Altfi providers focusing on sectors that conventional lenders frequently shun has been part of the altfi sector’s success, since they recognise that these are successful businesses with great potential, despite not fitting the banks’ rigid lending criteria.

Alex Littner
Alex Littner